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Edited Transcript of PFBC earnings conference call or presentation 16-Oct-19 6:00pm GMT

Q3 2019 Preferred Bank Earnings Call

LOS ANGELES Nov 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Preferred Bank earnings conference call or presentation Wednesday, October 16, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edward J. Czajka

Preferred Bank - Executive VP & CFO

* Li Yu

Preferred Bank - Chairman, CEO & Corporate Secretary

* Nick Pi

Preferred Bank - Executive VP & Chief Credit Officer

* Wellington Chen

Preferred Bank - President & COO

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Conference Call Participants

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* Aaron James Deer

Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst

* Donald Allen Worthington

Raymond James & Associates, Inc., Research Division - Research Analyst

* Gary Peter Tenner

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Stephen M. Moss

B. Riley FBR, Inc., Research Division - Analyst

* Timothy Norton Coffey

Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts

* Tyler Stafford

Stephens Inc., Research Division - MD

* Tony Rossi

Financial Profiles, Inc. - SVP

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Presentation

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Operator [1]

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Good day, and welcome to the Preferred Bank Third Quarter 2019 Earnings Conference Call. (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.

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Tony Rossi, Financial Profiles, Inc. - SVP [2]

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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 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'll 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 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.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [3]

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Thank you. Good day, ladies and gentlemen. 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 certainly slightly better than the second quarter, but we have had 2 Fed rate cuts in the quarter.

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

As a matter of fact, we had one of the largest loan production quarter in our corporate history. During the quarter, we had originated $511 million in new commitments, which had outstanding balance of $349 million of new loans for this quarter. But to us, the real highlights 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're so pleased to see this increase in deposits that have added additional liquidity to fund our future growth.

At quarter end, we had $460 million -- $465 million cash on hand. Although this large increase in deposits has changed somewhat the leverage which affected the net interest margin, which reduced 23 basis points from last quarter, the decrease was largely result -- I mean, related to the Fed rate cuts. We have had some interest cost reduction.

Our transactional accounts interest cost has reduced reasonably, but our TCD deposit interest did not reduce by much. This is remarkably because of the maturity schedule and market competition. We will continue focus on our deposit costs.

Loan quality -- I mean credit posture is stable. We had $435 million loan charge-off in the quarter, but that was related to all of the previously fully reserved nonaccrual loans. Year-to-date, we had a $216,000 of net recovery.

We have today -- or around September 30, we bought back 209 million -- 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 higher profitability, and we certainly continue to do so. Thank you. Now I'm ready for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Aaron Deer of Sandler O'Neill + Partners.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [2]

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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 what -- 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 at? I'm just -- I'm curious to know if you were lagging others in the market who were dropping the costs and so that helped to bring some more inflows your way? Or what was -- or what were the dynamics there?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [3]

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

Second is that actually relate to our customers. Last quarter had heavy usage of their own fund. As I always report -- also reported last quarter end, this has reversed to normal situation. So their bank account has increased with us. Other than that, our gathering team all over the bank is having their normal growth. So these 3 factors adding to a increase in our deposits.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [4]

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So have you tested the market in terms of where do your deposit costs stand today versus 3 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?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [5]

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Okay, we would -- I will have Ed reply to you, but we have on a general deposit reduction basis. To lead is that the transactional accounts will be priced based along the Fed movement. And certainly market competition will affect that. But the TCD will continue pricing -- I mean, pricing lower in our costs. But it depend on maturity schedule, okay? Not all TCD can change cost overnight. It's over -- I mean at average they reduced 1/12 each months. Ed, do you want to add to it?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [6]

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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 2 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 6 months, there is going to be a pretty decent differential 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.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [7]

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

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [8]

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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 will start to make a difference if we get any more.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [9]

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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 and -- as we come back down again?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [10]

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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 in an up-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.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [11]

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

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [12]

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Before Ed replies to you on that, okay, there's actually mathematically one thing. There are few other dynamics in the real life that we have to account for it. For our bank, I think, as for many other banks, there will be continuously new loans being made and old loans being paid off. Old loans usually carry a floor that is much lower. So the so-called layer will change on a monthly basis.

Second thing is, many new old loans gets renewed. And when they're renewed, they generally update it 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 changing. We have seen a very encouraging curve of the moving up the floors, okay, to the situation. So even I, with all this information on, can barely -- I cannot estimate what the results is.

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [13]

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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 indexed rates that are at their floor or below their 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. So some of that is a 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.

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Operator [14]

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

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [15]

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Wanted to follow-up on the -- kind of the loan floor question. If we get another rate cut here, whether it's October or December, how many additional loans will be at their floor with one more rate cut, all else equal?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [16]

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Let's see...

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [17]

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You want a rough estimate. Well, I will say, probably 20% of our loans, okay, will be updated -- 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 the -- whatever, below the index, okay?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [18]

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Yes, index.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [19]

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Okay. That's helpful. And then also want to dive in maybe a little bit further on the spread between the roll-off on new CD money dynamic. Ed, what is the spread now between the CD rates you're putting on today versus what's maturing?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [20]

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Today, Steve, it is around 30 basis points. However, as I said -- 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.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [21]

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And that's before if we had -- before any additional rate cuts?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [22]

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

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [23]

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Right. Okay. That's helpful. And then just wondering on the loan pipeline, you obviously mentioned it was a good quarter for originations. How was customer activity? And what's the outlook on that front?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [24]

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Well, the third quarter is historically one of our better quarters in a situation. And fourth quarter is historically one of the unpredictable quarter for our history. We have seen that with the rate reduction, many buyer that become little more active on the marketplace on the real estate and many more -- I mean many more new projects wanted to be started. So I would say the general environment of loan production is trending toward -- upward a little bit in terms of real estate activity, CRE is concerned. On the C&I side, we see a little bit more usage of our credit line maybe because of cost reduction. But the real thing is that -- Wellington will give you more color in the whole situation.

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Wellington Chen, Preferred Bank - President & COO [25]

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Well, I think the real color is basically, 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 there. So while our loan pipeline -- it looks pretty robust right now, we have -- we do have some loans that carried over from third quarter as well. So as I mentioned, again, the payoff is the bogey.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [26]

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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 a possibility that expenses could come down? I mean there was obviously very good cost control this quarter.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [27]

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Well, one thing is that certainly we all want to control our deposit, but we have been controlling cost to the level it's probably one of the lowest in the industry. So going forward, I think that the cost as a percentage-wise speaking, we'll maintain the current level because our total assets will be growing. Our loan portfolio 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, but -- so in fact, where the labor market is right now...

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [28]

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It would be suicide.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [29]

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Recruiting people is -- I never had such a difficult period in recruiting new staff. Well, actually -- I mean human cost is 2/3 of -- nearly close -- a little bit over 2/3 of total cost structure. So that's the biggest element. And rent has a speeding increase, right? And all other costs seems to be all ticked up a little bit. We don't see any decrease in the same, okay? Lawyers always charge you more by the day, okay? So we -- our hope is that -- our practice has been that to growing our bank just to keep our cost in control.

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Operator [30]

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

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [31]

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

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [32]

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Average loan yield for third quarter, Gary, was 5.93% versus an average of 6.14% for Q2.

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [33]

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

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [34]

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

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [35]

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

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [36]

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Well, we had a net loan origination of...

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [37]

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$511 million.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [38]

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$511 million, of which -- that's a commitment. The outstanding amount of new loan that was originated in the third quarter is $349 million.

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [39]

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So the differential would be the payoff.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [40]

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Actual payoff. $60 million (inaudible)

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Operator [41]

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(Operator Instructions) Our next question comes from Tim Coffey of Janney.

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Timothy Norton Coffey, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [42]

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Ed, if we looked at the reg data for preferred as of the second quarter, it indicated that 70% of CD book would mature by the middle of next year. A quarter since that data, has things have -- has that percentage materially changed?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [43]

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I wouldn't say so. No. That sounds about right. I mean 70% in 9 months, is that the time frame you're talking about, Tim?

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Timothy Norton Coffey, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [44]

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Yes.

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [45]

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Okay. So that sounds about right.

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Timothy Norton Coffey, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [46]

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

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [47]

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We have spent as of September 30 roughly 1/3 of our money. So we are intending that it continues.

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Operator [48]

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Our next question comes from Tyler Stafford of Stephens.

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Tyler Stafford, Stephens Inc., Research Division - MD [49]

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Just one more follow-up from me. I apologize if you've touched on this already. I'm just curious, 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?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [50]

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We had tariff impact 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 2 different times during the year on the tariff effect however account-by-account analysis in terms of the tariff situation. And in fact roughly maybe 40, 50 are invested during the conferences. I have been discussing in detail with Ed every one of these accounts and how they happen. We have spent a substantial management time in doing so.

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Operator [51]

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

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [52]

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Just a quick follow-up. Ed, on the $400,000 FDIC assessments credit, I'm guessing there is 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 there going -- is it going to extend for a longer period?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [53]

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

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [54]

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Not that's the same amount though.

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Operator [55]

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Our next question comes from Don Worthington of Raymond James.

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Donald Allen Worthington, Raymond James & Associates, Inc., Research Division - Research Analyst [56]

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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?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [57]

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Well, there is 2 things. On the next quarter, we will be providing based on current methodology. But in January, we'll be providing -- I mean, in the first quarter, we will be providing based on the new CECL. The early indication is that the increase is not big, okay. But we're happy with that. The hit to our capital is going to be very, very little. But when we're 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 is based on rigid formula that was really by our accountants that go into the historical factor and the so-called historical loss estimate, all those model they had built up. So right now, every quarter we're doing it based on whatever is needed. Having said that, we are fully and well reserved 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 are some changes in 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 Nick or not, okay?

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Donald Allen Worthington, Raymond James & Associates, Inc., Research Division - Research Analyst [58]

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I would be happy to take it if he has some.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [59]

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Nick, you will have to.

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Nick Pi, Preferred Bank - Executive VP & Chief Credit Officer [60]

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

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Operator [61]

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

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [62]

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Okay. I guess there is no further question. Okay. Thank you very much. Okay, thank you for your attention today. And although that in a very down moving market, but we are -- we feel pretty good with our production. We feel pretty good with our profitability, and we feel pretty good about our return for our shareholders. Thank you so much.

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Operator [63]

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