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Edited Transcript of PFBC earnings conference call or presentation 18-Oct-18 6:00pm GMT

Q3 2018 Preferred Bank Earnings Call

LOS ANGELES Nov 19, 2018 (Thomson StreetEvents) -- Edited Transcript of Preferred Bank earnings conference call or presentation Thursday, October 18, 2018 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

* Tony Rossi

* 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

* Christopher Edmund Hillary

Roubaix Capital, LLC - CEO and Portfolio Manager

* Donald Allen Worthington

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

* Stephen M. Moss

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

* Timothy Norton Coffey

FIG Partners, LLC, Research Division - VP & Research Analyst

* Tyler Stafford

Stephens Inc., Research Division - MD

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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 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tony Rossi, Investor Relations for Preferred Bank. Please, go ahead.

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Tony Rossi, [2]

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Thanks, Michelle. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2018.

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 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.

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

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Thank you. Good morning, ladies and gentlemen. I'm pleased to report for the third quarter ended September 30, 2018, we had a record quarter in total assets, loan, deposits, net interest income, net income and earnings per share. For the quarter, we earned $18.3 million a -- I mean, total net income or $1.20 a share. Among all the good news above it's a very competitive marketplace.

For the quarter, we continue to face strong payoff activities in loans. We lost loans to other banks and loan bank financial institutions, rates or loan terms that we cannot meet, okay? For instance, the most recent several loans of a commercial retail properties that the people are offering to our borrowers prime minus 1 1/4, okay? Or a 4.6% interest-only fixed rate for 10 years, okay? These are the terms we cannot possibly meet. However, we manage to increase our total loan portfolio by nearly $90 million or 2.8% on a linked-quarter basis.

Deposits is equally competitive. For me, personally, I have never seen the scope and the frequency of deposit rate adjustment that happened recently, especially many of the rate adjustment or rate parade was led by major banks or money central banks, which is quite unusual, okay?

Nationwide, there's a trend of money moving to time deposits. Nevertheless, our staff has managed to increase the Bank's total deposits by $108 million or 3.2%. Our net interest margin has moderately reduced 3 basis points to 4.04% because of the above. Our net interest income increased 5.9% between quarters. Net interest income, which is our -- it is our main focus.

Would like to think that with the upcoming deposit adjustments -- rate adjustments in the future will largely be absorbed by or well covered by any rate increases as Preferred Bank continue to have one of the most asset sensitive balance sheet. We have been and we will continue to manage our overhead.

Thank you very much. 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) The first question comes from Tim Coffey of FIG Partners.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [2]

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The last 2 quarters, Preferred has increased deposits faster than loans. Is that a trend that you see continuing going forward?

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

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Don't know. I have always been saying that there is no pipeline for deposits. All we know is continue to work on it, okay? And deposit product is what you're offering very generic product as everybody else. So there's no new programs for that. We just continue to work and we turn to -- continue to turn over any relationship that we find.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [4]

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Okay. And it makes a lot of sense to be growing deposits faster than loans right now, but it's also corresponded with an increase in your deposit costs. Would you see the deposit costs continuing at the same growth rate?

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

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We, largely because of the size of our institution, is a smaller institution in the sea of banks, okay? We really -- most of them reacting to the market deposit rate increases. And most of the time it's defensive movement rather than offensive movement. So I'd like to think in the upcoming 1 or 2 quarters deposit rate may continue to increase at the same speed as that -- as has in the past. But that's assuming everybody is still doing the same thing as before.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [6]

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Sure. And of the CDs that you added this quarter, what were the rates on those?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [7]

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We posted -- Ed, you want to answer that.

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

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Yes. Well, obviously, it depends on the term, Tim, but anywhere from 1% to probably 2.5% depending on the term. What we're seeing out there is, as Mr. Yu alluded to, a lot of larger banks at the very tops of some of these rate lifts, so it's very interesting to see. But yes, depending on the term, like, for instance, 1.5 year, we're looking at 2.2%, 1 year we're looking at 2% somewhere in there.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [9]

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By the way, just to give you a benchmark about what the rate in the marketplace is, a major $78 billion California bank is posting 14 months, 2.5%. So another $60 billion, conservatively managed California bank is posting 1 year, 2.5%. So it's all over the place.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [10]

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No. Absolutely. Is it -- do you feel the pressure, the competition for deposits is stronger in Southern California versus that your East Coast footprint?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [11]

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I don't know Wellington, how you feel. I see East Coast is so small, okay? That'll...

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Wellington Chen, Preferred Bank - President & COO [12]

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East Coast is small but the time that I spent over there and per the -- our people over there is just as competitive. And understanding that all branch facility on the East Coast, on The Street, there's about 50 banks, large and small. So the answer, Tim, is that it's pretty much the same, if not more actually.

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Operator [13]

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

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [14]

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I guess, folks on the other side of the balance sheet, just kind of wondering, where loan yields are these days? And kind of, what's running off and what are you able to book loans on these -- today?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [15]

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Well, most recent several increases that Fed Reserve has done, what the marketplaces used to be, we -- let's say, we're able to book certain type of loan a prime plus 1, okay? Now generally speaking, we're getting is prime plus 0.5 to kind of prime plus 3, 3 quarters for this segment type of a loan. There's all different segment of loans I mean that commands a different type of price, okay? Even in the real estate, when you -- even in the commercial real estate, when you are so-called the apartments usually to come in a much lower rate and many times it is fixed rate. So it is all over the place, it's safe to say that the margin over prime, our margin over the -- whatever the index is, has been gradually reducing.

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

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With that said, Steve, the average yield this quarter on the loan portfolio is 5.75%.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [17]

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Okay, that's helpful. And then, wondering on expenses here, what are your expense expectations for the fourth quarter? And the conversion-related stuff as well?

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

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Well, obviously, we're a little bit light in Q3 at 13.6%, which was nice to see. So we will definitely see some increase, we'll probably likely be in the low 14s for noninterest expense for Q4 would be my guess. As our day 2 items for our system conversion start to go into effect in terms of the people and the project.

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

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Okay. And kind of how do we think about the conversion expense beyond that and into 2019?

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

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Well, beyond that there shouldn't be much at all. We'll probably have a little bit in Q1 of 2019 as the last of the day 2 items are implemented, and then we shouldn't see anything in terms of impact from conversion beyond that.

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

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Okay, that's helpful. And then my third question with regard to the increase in the reserve ratio and the provision. Just wondering if any of that was related to the transfer of the New York loans back to held for investment or if there's anything just underlying that you're adding reserves for?

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

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That's the main reason.

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Operator [23]

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The next question comes from Tyler Stafford of Stephens Inc.

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Tyler Stafford, Stephens Inc., Research Division - MD [24]

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So I just wanted to follow up on that last question regarding the New York credits. So I'm just trying to understand, I guess, better what happened this quarter. So last quarter you decided to market the notes, move them to HFS. This quarter you moved it back into HFI. So are we to assume there is basically no market for the notes at a price that you found acceptable?

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Nick Pi, Preferred Bank - Executive VP & Chief Credit Officer [25]

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Tyler, this is Nick Pi speaking. The reason is that because currently we work with a bankruptcy trustee try to solve the issue as rapidly as possible. So the trustee, we signed stipulation with them to like have trust -- options to sell in the bankruptcy, which will speed up the process of solving these 2 New York loans.

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Tyler Stafford, Stephens Inc., Research Division - MD [26]

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Okay. So you think you can recover on these or move past these quicker by going this route rather than just selling the notes as you had planned last quarter? Is that...

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Nick Pi, Preferred Bank - Executive VP & Chief Credit Officer [27]

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Yes, that is true.

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Tyler Stafford, Stephens Inc., Research Division - MD [28]

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Okay. When was the last time you received a payment from those borrowers? Or borrower?

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Nick Pi, Preferred Bank - Executive VP & Chief Credit Officer [29]

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I believe it should be back in February of this year.

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Tyler Stafford, Stephens Inc., Research Division - MD [30]

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Okay, all right. Maybe just going back to the earlier comments, just about loan competition. Mr. Yu mentioned earlier that pressured your overall growth this quarter. As you point out the growth was still actually quite strong this quarter. So I was just wondering if you could give us an idea of the magnitude of that impact that the competition had on the overall growth this quarter.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [31]

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Well, we could have grown similar to last year, okay? Which is in the mid-teens, a little over mid-teen in the growth rate. But this quarter, as I've spoken, the -- some of the loans that's been offered to our customers, in my personal opinion, is unimaginable in the rate they've being offered. We can only congratulate our customer and encourage them to just go ahead and take the deal. How can you not taking those shopping center loans, what 1 year ago it was a dog, okay? Let me -- by everybody's opinion, shopping center is bad, okay? While people offering prime plus 1 1/4 now, okay? So it's something that you love the customer, they -- hopefully they still like us, but you just have to give up.

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Tyler Stafford, Stephens Inc., Research Division - MD [32]

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Yes, understood. And then I just want to clarify one more comment, just around the deposit pricing expectation, so if competition stays status quo as it is today then you'd expect a similar deposit cost increase next quarter, was that the comment you said earlier?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [33]

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Well, it is just the larger type of comment, okay? If deposits costs marketplace increase at an average of, let's say, 30 basis points, well, next quarter probably a 30 basis point too. But I hope it is not that much because everybody is pressing their deposit costs pretty much to the side in excess of loan rate increases. You -- Ed, you have some numbers, right?

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

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Yes. So Tyler, just to give you a little -- some maths behind it. Our total cost of deposits in the second quarter went up 19 basis points, okay? And if you will recall, that's when we kind of jump back in the market for deposits, we kind of just took the first quarter off. The increase in cost of deposits in this quarter moderated down to 16 basis points. So if we can see that as a trend, that's great. But as Mr. Yu said, we'll certainly still be looking for certainly an increase in cost of deposits. But what we don't have yet baked in is the 25 basis points we got at the end of September on the loan side.

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Tyler Stafford, Stephens Inc., Research Division - MD [35]

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Yes. Okay. Well, so if you don't have -- let me just ask one more. So if you don't have the September hike, I guess, obviously not in the quarter, but would just -- from a trajectory standpoint, if those deposit costs do, hopefully, plateau or migrate modestly lower and you get the benefit from September. So you -- would you expect the margin to expand from this level over the near term?

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

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Well, I can only hope for it because that will certainly enhance our earnings.

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

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It's a possibility.

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Operator [38]

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The 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 [39]

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Am I coming through?

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

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Yes.

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [41]

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Now you are.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [42]

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Sorry. Okay. The -- just kind of following through on the margin discussion. I know you guys booked mostly variable rate loans. Can you remind me if -- is that still north of 90% of the total portfolio that's variable rate? And I think, also, predominantly tied to prime, is that correct?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [43]

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Yes. Okay?

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [44]

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Okay. And then, maybe give us a sense of what the -- it sounds like paydowns are a challenge as they're for a lot of banks. What was the magnitude of the paydowns this quarter? And how does that compare to recent quarters?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [45]

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Well, paydown in the last 3 quarters is probably...

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [46]

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$150 million.

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

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Yes. But consistently at the $150 million level. So last quarter, I mean, September quarter is slightly less than that, but the kind of the paydown is hurting. We saw that some of the loans are really good quality loan on that as we were explaining in the earlier meeting.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [48]

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Okay. And then, you continue to see some pretty good growth in the C&I category. Is that all homegrown stuff or is any of the participations or what -- and what kind of industries are -- you're seeing the best growth in?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [49]

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So for this quarter, I think all the C&I was homegrown, right?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [50]

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Yes.

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [51]

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Okay.

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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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Okay. Any particular industries where seeing particular success on that front?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [53]

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No. It's across the board.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [54]

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Okay. And then lastly, on fees. You guys have been making some good progress on growing your trade finance fees. Do you expect that to continue? Or is there any sort of seasonal impact we should look for in the fourth quarter that might bring that down or up?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [55]

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We're not hoping any increase in this first quarter, okay?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [56]

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Yes, I would look for that to be fairly flattish, Aaron, from herein.

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Operator [57]

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The next question comes from Don Worthington of Raymond James.

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

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Couple of questions in the expense area. Looks like salaries and benefits were down linked quarter. Anything in particular driving that?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [59]

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Well, few things, Don. One was, the bonus accrual was slightly less in Q3 than it was in Q2 as interest rates go up. Our hurdle rate goes up in terms of our formula for adding to the bonus pool on our -- in terms of our pretax earnings. So that was one factor. The other was, as loan production increases so does the capitalized costs -- the capitalized personnel costs. So that also increased in Q3 over Q2 and as you know, that's a credit to personnel expenses. We capitalize those costs and amortize them over the life of loan.

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Donald Allen Worthington, Raymond James & Associates, Inc., Research Division - Research Analyst [60]

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Okay, great. And then REO expense was up as well. And was that just related to that 1 property that's been there for a while, the $4.1 million?

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Edward J. Czajka, Preferred Bank - Executive VP & CFO [61]

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Yes. As you know, we do pay some HOA fees on this, the units that we own. I think we also had an additional legal bill this quarter which drove that up a little bit.

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Operator [62]

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The next question comes from Christopher Hillary of Roubaix.

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Christopher Edmund Hillary, Roubaix Capital, LLC - CEO and Portfolio Manager [63]

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You shared some color just on what was changing in the marketplace during the quarter. Would you care to share with us some thoughts on how you think the competitive dynamic around loans and deposits will play out for the rest of the year or the rest of this cycle?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [64]

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You mean for this cycle? And for overall in my personal opinion for Preferred Bank?

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Christopher Edmund Hillary, Roubaix Capital, LLC - CEO and Portfolio Manager [65]

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Well, just -- you commented how there's aggressive loan terms and you've never seen deposit rates move in the way they move during the quarter. So to what extent do you think that's an unusual moment? To what extent -- and just how do you think it's going to play out from here given it's -- I guess so unusual...

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [66]

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First of all, there's no history to follow up on that. Logic tells me, things like that couldn't last very long, okay? People cannot be making the loans at, basically, that kind of rate was the cost of fund. I hope everybody has pretty close cost of fund. So how does these particular institution were able to compete that way, we're at a loss. But I don't think it's going to last very long, but again, as a operator of the bank you just have to stay conservative, thinking it might happen now.

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Christopher Edmund Hillary, Roubaix Capital, LLC - CEO and Portfolio Manager [67]

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Okay. Are there certain areas of loan demand that you think stand out, where there are still opportunities without the unusual degree of competitive rates and terms?

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [68]

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Well, there are loan payments outstanding, I mean, there's lot of demand over there, there are certain segment of the loan that people cannot do. For instance, California is short of housing, okay? And that's -- one of the reasons short of housing is that banks generally are keeping their total construction loan portfolio to a certain level, okay? Which is conformed to the current credit environment, okay? And government policy, okay? So result of that, not enough people is making loan in this particular segment, okay? And there's opportunity there but nobody is, really I shouldn't say, be very aggressive about chasing loans there. So there are few segments of that but.

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Operator [69]

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

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Li Yu, Preferred Bank - Chairman, CEO & Corporate Secretary [70]

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Well, thank you very much, okay? So obviously, everybody's question seems to be about how competitors' future will be, okay? Sitting over here, we certainly like to be less competitive, make our job a little bit easier and make our shareholders a little bit more happier, okay? But we have to be well prepared for that, and we have to gear up our operation as if the situation will be a long-term situation, so -- and we're ready to do that, okay? Thank you so very much.

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Operator [71]

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The conference is now concluded. Thank you for attending today's presentation, you may now disconnect.