KBRA Affirms Ratings for Preferred Bank

KBRA affirms the deposit and senior unsecured debt ratings of A-, the subordinated debt rating of BBB+, and the short-term deposit and debt ratings of K2 for Los Angeles, California-based Preferred Bank (NASDAQ: PFBC) (“the bank”). The Outlook for all long-term ratings is Stable.

Key Credit Considerations

Preferred Bank’s ratings are anchored by its consistently strong profitability metrics, highlighted by a fairly robust NIM (4.06% for FY24) that benefits from a high-yielding loan portfolio (8.25% average loan yield for FY24) and lean cost structure stemming from its branch-lite model, which has resulted in a comparatively strong efficiency ratio (31% vs. peer group 59%). Furthermore, the bank reduced asset sensitivity in 2024 by shifting a significant portion of its loan originations into fixed-rate structures, now comprising roughly one-third of the portfolio (17% entering the year); a strategy which is expected to reduce potential NIM compression in the event of further rate cuts from the Fed. We also note that PFBC’s revenue profile is less diversified, including noninterest income representing 4% of total revenue in 2024. Conversely, the bank’s funding profile remains a rating constraint, as time deposits continue to represent a majority of the deposit base (53% at YE24). This funding structure has contributed to a relatively high cost of deposits (3.96% for FY24), though PFBC has experienced moderate relief from CD repricing as some maturities have rolled into lower-rate offerings in 4Q24 and is expected to continue throughout 2025. While ROA is expected to moderate from the 1.90% level recorded in 2024, PFBC’s core profitability should remain above the peer median, supported by a strong margin and low overhead costs.

Asset quality remains sound but showed signs of normalization in 2024. The NCO ratio increased to 0.35% in 2024 (from essentially zero the prior year), primarily attributable to a single C&I relationship that was fully reserved for, with the potential for recoveries throughout 2025. Moreover, the NPA ratio is expected to increase significantly in 1Q25 from the addition of two large CRE relationships (totaling $65 million; NPA ratio expected to rise to ~1.5%), one piece of vacant land and a large multifamily property, both located in CA, which reflect relatively low LTVs and strong guarantors in place. As such, management does not expect any significant losses on these loans. Barring these instances, overall risk rating migration has been minimal, and criticized/classified balances remain low. Still, the loan book has exposure to potentially volatile segments, including office (8% of total loans), with originations paused in 2022, and hotel (10%), as well as outsized growth in the C&D book over the past year (47% growth YoY). With that said, we acknowledge that credit performance has remained generally sound in recent years and despite the higher-than-peer concentration in the office sector, risks have been well contained, and most of the properties are situated in suburban markets and reflect conservative LTVs.

Additionally, we view the bank's core capital profile as adequate given the context of a relatively more capital-intensive balance sheet (97% RWA density) and concentration in investor CRE (318% of total risk-based capital). PFBC’s regulatory CET1 ratio (11.8% as of YE24) has generally lagged peer averages, while the TCE ratio (11.0% as of YE24) is viewed favorably. Considering the bank’s strong pre-provision income, and solid LLR ratio of 1.26%, we consider total loss absorbing capacity to be ample should rising credit costs occur.

KBRA also recognizes the concentration risks on both sides of the balance sheet, with the top 20 relationships representing an above average amount of total loans and deposits. As such, there is the tendency for volatility in the asset quality metrics, as issues with one or two loans can cause a significant spike in NPAs and NCOs, with the former ratio generally being more volatile than most of the banks in the rating group. Moreover, despite the concentration on the deposit side, as well as higher level of uninsured deposits (46% of total), we believe that the bank maintains adequate liquidity management, including an abundant cash position of $785 million, or 11% of total assets. Furthermore, combined with unencumbered securities and off-balance sheet contingent funding sources, the total availability liquidity is considered adequate at 74% of uninsured deposits.

Rating Sensitivities

Barring an exogenous event, a rating upgrade is unlikely. Conversely, rating pressure would most likely develop if loan quality deterioration emanated such that earnings performance becomes highly variable, including episodes of net losses, or if consolidated regulatory capital ratios were to decline to (and likely be maintained at) levels below the current range.

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