PREFERRED BANK LOS ANGELES

Description PREFERRED BANK (PFBC) Preferred Bank (“PFBC”) is a community bank located in California that provides banking service to small and mid-sized businesses (“SMEs”) in California, Texas and New York.  PFBC’s initial customers were from the Chinese community of Southern California. PFBC also originates and services SBA and commercial real estate loans.  PFBC operates out of its headquarters in Los Angeles, California and twelve locations in California, one in Houston and one in New York City.  PFBC has organically grown in Texas and San Francisco.  PFBC is one of the most efficient bank in the United States (26% Efficiency Ratio) due to its streamlined loan origination process. PFBC has grown EPS by almost 18% per year over the past five and 22% over the past ten years.  This growth is driven by providing commercial and commercial real estate loans which have grown by 15% per year over the past ten years and 10% per year over the past five years.  PFBC’s lending franchise and loan purchase generates an average loan yield of 7.1% and has organically grown loans by 10% per year over the past five years.  The strong loan growth is comprised of criticized plus watch list loans of 1.6%, non-performing assets (“NPAs”) of 0.5% and a loan loss reserve to NPAs of 435%. PFBC finances its loans through non-interest bearing and interest bearing deposits generating a low cost of funds of 3.6%.  The resulting net interest margin (NIM) is 4.1% and is sustainable as funding costs will decline with declining loan yields.  PFBC’s largest shareholder is its management, which holds 8% of its common stock.  Historically, PFBC has generated on average less than  five percentage of its revenue from non-interest bearing or spread activities. From 2013 to 2023, PFBC realized operational leverage from its loan growth over a slower growing fixed cost base. PFBC was founded in 1991 in Los Angeles, California to provide banking services to the Chinese community in Southern California.  Over time, PBFC serviced a larger customer base including non-Chinese customers in Southern California.  PFBC’s growth from Southern California came about from organic growth (opening branches) in San Francisco (2013) and Houston (2023). Expansion in  New York City (2015) came from the acquisition of a Chinese bank, UIB, located in Flushing, NY.  From 2013 to 2023, PFBC’s book value plus dividends increased by 15% per year and EPS grew by 22% per year.  From 2020 to 2024, MSBC repurchased shares at a rate of about 2.5% per year.      A bank productivity measure is the efficiency ratio, non-interest expense divided by total revenues.  A good benchmark for efficiency is a 50% efficiency ratio.  The average efficiency ratio for commercial banks in Q2 2024 was 56%.   PFBC’s efficiency ratio is 26% for the trailing three quarters ending Q3 2024.   PFBC has generated on average returns on equity of 18% over the past five years.  This has been an increase from an average of 13% in the previous five-year period.  The average incremental return on equity over the past five years has been 27%, see the calculation below. The ability to generate these returns is the result of increased efficiency and expansion in existing and new markets. Loan growth has been robust with 12% per year growth from 2013 to 2018 to 18% per year growth from 2019 to 2023.  Below is a return on incremental equity capital (“RoIEC”) analysis for PFBC:   PFBC has three levers for earnings growth: 1) expansion into new markets; 2) increased efficiency; and 3) distributing excess cash by buying back shares. PFBC has economies of scale in the service markets it currently or historically competed in (Local real estate and business loans). They also have scale based upon the volume of the loans they originate; so as they grow, they should become more efficient.  Los Angeles, San Francisco, Queens and Houston and Ethnic Chinese Loan Market Is Apple a good investment? Apple Cost of Equity Apple Cost of Debt How to Invest in OpenAI How to Invest in SpaceX PFBC competes in California’s Los Angeles and San Francisco, New York City’s and Houston’s banking markets. The table below illustrates the population, income and housing price growth over the past five and ten years in the five MSAs MSBC competes in:   These are healthy growth rates for PFBC to provide loans into.  Downside Protection PFBC’s risks include both operational leverage and financial leverage. Operational leverage is based upon the fixed vs. variable costs of the operations. There are economies of scale related to some functions such as loan processing and cross-selling of banking services.  For banks the amount of non-interest income can provide downside protection especially if this revenue is recurring as is the case for UBAB.  Over the past five years, about 5% of PFBC’s revenues were from non-interest income. PFBC’s balance sheet, as of September 30, 2024 is comprised of $805 million of cash, $405 million of securities and $5.485 billion of loans.  The securities have a $26 million mark to market losses which should decline as the securities mature.  The largest part of the loan portfolio includes: owner commercial real estate loans (40% of loans), commercial and industrial loans (26% of loans) and 1-4 family loans (14% of loans). Financial leverage can be measured by the equity/assets and CET1 ratios. PFBC has higher equity/assets of 10.7% and CET1 of 15.1% than other niche lenders.  The historical financial performance for PFBC is illustrated below.   Management and Incentives PFBC’s management has developed a loan origination pipeline of C&I and real estate loans over time.  PFBC has been awarded the Super Premier Bank award by Findley Companies.   The base compensation for the management team (top five officers) ranges from $1.0 million per year for the President/CEO to $350,000 per year for the Deputy Chief Credit Officer. Over the past year, the top three management folks total compensation was about $9.7 million per year, about 6.5% of net income per year.  The CEO currently holds 692,247 shares and options (worth $56.4 million), which is more than eleven times his 2023 salary and bonuses.  The CEO’s compensation is structured to include a $1.0 million base pay, $2.5 million in stock compensation and $1.2 million in cash performance-based compensation.  The performance-based cash compensation is based upon achieving a combination of quantitative and qualitative strategic goals. The quantitative goals include an EPS growth target, a deposits growth target and a loan growth target.  The equity incentives are vested based upon time and performance based upon relative return on equity and return on assets goals set by the board of directors.     Board members have a significant investment in PFBC. The board and management owns 1,037,900 shares, about 7.8% of shares outstanding ($85 million). Stock grants, provided management and  employees, were equal to 0.8% per year of the shares outstanding over the past three years.  Valuation    The key to the valuation of PFBC is the expected growth rate. The current valuation implies an earnings/FCF increase of 0.6% in perpetuity using the Graham formula ((8.5 + 2g)). The historical 5-year earnings per share growth has been 22% per year and the 5-year average return on equity of 18%. A bottom-up analysis based upon PFBC’s market growth rates (California real estate and business development loan markets) and historical growth rates results in an estimated 15% projected EPS growth rate driven by expected loan growth rates of 15% per year consistent with history.  Historically, PFBC’s EPS growth rate was 22% per year driven by new customer relationships over ten years. Using a 15% expected growth rate, the resulting current multiple is 33x of earnings, while PFBC trades at an earnings multiple of about 8.1x. If we use a 3% growth rate, the implied multiple is 15x. If we apply 15x earnings to PFBC’s current earnings of $10.00, then we arrive at a value of $150 per share, which is a reasonable short-term target. If we use a 15% seven-year growth rate, then we arrive at a value of $326 per share. This results in a five-year IRR of 32%.  Growth Framework   Another way to look at growth and the valuation of companies is to estimate the EPS five years into the future and see how much of today’s price incorporates this growth.  We are also assuming about 50% of net income will be used for buy-backs, consistent with the trailing buyback levels. Using the same revenue described above results in a 2029 EPS of $17.47, or 4.66x the current price. If we assume a growth bank multiple of 15x, or $262 per share, lower than the five-year-forward valuation above of $326 per share. Comparables and Benchmarking Below key KPIs of the highest growth specialty banks firms located in the United States.  I have ranked the banks by expected return as calculated as the sum of the earnings yield plus the earnings growth rate.   Compared to the specialty banks, PFBC has one of the highest 5-year average return on equity and TBV plus dividends growth and the lowest criticized loan amounts.     Nancy Pelosi Stock Portfolio Nancy Pelosi Stock Trades Nancy Pelosi Insider Trading Is Apple undervalued? Is Apple a buy? Risks The primary risks are: ·       slower-than-expected market growth due to slower than expected loan growth; ·   higher-than-expected efficiency ratios; and ·       a lack of new investment opportunities (real estate and business development loans) and/or coupled with higher stock prices making buybacks less accretive. Potential Upside/Catalyst The primary catalysts are: ·       faster-than-expected real estate and business development loan growth; and ·       lower than expected efficiency ratios due to economies of scale. Timeline/Investment Horizon The short-term target is $150 per share, which is almost 85% above today’s stock price. If the continued service growth due to geographic expansion plays out over the next five years (with a resulting 15% earnings per year growth rate), then a value of $294, an average of $263 and $326 derived above, could be realized. This is a 29% IRR over the next five years.   Disclaimer   This letter does not contain all the information that is material to a prospective investor in the Bonhoeffer Fund, L.P. (the “Fund”).   Not an Offer: The information set forth in this letter is being made available to generally describe the philosophies of the Fund. The letter does not constitute an offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment advisory services. Such an offer may only be made to accredited investors by means of delivery of a confidential private placement memorandum, or other similar materials that contain a description of material terms relating to such investment. The information published and the opinions expressed herein are provided for informational purposes only.   No Advice: Nothing contained herein constitutes financial, legal, tax, or other advice. The Fund makes no representation that the information and opinions expressed herein are accurate, complete or current. 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