Charges on Deteriorating Loans Trip Up Lender

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New revelations of loan trouble could put a damper on things when Preferred Bank reports earnings next week.

The downtown L.A. lender, which caters to the Chinese-American community, said it will be forced to take charges on a pair of deteriorating loans when it announces second quarter earnings July 25, resulting in a loss of as much as $5.7 million.

The unexpected disclosure prompted analysts at B. Riley & Co. and Sandler O’Neill & Partners to downgrade the company’s stock. Shares fell more than 17 percent before closing July 11 at $11.60, making Preferred the biggest decliner of the week on the LABJ Stock Index. (See page 32.) The S&P 500 slid 2.4 percent over the same time.

The bank said July 5 that it discovered “significant irregular borrower activity” related to a $16.9 million loan relationship that could result in a collateral shortfall of $8 million. Management took action after learning of missing inventory that had collateralized that particular commercial and industrial loan, but declined to provide more details.

Separately, Preferred wrote down a portion of a $13.9 million syndicated loan due to a change in its collateral. Despite that, the loan remains current and the bank said it expects full repayment.

Edward Czajka, Preferred’s chief financial officer, noted that both of the loans had previously been classified as substandard, so the problems were not entirely unexpected.

“These loans are reviewed on a very regular basis,” Czajka told the Business Journal. “We already knew there were weaknesses inherent in them.”

Still, he said the loan troubles are likely to be isolated events.

“(There will be) no lasting effects at all,” he said. “We don’t believe this affects the profitability of the bank beyond this quarter.”

After taking steps to improve asset quality, the bank’s performance had been trending positively. It has recorded five consecutive profitable quarters.

Preferred also announced May 31 that it had terminated a consent order with its regulators and replaced it with a memorandum of understanding, a less severe enforcement order.

Despite the stock downgrades, analysts believe that the bank’s long-term outlook remains positive. Analysts surveyed by Bloomberg News expect a return to profit in the third quarter.

“We are disappointed to see this spike in loan losses at Preferred Bank following such promising credit improvement over the last several quarters,” said Sandler O’Neill analyst Aaron Deer in a report, “but we believe overall asset quality continues to move in the right direction at the bank and do not expect similar issues in the future.”

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