Description

 Description of the bank:

• Primarily serves Korean American community in California and across the United States (branches and loan production offices in eight states in areas with significant Korean communities)
• Diversified loan portfolio including CRE (68%), business loans (15%) and residential mortgages (17%)
• Sold deposit franchise, yielding 3.6% interest expense as a percentage of total deposits vs. Fed Funds rate at 5.3% as of Q2 
• Loan-to-deposit ratio of 101%, which non-interest bearing deposits 23% of the total
• Reasonable leverage including ratio of Common Tier 1 to RWA of 14.4% vs. regulatory required level of 6.5%

Thesis:

1. PCB has been very profitable historically, but is currently delivering cyclically low returns
2. Earnings power is currently masked by trough NIM and 1x expenses in 1H 2024
3. Very high insider owernship aligns incentives and is a good sign of bank culture
4. The bank pays healthy dividends and buys its own stock
5. PCB is an ECIP recipient: the stock looks like it trades close to book value, but it's actually at a 21% discount; I think it deserves 1x P/B (27% upside)
6. Key risk: loan portfolio deteriorates, causing credit losses

1) PCB has been very profitable historically, but is currently delivering cyclically low returns:

2) Earnings power is currently masked by trough NIM and 1x expenses in 1H 2024:

The adjustment to earnings is from two categories, which are fleshed out below: 

• NIM is at trough levels, and will rebound
• 1H results had three 1x expenses, which will abate

NIM is at trough levels, and is likely to rebound, driving earnings upside: 

PCB's loan book: 

• 68% of the loan book is commercial real estate (generally up to 7 year terms)
• 15% commercial and industrial (also often 5-7 year term)
• 17% is residential mortgages (mostly ARMs with a fixed-interest-rate period of 5-7 years)

Across the book, the loans carry fixed-interest rates for 5-7 years, which has created the NIM pressure through the Fed's tightening cycle since 2021. With rates coming down and also with loans repricing through time, NIM will expand. 

Returning to normal NIM drives >$1.00 in incremental EPS: 

1H results also had three 1x expenses, which further mask the PCB's earnings power:

Unfortunately, I don't have more detail on the 1x costs, as I'm relying only on what's in their press release (here). I've found managment/IR inaccessible. However, the historical track record of profitability and the PR decision to call out the 1x expenses make me think that these issues will cycle. 

3) Very high insider owernship aligns incentives and is a good sign of bank culture

Incentives are highly aligned:

• The Chairman owns $34M of the stock
• The board owns another $28M

Furthermore, the Chairman keeps buying stock at a rate of ~$1.5M per year, including in September of this year above $18 per share. See his purchases here.

The Chairman doesn't seem to be abusing his voting power either: his salary is $100,000 per year, which seems reasonable. Clearly, the Chairman makes money in this bank if the stock goes up, not by unduly appropriating shareholder resources. 

4) The bank pays healthy dividends and buys its own stock:

Dividend yield is 3.9%, and the sharecount has also declined by 2.7% CAGR over the past 4.5 years. So total shareholder return is 6.6% (although lumpy with buybacks). 

5) PCB is an ECIP recipient: the stock looks like it trades close to book value, but it's actually at a 21% discount; it deserves 1x P/B (27% upside):

PCB recieved $69M in perpetual preferred capital from the ECIP program. As discussed in many VIC posts, this program was an absolute give-away. In PCB's case, based on current-level of low-income lending, the dividend is 2% (maximum possible). PCB has an option buy this capital back for 28% of face value according to new treasury guidelines, making it easy to value.

Given the history of delivering low-double-digit ROE, the commitment to paying dividends, the low credit losses, and the high insider alignment, I think PCB will trade at or above tangible book value, for a 27% return (plus book dividends and book value growth in the meantime). 

6) Key risk: loan portfolio deteriorates, causing credit losses: 

Acceleration of non-performing assets and eventually charge-offs is the biggest risk for the stock, and there has been some uptick in non-performing assets:

However, the amount of non-performing assets and NCOs both remain exceptionally low:

• NPAs, even at today's elevated level, at just 0.31% of loans outstanding
• NPAs are very well covered by provisions (380%)
• NCOs through the period are low compared to NPAs, indicating effective collateral and recovery

Moreover the bank is likely to earn >$30M in annual net income from 2025 on; it's very unlikely to have charge-offs that would come close to wiping out a year of earnings.  Furthermore, the easing of the rate cycle should take pressure out out of hurting sectors of the economy, such as commercial real estate. 

Catalyst

NIM expansion over the next 18 months as rates are cut, funding costs come down, and loans reprice to higher levels. 

Cycling of 1x expenses to reveal stronger earnings power.