Cathay General Bancorp (CATY) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Cathay General Bancorp's Second Quarter 2015 Earnings Conference Call. My name is [Letif] and I'll be your coordinator for today. [Operator Instructions] Today's call is being recorded and will be available for replay at www.cathaygeneralbancorp.com. Now I would like to turn the call over to Monica Chen, Investor Relations for Cathay General Bancorp.

Thank you, [Letif], and good afternoon. Here to discuss the financial results today are Mr. Dunson Cheng, our Chairman of the Board and Chief Executive Officer, and Mr. Heng Chen, our Executive Vice President and Chief Financial Officer. Before we begin, we wish to remind you that the speakers of this call may make forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 concerning future results and events, and that these statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are further described in the Company’s annual report on Form 10-K for the year ended December 31, 2014, at Item 1A in particular, and in other reports and filings with the Securities and Exchange Commission from time to time. As such, we caution you not to place undue reliance on such forward-looking statements which speak only as of the date of this presentation. We undertake no obligation to update any forward-looking statements or to publicly announce any revision of any forward-looking statements to reflect future developments or events except as required by law. This afternoon, Cathay General Bancorp issued an earnings release outlining its second quarter 2015 results. To obtain a copy, please visit our website at www.cathaygeneralbancorp.com. After comments by management today, we will open up this call for questions. I will now turn the call over to our Chairman of the Board and CEO, Mr. Dunson Cheng.

Thank you, Monica, and good afternoon everyone. Welcome to our 2015 second quarter earnings conference call. This afternoon we reported net income of $45.2 million for the second quarter of 2015, a 28.8% increase when compared to a net income of $35.1 million for the second quarter of 2014. Diluted earnings per share increased 27.3% to $0.56 per share for second quarter of 2015, compared to $0.44 per share for the same quarter a year ago. In the second quarter 2015 we had solid loan growth of $277 million, representing a 12% on an annualized basis. This brings our June 30th, 2015 total loan balance to $9.5 billion. The driver of the increase came from CRE loans which increased by $186 million, while residential mortgages grew by $113 million and construction loans by $25 million. For the six months ended June 30th, 2015, our loans increased $588 million or 13.2% annualized, compared to an increase of $481 million or 11.9% annualized for the six months ended June 30th, 2014. We continue to see our loan growth in 2015 in the range of at least 10%. For the second quarter of 2015, our total deposits increased $226 million to $9.3 billion. This represents an increase of 2.5% quarter over quarter or 10% of an annualized basis. Our core deposits increased by $220 million or 8.6% on an annual basis from December 31st, 2014. In January we announced the signing of the merger agreement with Asia Bancshares. We have received all required bank regulatory approvals and on July 17, Asia Bancshares shareholders approved the merger with Cathay. The closing is scheduled July 31st, 2015. We are looking forward to the completion of the merger. We expect a smooth integration of the two banks with a retention of key offices and business to be high. The merger will further strengthen our Hong Kong presence -- New York presence, having total of 12 branches in the city. It will also open a new market for us near Washington, D.C. On June 26th we released summary results of our 2015 Dodd-Frank Act Stress Testing. Under this hypothetical severely adverse economic scenario, the minimum common equity tier 1 ratio is projected to be 11.5%; the minimum tier 1 risk-based ratio is projected to be 12.6%, the minimum total risk-based capital ratio is projected to be 13.9%, and the minimum tier 1 leverage ratio is projected to be 10.7%. The complete summary is available on our Company website. We are pleased to note that, under the hypothetical severely adverse economic scenario, all our projected capital ratios significantly exceed the regulatory minimum for adequately capitalized financial institutions. They will serve to support our Company exposure growth and our strong dividend policy. With that, I will turn the floor over to our Executive Vice President and CFO, Heng Chen, to discuss the second quarter results in more detail.

Thank you, Dunson, and good afternoon everyone. For the second quarter, we announced net income of $45.2 million or $0.56 per share. Our net interest margin was 3.51% in the second quarter of 2015, compared to 3.41% in the first quarter of 2015 and 3.37% for the second quarter of 2014. In the second quarter of 2015, interest recoveries and prepayment penalties added 9 basis points to the net interest margin versus 4 basis points in the first quarter of 2015. We also received a special dividend from the Federal Home Loan Bank, which increased the net interest margin by 4 basis points in the second quarter. Non-interest income during the second quarter 2015 was $9 million, excluding $3.3 million of net security losses. Non-interest expense increased by $5.1 million or 11.9% to $47.6 million in the second quarter of 2015, compared to $42.5 million in the same quarter a year ago. The increase was mainly due to a $4.5 million increase in amortization of investments in affordable housing and alternative energy partnerships, a $1.1 million in the amount of employee salaries and benefits expense, and a $1 million in professional services expense, partially offset by a $1.4 million decrease or expense in the second quarter of 2015. We expect amortization of alternative energy partnerships to increase from $3 million in the second quarter to between $11 million to $12 million a quarter in the second half of 2015. The conversion of Asia Bank to Cathay's data processing system is scheduled for August 24. We expect to incur approximately $2.5 million in merger and integration charges during the third quarter. Asia Bank's loans at March 31, 2015 were $423 million, with an average yield of 5.26%, and deposits were $442 million. We expect to issue approximately 2.6 million shares for the acquisition of Asia Bank shares based on the expected final stock cash mix of 55% stock and 45% cash. The effective tax rate for the second quarter of 2015 was 17.7%, which includes a catch-up adjustment to reflect the lower effective tax rate for the full year of 2015, resulting from the investment in the renewable energy tax credit fund in early April. As a result of the investment in the renewable energy tax fund, we expect the effective tax rate for the full year 2015 will be around 27.7%. At June 30th, 2015, our tier 1 leverage capital ratio remained flat at 12.99%, our tier 1 risk-based capital ratio decreased to 14.53%, and our total risk-based capital ratio decreased 15.81% as compared to December 31, 2014. Our ratios significantly exceeded well-capitalized [inaudible] ratios under all the regulatory guidelines. At June 30th, 2015, our common equity tier 1 capital ratio was 13.39%. Net charge-offs for the second quarter of 2015 were $0.5 million, compared to net charge-offs of $331,000 in the first quarter of 2015 and net recoveries of $3.7 million in the same quarter a year ago. Our gross loan loss recoveries during the second quarter 2015 were $2.2 million and our gross charge-offs were $2.7 million. Our loan loss reversal was $2.2 million for the second quarter of 2015, compared to $5 million for the first quarter 2015 and $3.7 million for the second quarter 2014. Our non-accrual loans decreased by 17.8% or $14.3 million during the second quarter to $66.1 million or 0.7% of period-end loans, as compared to the first quarter of 2015.

Thank you, Heng. We will now proceed to the question and answers portion of the call.

[Operator Instructions] Our first question comes from the line of Aaron Deer of Sandler O'Neill. Your question please. Aaron Deer - Sandler O'Neill & Partners: Hey good afternoon guys.

Hi, Aaron.

Hi, Aaron. Aaron Deer - Sandler O'Neill & Partners: I guess first question, Heng, is on the deposit flows and kind of margin expectations. Obviously this quarter you got some benefits that helped the margin. But backing those out and then kind of looking at where the loan-to-deposit ratio has climbed up to, as you guys look at the loan pipeline, that sounds like you still have some good expectations, as well as kind of what's gone on with your deposit flows, is there any expectation you might have to pay up a little bit more for deposits and with the resulting negative impact on the margin as you look out over the remainder of the year?

Yeah, Aaron, this is Heng Chen. We had a couple of promotions in the first half of the year which had limited success. They focused mainly on just I think business accounts and things like that, but we have, starting in July, we'll be running a two-month CD promotion. And so far in just ten days, it's generating quite a bit of new funds. So we are paying for two-year money 1.3% and then one-year I believe is around 1%. And so right now our loan-to-deposit ratio with that promotion is closer to 99%, whereas we historically had been at 100% loan-to-deposit ratio. So I think once can we have another eight weeks or six weeks to go on this special CD promotion, and we would expect to, if we get strong demand, we'll let the loan-to-deposit ratio drift down. And then on the margin, Asia Bank should add about 2 basis points to our margin. Their loan yield is 5.26%. And then they don't -- they only have about $4 million in securities. So their deposit costs are similar to us. They actually have a higher proportion of checking accounts than we do. So, once can Asia will add a couple of basis points to the margin, and then we -- we're buying a 15-year MBS, particularly in late May and June, so we'll get the full quarter impact of that. So I've stopped giving guidance on the NIM itself, but I'm optimistic. Aaron Deer - Sandler O'Neill & Partners: That's fair. And then just as a follow-up, the -- if I could get a little bit of color on what drove the C&I balances a little bit lower this quarter and what the outlook is for new production in that category for the remainder of the year.

C&I.

C&I, yeah. We had a couple of large pay-offs.

Yeah. C&I loans I have to admit is a little bit difficult to increase and originate in the second quarter. And in the second quarter we look at our payoffs and it's a little bit more substantial than the first quarter, as Heng mentioned, there are a couple of loans being paid off. So my expectation is that C&I loans continue to be sluggish, and there are several reasons for that. One is that new business formation is very hard to come by, and roughly 60% of our portfolio is trade [ph] related. And you might be aware, might have heard about this before, that China export had slowed down about 10% in the second quarter. So that had a little bit to do with that. On the other hand, I've seen some projections that in the second half of the year exports should pick up a little bit in China, as the holiday season is at the end of the year. So, hopefully the third and fourth quarters we will see more increases in C&I loan. But overall, C&I loans are very sluggish. Aaron Deer - Sandler O'Neill & Partners: Okay, that's helpful. Thank you, Dunson, and thank you, Heng.

Sure.

Yeah.

Thank you. Our next question comes from Matthew Clark of Piper Jaffray. Your line is open.

Hey. Good afternoon guys.

Hi, Matt.

Can you just reiterate the -- your expectations for the amortization of the tax credits in the third and fourth quarter, and then, just on a dollar basis, I'm not sure I caught it correctly.

Yeah. It's between $11 million to $12 million per quarter. And we're still funding -- it takes five months to fund into this particular investment, so we don't have the final numbers. We won't know till September, and then we'll update our amortization. But this is a ballpark. Meanwhile, it -- that higher amortization continues to be offset by the 27.7% effective tax rate.

Right.

So, you know, it's a very similar situation than one of our competitors announced last week where they have a timing issue as well on the amortization.

Okay. And then the -- and then you gave it on basis points, but just to have it on a dollar basis, the [inaudible] dollar basis?

Yeah, it was about a $1.1 million.

Okay, thank you. And then, I know you guys recently increased the dividend by about 40% or so, but your payout is still comparatively low, you have a ton of excess capital. Is there, you know, how should we think about now with the formal [inaudible] process in the rearview mirror, how should we think about more competitive dividend payout in the not-too-distant future? Are you willing to go up to, say, 35%, 40%?

Yeah, probably. We're sort of thinking, without giving -- well.

Let's say that, as you mentioned, that our capital ratios are very strong and the earnings are coming in as expected, so there's room for improvement.

Yeah. Certainly over the 30%. And we know some of our -- some of the banks in Southern California, they're paying 50% to even 60% of current year's earnings. So if our stock, depending on where our stock price is, we'll trade -- we'll do a mix of both stock buyback as well as higher dividend increases. But that's -- it's something we'll look at in the third quarter, starting in the third quarter.

Okay. Okay. Thanks guys.

Yeah.

Thank you. Our next question comes from Joe Morford of RBC Capital Markets. Please go ahead.

Thanks. Good afternoon everyone.

Hi, Joe.

Most of my questions have been asked. I guess just one other one, on the loan side. Just curious what the pipeline is like on the residential mortgage side and just kind of overall expectations for loan growth. The 10% guidance seems fairly conservative given the momentum for the growth you've seen year to date.

Yes. Joe, we're, you know, I get the rate lock report every Friday, and we're rate-locking between $15 million and $20 million a week. And so it's a very strong pipeline. It's -- we seem to have found a niche where our loans to non-U.S. resident borrowers as well as investment loans for investment property that's proven to be very popular. And the -- there's been a fair amount of payoffs as well, but it's -- in terms of the rate of payoffs, it's less than conforming mortgage because almost our whole portfolio is made of Chinese borrowers, and so many of the loans are not conforming loans. So we would, you know, our goal is we want to continue to increase the mix of our loans from residential mortgage. Back in the second quarter last year, we stopped originating 30-year fixed rate mortgages. So the bulk of our new mortgages are either five-one ARMs or 15-year mortgages, fixed-rate mortgages. So we feel very comfortable with continuing to grow those. And now with the interest rates going up in the last six weeks, we're getting very little pressure on new originations in terms of lowering our overall portfolio yield for residential mortgage.

Joe, this is Dunson Cheng. And our guidance of -- our guidance is at least 10% growth for the rest of the year. And that is because there's a lot of volatility in the market and it's really very difficult to make a very -- bank statement that is going to be 13%, 12%. So I think at least 10% is something that we are comfortable with.

Okay. That's helpful. Appreciate that. I guess the other one was just a quick follow-up on the buyback question. You're currently contemplating buying back entity, the shares issued in the Asia Bank transaction, and what might be the timing of that if you are?

Yeah. Joe, this is Heng Chen. Our first preference is we want to buy back shares that were issued through stock option exercises. So that's not that, you know, not that we can find those exact shares out in the market, but in terms of dollar amount. And then we would -- for Asia, the -- originally it was targeted to be a 45% cash -- I'm sorry, 55% cash, 45% stocks deal. But because our stock price has traded above [inaudible] the Asia shareholders are mainly electing stocks. So we're winding -- we're going to issue more stock than we originally thought. And so, you know, it's -- we don't have an issue with later on buying back most of those shares.

Okay. Thanks very much, Heng.

Great. Thank you, Joe.

Thank you. Our next question comes from Lana Chan of BMO Capital Markets. Your question please.

Hi, good afternoon. A couple of questions. One, on the new securities purchases, what's the average yield on those new purchases?

They're just -- they're 15-year threes [ph], so they're probably close -- they're probably right at maybe 2/10 or something like that. So it's higher than what our average overall portfolio yield.

Okay, thank you. And also how about pricing on the new CRE originations now?

Lana, the pricing has been pretty stable for the last, I would say, six months or so. And for fixed five-year loans, we are looking at somewhere around 4-1/2% to 4-3/4%. And for floating, typically we would -- it's between prime plus prime-and-a-half, in that range.

With a floor, right?

Yeah, right. I guess the floor is not as meaningful as before.

Yeah.

Okay. So it seems like the margin should be able to, excluding some of the noise in the second quarter, the margin will see loan yields kind of stable and the securities purchases should at least hold if not be a little bit higher.

Above the 3.40?

Yeah. And Asia Bank shares.

Right, right. I mean I'd be happy if we came in at 3.40, yeah.

And just second question on the affordable tax investments. Net-net, is that still about $0.10 accretive to earnings this year?

It's $0.08.

$0.08.

Yeah.

Okay. And any guidance about that going into 2016?

You know, I think our effective tax rate will go up by 1%. So if we're 27.7%, it might go up to 28.7%. We're thinking of doing a similar amount, but now that we know the accounting, it's going to be much smoother because we're going to -- if we sign a deal let's say in November, all of the amortization in 2016 will be spread out through the year rather than -- and the tax rate will be constant in 2016. So it's a learning process for us, but we're working on a second deal.

Okay. But the net-net benefit should be similar to this year?

Yes.

Okay. And just my last question was on some parts of the non-interest expense. Anything unusual to point out on the personnel line item, or is that just higher accruals because of more activity?

Yeah. We had, you know, we look at the overall trend in net income, and so, because we expect to be higher than our internal budget, we -- and therefore, we would have higher bonus expense, we accrued all of that, that extra bonus for exceeding the budget, we accrue that in the second quarter. So we're 1.4 million higher than our normal bonus accrual in Q2. Then we also accrued roughly half-a-million of integration charges for Asia, mainly for legal fees.

Okay.

In Q2.

Okay. Thank you.

Sure.

Thank you. [Operator Instructions] Our next question comes from Julianna Balicka of KBW. Your question please.

Good afternoon.

Hi.

Hi.

Hi. I just wanted to follow up on some of the questions on the tax rate for 2016. Will the amortization for the investment you made this year be fully done in 2015, therefore we're starting over in 2016 with the new amortization for the new investment or is it going to be kind of the period of kind of double amortization or something like that?

No. It's all of the amortization is, more or less, it's in this year.

Okay. And then in terms of next year, you said you're working on a new investment and -- but you said that the tax rate would be 1% higher than this year. So, should we think about a lower level of aggregate amortization next year or is it just a different structure of the tax investment?

No. It's -- because our pretax income is going to go up by a certain percentage.

Okay. And -- go ahead.

So these tax credits are fixed dollar amount, so they're going to make up a smaller percentage of the pretax income.

Okay, very good. And then in terms of your balance sheet management, any securities sales redeployments or funding prepayments that you have planned for next quarter, second half of the year?

No. No, we're -- we think we're in a pretty good position. We have about $115 million of treasuries that are maturing here at the end of July and we'll probably just pay off some short-term borrowings with that. And then we have some more in March of next year, treasuries. But since we're trying to position for higher interest rates, so [inaudible] to be very active in terms of buying a lot of new securities.

Got it. And then switching real quick also back to reserve coverages and OREO gains. Are there any larger OREO gains that you are expecting coming through the next couple of quarters? And in terms of reserve reductions and negative or zero provisions, where can your reserves stabilize from here?

Yeah. On the OREO gains, we have one that will generate a few million, but we don't know the timing. It's listed for sale, but -- it's a few million. And then on the reserves, we -- I think our reserves are still higher than most banks in Southern California, so we're okay with just having the loan growth sort of absorb any reserve releases.

Got it. Okay, very good. Thank you very much.

Sure. Thank you.

Thank you. And as there are no further questions in queue, I would now turn the call back over to Cathay General Bancorp's management for closing remarks.

Thank you again for joining us for this call. And we look forward to talking with you at our next quarterly earnings release date. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.