Cathay General Bancorp
NASDAQ:CATY
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Good afternoon, ladies and gentlemen, and welcome to Cathay General Bancorp's Second Quarter 2018 Earnings Conference Call. My name is Latif, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. [Operator Instructions] Today's call is being recorded and will be available for replay at cathaygeneralbancorp.com.
Now I would like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp.
Thank you, Latif, and good afternoon everyone. Here to discuss the financial results today are Mr. Pin Tai, our Chief Executive Officer and President; and Mr. Heng Chen, our Executive Vice President and Chief Financial Officer.
Before we begin, we wish to remind you that the speakers on 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, 2017, 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 statement to reflect future developments or events, except as required by law. This afternoon, Cathay General Bancorp issued an earnings release outlining its second quarter 2018 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 Chief Executive Officer, Mr. Pin Tai.
Thank you, Georgia, and good afternoon. Welcome to our 2018 second quarter earnings conference call. This afternoon we reported net income of $73.7 million for the second quarter of 2018, a 43.3% increase when compared to a net income of $51.4 million for the second quarter of 2017. Diluted earnings per share increased 40.6% to $0.90 per share for the second quarter of 2018 compared to $0.64 per share for the same quarter a year ago.
Second quarter results were impacted by the seasoned conversion of Far East National Bank on to Cathay System, which was successfully completed in April and allowing for the complete integration of our operations. The second quarter 2018 acquisition and integration cost totaled $1.7 million, which reduced earnings per share by $0.015. In the second quarter of 2018, despite of a large amount of commercial real estate loan payoffs, our gross loans grew by $334.2 million to $13.3 billion, or an increase of 10.3% on an annualized basis.
The increase in loans for the second quarter of 2018 was primarily driven by the strong growth in residential mortgage loan of $188.1 million or 22.5% annualized and commercial loans of $140.2 million or 23% annualized. We continue to project loan growth in 2018 to be between 7% to 8%. For the second quarter of 2018, our total deposit increased $92.3 million or 2.8% annualized to $13.1 billion.
Now, I would like to address the potential impact of the trade tariff between the U.S. and China on our borrower. Starting with the first quarter we have reviewed all of our commercial borrowers to help access the potential as well as impact of the imposed and proposed tariffs on Chinese imports. As of June 30 2018, those borrowers which we believe will be adversely impacted by the tariffs will be less than 1% of our total loan. We continue to monitor and evade the trade dispute between the U.S. and China and its potential impact to our loan portfolio.
With that I will turn the floor over to our Executive Vice President and CFO, Heng Chen to discuss the second quarter 2018 financials in more detail.
Thank you, Pin and good afternoon everyone. For the second quarter we announced net income of $73.7 million or $0.19 diluted earnings per share. Our net interest margin was 3.83% in the second quarter of 2018, as compared of 3.63% in the second quarter of 2017 and 3.75% for the first quarter of 2018.
In the second quarter of 2018 interest recoveries and prepayment penalties added four basis points to the net interest margin, compared to five basis points for the first quarter of 2018 and six basis points for the second quarter of 2017.
Given the second quarter results, we believe that our net interest margin for the second half of 2018 would be between 3.75% to 3.85%. Non-interest income during the second quarter of 2018 increased by $1.6 million to $7.8 million, when compared to the second quarter of 2017. That increase in the second quarter of 2018 compared to 2017 was primarily due to a increase in income from wealth management commissions, other fees, net gain on interest rate swaps as part of the income partial offset by a decrease in the fair value of equity securities.
Non-interest expense increased by $6.4 million, or 11.3% to $63.1 million in second quarter of 2018, when compared to $56.7 million in the same quarter a year ago, due impart to the acquisition of Far East National Bank. For the second quarter of 2018 the increase in non-interest expense was primarily due to $4.5 million increase in salaries and employee benefits expense, $1.2 million in contributions to the Cathay Bank Foundation that is usually made in the second quarter of each year and $1.7 million increase – $1.7 million in acquisition and integration costs which were partially offset by $1.5 million decrease in the reserve for unfunded commitments.
The effective tax rate for the second quarter of 2018 was 13.0%. We completed our investment in the solar tax credit fund during the second quarter, which we expect will reduce our full year – our projected full year 2018 effective tax rate to approximately 18.5%. A second quarter effective tax rate reflects a year-to-date adjustment to a new full year effective tax rate. Because the new solar tax credit investment was made late in the second quarter, there was no amortization expense recorded on this new investment.
We expect solar tax credit amortization to be approximately $5 million in Q3 and $15 million in Q4 of 2018. At June 30, 2018 our Tier 1 leverage capital ratio increased to 10.95%, as compared to 10.35% at December 31, 2017. Our Tier 1 risk-based capital ratio increased to 12.58% from 12.19% at December 31, 2017. And our total risk-based capital ratio increased to 14.37% from 14.11% at December 31, 2017.
Net charge offs for the second quarter of 2018 were $185,000, compared to net recoveries of $1.8 million in the first quarter of 2018 and net recoveries of $266,000 in the second quarter of 2017.
There was no loan loss provision for the second quarter of 2018 and 2017, compared to a loan loss reversal of $3 million for the first quarter of 2018. Our non-core loans decreased by $11.3 million to $52.7 million, a 0.04% of period end loans as compared to the end of second quarter of 2017.
Thank you, Heng. We will now proceed to the question-and-answer portion of the call.
[Operator Instructions] Our first question comes from the line of Aaron Deer of Sandler O'Neill. Your line is open.
Hi, good afternoon, everybody.
Hi Aaron.
Heng, pardon me if you mentioned this in your opening remarks but my audio quality is kind of bad. But in regard to the margin in the quarter, was there anything unusual that supported. I was a bit surprised by the strength of the margin this quarter, I just wanted if there's anything unusual in there that might have caused it to be elevated this quarter, caused it to pullback in the third quarter?
Well, we gave the prepayment penalty which was four basis point this quarter versus five last quarter, the only other thing is the discount accretion was two basis points this quarter and one basis point in the first quarter. But we think that two basis points is probably a good run rate for the rest of this year. So in terms of what happened to the margin, the loans increased by 16 basis points and deposits only increased by 11 basis points. So it’s just a result of those dynamics.
Sure. And then I guess that the stronger loan growth and deposit growth, if you were to work to keep the loan-to-deposit ratio at 100 versus a little over 100. To what extent would you anticipate having a pay up for deposits that maybe puts more downward pressure on the margin than the lift that you’ve been getting?
I think it’s going to be pretty minor. Surprisingly two weeks, Federal Home Loan Bank advances are at 2.1% 210 basis points whereas we're thinking of some of our CD promotion would be lower than that. And then our broker CDs were – for one-year broker CDs were at 2.4, it’s the current rate. So I think overall it's going to be relatively minor and then another dynamic is that our period-end loans was $300 million higher than the average second quarter loans so that’s going to give us momentum going into Q3.
Sure. And then just on – with respect to capital, it continues to be strong, and didn’t look like yesterday in your share repurchases. I gather that’s because of the stock stayed above 40. I think that’s kind of your threshold for buybacks, is that still the case or are you reevaluating your thoughts on share repurchases at this point?
Well, we’ll move the price up slightly each quarter but I think Far East, did that target and then we will have a pretty robust dividend increase in Q4 that would help. And then in terms of future capital management, there is some capital instruments in the holding company, some higher cost troughs we could redeem in the next year that would be a use of capital.
Okay, perfect. Thanks for taking my questions.
Sure.
Thank you. Our next question comes from the line of Chris McGratty of KBW, your question please.
Yes, thank you. Thanks for the question. Heng, could you just repeat the loan growth guidance, I may have missed it as well. Can you just repeat what your expectations for the back half of…
Yes, its still between 7% to 8%.
Okay. And then could you remind me based on the favorable prices happen in your loan book, the split between fixed and variable and kind of a LIBOR component that’s helping some banks?
Yes, we think the floating including about 600 million of fixed rate loans that would be swapped into LIBOR. We think that’s about 60% to 65% is floating. And then the – so we have once again $600 million that’s swapped into one month LIBOR. But we have only a couple – $300 million or $400 million loans that’s tight to LIBOR by itself organically.
Okay, great. And then maybe if I could on the expense rate – expense growth rate, you gave the color on the, I assume $6 million still on the low income tax is that still about. How should we think about the total amortization expense?
Yes, $6 million each in Q3 and Q4.
Okay. And then kind of operationally now that the conversions occurred, how should we thinking about just organic upward pressure on cost in that low-single-digit, mid-single-digit what’s there for us.
Hopefully, it’s low-single-digits. We have – we still have a couple of branch closures from Far East that will happen in the summer. So that will help and then in terms of the layoffs that happened late, yes that happened mostly in June of a back half of personnel. So we’ll get the full quarter impact in Q3.
Okay, great. And then maybe I could on the tax rate between Q3 and Q4. Do you happen to have that in calculated offline? But do you happen to have the expectation for the effective Q3 versus Q4 given the moment in the amortization.
Yeah. The amortization is doesn’t impact, it just impacts pretax income, it doesn’t impact the rate. So we’re thinking it’s 18.5% for Q3 and Q4.
Okay, thanks.
Thank you. Our next question comes from Lana Chan of BMO Capital Markets. Your line is open.
Hi, good afternoon. Could you talk about where the strong C&I growth came from that you had this quarter on the period end basis with that participations in any particular verticals.
We have increasing ABL participation and also we have approved in new customer appreciation also. And also a seasonal back up that caused $140 million increase in C&I loan in the second quarter.
What was the last part, I’m sorry?
Seasonal, high seasonal…
Draw down, yeah.
First quarter is a low season for C&I draw down.
Okay, got it. And then what are the new loan yields on resi mortgages now.
Residential mortgage, right now we on the right thing at above 4.5%, currently yield is about 4.46%, and our new yield is close to 5%, residential mortgage.
The new yields are close to 5%.
Yeah, 4.75%, 5%.
Okay. And just one question, I not sure I heard of before saying but could you given any action in terms of the loan yield this quarter how much that benefited from the interest recoveries and prepayment penalties. I know you gave it on the margin, but what about a loan yield.
In terms of absolute dollar amount is that what you’re looking at sort of…
Yes, either in dollar [indiscernible] basis points.
Yes, yes. I have it in dollar amounts. So just with me its people don’t normally ask, but it is $1.6 million.
Okay, thank you.
Sure.
Thank you. Our next question comes from the line of Michael Young of SunTrust. Your line is open.
Hey, thanks for taking the question. Heng, I wanted to see if we can just cover maybe the credit side of the equation, obviously, back to kind of no provision this quarter and slight very marginal net charge-offs. Are we kind of through the backlog of recoveries and we should be moving into higher net charge-offs in positive provision going forward or there is still some tailwinds and something you see in the pipeline?
Yes, well we – Michael, we did get a $2.6 million recovery here in July, it was from a commercial real estate loan where we did a AB split of two years ago. But then in terms of charge-offs of Q3 was not sure, it’s been well, but it could pick up. So, and then with the loan growth probably sometime before the end of the year will start to provide for incremental loan growth.
And any credit areas that you are kind of keeping a closer eye on particularly maybe in real estate or commercial real estate obviously did the review of tariff impacted maybe things in the commercial – C&I space, anything from the real estate front that you’re watching.
We had reviewed the portfolio actually our loan to value ratio is pretty low, ultimately, I think, 52% around. So the C&I portfolio is really healthy.
Right. And then I think this is data information but in the first quarter we looked at our retail concentration and I think the average loan size was about $2 million the average LTV was like 58% and then debt to reverse coverage ratio was well over $1.4 million.
Okay, great.
I mean, things are pretty good, but we’re always cautious and we’ll see value.
Thank you. Our next question comes from the line of Matthew Clark with Piper Jaffray. Your line is open.
Hey, good afternoon. On just reserves, I think in the past you talked about giving up a decent slugger loan growth is coming from single payment resi and the coverage that you provide on that I think is close to that 40, 45 basis points. Is that still the way we should think about it, and is it fair to assume that reserve continues to trip a little lower? And then just as a follow on to that how season might play into that in 2020?
Yes, well, first 40 basis points is probably a reasonable rate and then in terms of our CRE payoffs in the second quarter there we have a lot in hotels and office buildings. So those tend to be more heavily reserved even when there are pass. And then as to CECL we’re just – we’re in the trying in a parallel stage so we’ll – I think in the second half will have a idea on what that transition might be.
Okay. And then just on the potential dividend increase here in the fourth quarter it’s 40% payout still kind of the way you’re thinking about it or likely.
Yeah, yeah, I mean, we’ll have to look at what the full year results are in terms of number I think maybe $0.30 – we’ll look at the EPS.
Okay. And then just on the C&I loan growth, I think it sounded like $140 million of it was related to increase utilization. Can you just give us an update as to what that utilization rate did from the first to second quarter?
We don’t have that on the portfolio wide basis.
I would say probably a half of the $140 million increase [indiscernible] the other half is actually new long appreciation, new relations about [indiscernible] and also participation in the ABL outstanding.
Okay. Okay, great. Thank you.
Thank you. Our next question comes from the line of Gary Tenner of D.A. Davidson. Your line is open.
Good afternoon. I just want to ask on the commercial real estate payoffs do you have a sense of whether the elevated payoffs were due to properties being sold or maybe movement of the real estate and kind of the permanent financing market. Any sense of why there was higher pay downs and why maybe you lost some credits if there was some element of that?
It’s a combination of reasons. there are some loans, because of – because of properties being sold, because market is still very strong. the price is good and also – we’ll also have payoffs coming from this financing other than the offering the old rate.
Okay. So, with the unusually large amount of payoff activity, it wasn’t weighted one way or the other more so than usual?
At least scale, but yeah, across the different regions.
Okay. And then I know you already answered this, but I missed it. The expected amortization in the back half of the year on the energy investments would be what…
It’s $5 million in Q3 and $15 million in Q4.
Okay. And that’s on top of the kind of $5 million run rate on the low income housing?
Yeah. $6 million run rate. Yeah.
$6 million, okay. All right. I got it. Perfect. Thank you very much.
Thank you. Our next question comes from the line of David Chiaverini of Wedbush Securities. The question please.
Hi, thanks. So, I had a follow-up on the loan growth. So the competitive pressure in the commercial real estate. So when we look out going forward, should we expect – is your expectation at the payoffs, elevated payoffs are going to kind of stay in place or are you guys – and at the same time, are you guys kind of pulling back from the market, because of any perceived risk that you’re seeing?
Definitely, no yield, a little concerned above the future prospect, but we are seeing the market that’s why, we are taking a look at our portfolio and also our lending criteria. However, I know, we also see that there’s a lot of competition coming from other banks, especially, big bank. They're offering very loose term and low interest rates, because they also need to show their loan growth. these are the pressures coming from the competitions. Our loan officers are working very hard, so we shall maintain our portfolio and that [could utilize] as much as possible.
And with you maintaining the 7% to 8% loan growth guidance, should we expect this high level of C&I growth to continue in the back half of the year and looking at the resi mortgage on an end to period basis, it looks like it was kind of flattish, should we expect that to pick up in the second half as well?
Yes. Residential mortgage and C&I, these are the – either be a true portfolio that we expect to have a higher growth rate in the second [indiscernible] and fourth quarter.
Yeah. Again, residential mortgage, I don’t think it was flat during the quarter, it was our strongest segment for loan growth.
Okay. yeah. I see what I’m missing here in the number. Okay. And then shifting gears to the net interest margin with the new guidance of 375 to 385, if I plug in to 383 and if that were to stay flat for the third quarter and the fourth quarter, it kind of lands right at the midpoint of the guidance. So in the near-term, would you – is your expectation for the NIM to kind of trend sideways from here?
Well, it depends on the prepayment penalty. So, yeah, it could be – some quarters, it’s been as low as two basis points. And so we – that’s why we have that 10 basis-point range.
Got it. And then last one for me is on the securities portfolio and the duration, and what your outlook is for the duration?
Yeah. I think, it’s now about 40% in name of treasuries, with still four more prime rate increases we want to wait a little bit longer before we add to – before we extend in the securities portfolio. And I think the duration is about 2.5 or so in the securities portfolio.
So, the expectation is as we get a couple more rate hikes you may extend that duration to take advantage of higher rates.
Yeah, yeah. I mean in normal times, the target of that duration of three.
Got it. thanks very much.
Thank you.
Thank you. [Operator Instructions] our next question comes from the line of Jon Arfstrom of RBC Capital. Your line is open.
Thanks. good afternoon.
Hi, Jon.
Hey, just a couple of follow-ups here on the margin guidance. You’re not assuming any changes in interest rates without guidance. is that right?
well, it’s a normal. One or two more prime rate increases for this year and we’re not giving guidance for 2019, but…
Okay.
But yeah, we will find out as time goes on.
Yeah. Okay. And the commercial real estate question, right. the message is, you’re still seeing good opportunities, it’s just tough to hang on when you’ve got so many pay-offs, is that a fair assessment that this is still a good market for you?
It is still very competitive.
Okay. And it’s – would you say it’s more competitive over the last quarter?
I think probably similar in terms of level of competition in the first and second quarter.
Okay, okay. Good. And then on the commercial, any changes in the pipelines, any changes in borrower mood, would you say more positive or the same?
Because we book a lot of loan in the second quarter, so our [indiscernible] have reduced absolutely because of that. And it’s still healthy which we’ve seen is above $1.6 billion in the pipeline.
Yeah. That’s – yeah, yeah, it’s a soft number. Well, I mean we don’t expect…
That was like…
That’s fair. And then I appreciate the comment on the some of the tariff conversation or I know it’s extremely difficult to predict all of this, but what do you think about big picture? is there any secondary or derivatives impact that you worry about outside of just less than 1% of loans that you disclosed?
Let me do, you know first that 1% is just on the current imposed tariffs.
Yeah.
Yeah. So that’s mainly, we have a few metal distributors, where some of their inventory comes from China, that’s I mean, I don’t – I think nobody here, has the crystal ball on what’s going to happen although the 10% tariffs will be more tolerable, and then as part of our deep dive into our import is our trade finance portfolio. We have a lot that’s general merchandise footwear and hopefully, those more consumer-oriented imports, so the last thing that the administration will want to put tariffs on.
Okay. Yeah, it’s difficult to know, but I appreciate the information you gave us. So, thanks for taking the questions.
Yeah. Thank you, Jon.
Thank you for your participation. I would now turn the call back over to Cathay General Bancorp’s management for closing remarks.
thank you for joining us for this call and we look forward to speaking with you look in our next quarterly earnings release date.
Ladies and gentlemen, thank you for your participation in today’s conference. this concludes the presentation. you may now disconnect. Good day.