Cathay General Bancorp
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Good afternoon ladies and gentlemen and welcome to the Cathay General Bancorp Second Quarter 2020 Earnings Conference Call. My name is Val and I'll be your coordinator for today. At this time, all participants are in 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 www.cathaygeneralbancorp.com.
Now, let's turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp. You may begin.
Thank you, Valerie and good afternoon. Here to discuss the financial results today are Mr. Pin Tai, our Chief Executive Officer; Mr. Chang Liu, Cathy Bank's President and Chief Operating Officer; 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 31st, 2019, at Item 1A in particular, and another 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.
Any forward-looking statements speaks only as of the date on which it is made, and except as required by law, we undertake no obligation to update or review any forward-looking statements to reflect future circumstances, developments or events, or the occurrence of unanticipated events.
And this afternoon, Cathay General Bancorp issued an earnings release outlining its second quarter 2020 results. To obtain a copy of our earnings release as well as our second quarter earnings presentation, please visit our website at cathaybank -- cathaygeneralbancorp.com. After comments from management today, we will open this call up 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 2020 second quarter earnings conference call. While we acknowledge our second quarter operating results, our commitment and focus today is on continuing to support our clients, team members, and communities during the COVID-19 pandemic.
This afternoon, we reported net income of the $54.3 million for the second quarter of 2020, a 24.8% decrease, when compared to a net income of $72.2 million for the second quarter of 2019. Diluted earnings per share decreased 24.4% to $0.68 per share for the second quarter of 2020 compared to $0.90 per share for the same quarter a year ago.
In the second quarter of 2020, our gross loans grew by $74.1 million to $15.6 billion or an increase of 1.9% on an annualized basis. The increase in loans for the second quarter of 2020 was primarily driven by the origination of $261.7 million of Paycheck Protection Loans and $47 million or 32.5% annualized of construction loans as a result of drawdowns. Net changes in the remaining loan portfolio was relatively muted.
As of June 30th, 2020, we have originated 1,381 PPP loans with an aggregate balance of approximately $261.7 million. We will continue to monitor the impact of the COVID-19 pandemic on our financial results as well as demand for our loans, deposit, services, and products during the third quarter of 2020 and beyond.
During the second quarter, we've conducted credit reviews of our borrowers in industries, particularly impacted by the economic impact of the pandemic. We are encouraged by the generally low loan to values for these reviewed loans and a review of the outside liquidity that is helped by the carrying cost of these loans, which we expect could be used to support this loan.
With that, I will turn the floor over to the Bank's President and Chief Operating Officer, Chang Liu, to discuss our second quarter asset quality in more detail and our COVID-19 initiatives for our borrowers.
Thank you, Pin and good afternoon everyone. With respect to the COVID-19 pandemic, we have implemented several lending initiatives to assist borrowers that are impacted by the pandemic. 41 C&I loans with an aggregate balance of $43.2 million as of June 30th, 2020 or approximately 1.6% of our commercial loan portfolio have been modified to provide relief on repayment terms based on requests from borrowers.
Turning to slide seven of our earnings presentation, at June 30th, 2020, 431 CRE loans with an aggregate balance of $1.269 billion or approximately 17.2% of our CRE loan portfolio and 8.1% of our total loan portfolio have been modified to provide relief on repayment terms. The average loan to value ratio at origination for these loans was 52%.
For the loan mods that matured during the month of June 2020, 81% went back to regular payment terms. At June 30th, 2020, Cathay has 64 hotel loans that totaled $296 million. We have processed loan mods on 51% or $151 million. Of this 64 hotel loans, 60 are limited service and four are full service, three in Southern California and one in Texas.
Turning to slide eight, we note that we reviewed 83% of the loans in our retail loan portfolio, which comprises 24% of our total commercial real estate loan portfolio and 11% of our total loan portfolio as of June 30th, 2020.
The majority, 62% of the $1.46 billion in retail loans reviewed is secured by neighborhood community or strip centers and only 12% is secured by regional malls, power or lifestyle or factory outlet properties. Of this $676 million of CRE retail loans with loan modifications, approximately 37% are paying interest only.
Turning to slide nine, as of June 30th, 2020, we have approved 1,198 payment deferment requests for 90 days with an aggregate balance of $518.1 million or approximately 12.4% of our residential mortgage loan portfolio.
Through July 24th, 2020, 37% of the $140.4 million of July maturing loan deferments have requested an additional deferment. We also launched a micro loan program, the smart relief loan program, which is independent and separate from any SBA or government-backed loan relief programs.
The purpose of the program is to help small business owners affected by the COVID-19 pandemic in our nine-state footprint with loans between $5,000 to $10,000. As of June 30th, 2020, we are processing over 250 applications with an aggregate balance of nearly $2.5 million.
For the second quarter of 2020, we reported net charge-offs of $3.6 million compared to net recoveries of $49,000 in the first quarter of 2020 and net recoveries of $96,000 in the second quarter of 2019.
Our non-accrual loans increased by $2.7 million to $56.5 million or 0.36% of period-end loans as compared to the end of the first quarter of 2020. Accruing loans past due 90 days or more at June 30th, 2020 have been reduced from $21.4 million to $3.1 million as of July 24th, 2020, as renewals for these past due loans were completed.
We recognized a $25 million loan loss provision in the second quarter of 2020, the same amount as in the first quarter of 2020. The $25 million loan loss provision in the second quarter of 2020 included qualitative adjustments under the incurred loss model due to the impact of the COVID-19 pandemic.
We have elected to defer the implementation of the CECL standard for recognizing credit losses as permitted under the recently enacted CARES Act. We continue to work on the loan loss reserve under CECL and we'll disclose the estimated range in our second quarter Form 10-Q.
We also continue to monitor and evaluate the potential impact of the continuing tariffs from the partially resolved trade dispute between the U.S. and China to our loan portfolio. Borrowers that we believe could be adversely impacted by the current tariffs hold approximately 2.5% of our total loans.
Turning to slide 12, total deposits increased by $1.2 billion or 32% annualized during the second quarter. DDA balances increased by $438 million or 61% annualized due primarily to unspent PPP funds on deposit with Cathay and customers increasing liquidity during these uncertain times.
Money market deposits increased by $499 million, 80% annualized in part as a result of marketing efforts to large corporate depositors. We plan to address the excess liquidity brought by the growth in core deposits by reducing brokered and wholesale deposits during the second half of 2020.
With that, I'll turn the floor over to our Executive Vice President and Chief Financial Officer, Heng Chen, to discuss the second quarter 2020 financial results in more detail.
Thank you, Chang and good afternoon everyone. For the second quarter of 2020, net income decreased by $17.9 million or 24.8% to $54.3 million compared to the second quarter of 2019, which was primarily attributable to the $25 million loan loss provision due to COVID-19, as mentioned earlier.
Our net interest margin was 3.02% in the second quarter of 2020 as compared to 3.34% for the first quarter of 2020. There were $2.4 billion of loans at their floor rates as of June 30, 2020 compared to $2.1 billion of loans at their flow rates as of March 31, 2020.
In the second quarter of 2020, interest recoveries of prepayment penalties added three basis points to the net interest margin compared to one basis point for the first quarter of 2020. Approximately $1.8 billion, $1.5 billion and $2.5 billion of our CDs mature during the third and fourth quarters of 2020 and the first quarter of 2021, with average rates of 1.7%, 1.47%, and 1.55% respectively. We are targeting renewing retail CDs in the 50 to 60 basis point range.
Non-interest income during the second quarter of 2020 increased by $2.8 million to $15.6 million when compared to the second quarter of 2019. The increase was primarily attributable to a $2.5 million increase in the valuation of equity securities.
Non-interest expense decreased by $2.2 million or 3.2% to $67.3 million in the second quarter of 2020 when compared to $69.5 million in the same quarter a year ago.
For the second quarter of 2020, the decrease in non-interest expense was primarily due to a $5 million decrease in salaries and employee benefits expense, resulting from lower bonus accruals and the increase in salaries capitalized for loan originations.
The effective tax rate for the second quarter of 2020 was 6%, compared to 16.6% for the second quarter of 2019. We completed an investment in a solar tax credit fund in the second quarter of 2020, which we project will lower our full year effective tax rate to approximately 11%. Solar tax credit amortization was $6.6 million in the second quarter 2020 and is expected to be $8.5 million a quarter in each of the last two quarters of 2020.
At June 30, 2020, our Tier 1 leverage capital ratio decreased to 10.46% as compared to 10.83% at December 31, 2019. Our Tier 1 risk-based capital ratio increased to 12.88% from 12.51% at December 31, 2019. And our total risk-based capital ratio increased to 14.81% from 14.11% at December 31, 2019.
Thank you, Heng. We'll now proceed to the question-and-answer portion of the call.
Thank you. [Operator Instructions]
Our first question comes from Michael Young of SunTrust. Your line is open.
Hey, good evening. Thanks for the question. Wanted to just start with outside of the classified assets, could you provide the levels of criticized and/or special mention assets at this time?
Yes, it's -- it actually went down. At March 31st, 2020 it was $505 million, and it went down to $414 million. So, there was a migration from special mention to substandard during the second quarter.
Okay, that's helpful. And then I was just -- kind of bigger picture question, I guess, Heng on the loan loss reserve. It just seems like maybe the level of reserve on the CRE book is low relative to peers. I understand you guys have a low end value, but looks like it's about sub 60 basis points of reserve on the $7.4 billion book. So, just was trying to help parse that out a little bit better, if you could help me with that?
Yes, let me make a stab at that and maybe Chang or Pin can add in. We did a very deep dive, as we tried to mention in all our loan portfolio, starting with our hotel loan portfolio. And most of our real estate loans are -- almost all of them have full personal guarantees.
So, our review involved looking at the outside liquidity of the borrowers as well as the operating statistics of the hotel portfolio. So on that one; we didn't mention much in the -- in our prepared remarks. But we calculate the burn rates and as well as the outside liquidity. And I think on the whole, most of them can last a year or more based on the current occupancy levels.
Then we go to the retail, we did a similar analysis looking at outside liquidity as well as the current fee rates. And I think we've had it in our comments that many of our retail loans are secured by this neighborhood center with a supermarket or a drugstore as an anchor that's 20% or the neighborhood centers without that type of anchor, but they're neighborhood centers. So, we think they will hold up pretty well.
So, I think all in all, our historical loss for our CRE is generally 15 basis points a year. So -- and that's when our loan to values were typically in the 70% range. So, Chang, would you -- or Pin, anything else?
I think you covered it.
Okay. Yes, so I mean that's kind of how we look at. I think time will tell. I think one of the things is that Chang mentioned that 80% of the CRE that had loan mods, they're going back to full interest and principal repayments. This is for June. So, these borrowers are capable of supporting their properties.
Okay, that's helpful. And I did appreciate all the break out in the slide deck, very helpful. Last one for me, it was just on PPP, just trying to understand how much of the fee amortization and total impact there was in the margin and net interest income this quarter? And if there is any offsetting expense fees?
Yes. The origination fees was $8.8 million, which is 3.27%. We are amortizing the straight line over the 24-month term. I know some other banks are doing quicker and then we capitalize about almost $2 million of salary expense related to the amortization of the PPP loans.
Okay, perfect. Thank you, Heng.
Sure.
Thank you. Our next question comes from Chris McGratty of KBW. Your line is open.
Great. Thanks. Heng, how should we think about near-term loan growth absent the impact of the PPP program? A lot of banks shows growth in the first quarter, and then some moderation given line utilization rates in the second quarter. How do we think about core loan demand into the back half of the year? Thanks.
I think we are not giving formal guidance given the uncertainties, but our pipelines are lighter than normal. And I think given the fact that we're in a recession, we're very cautious about underwriting new loans. Residential mortgage, that's continuing. We are originating about $80 million a month of the residential mortgage and that so far has offset the prepayments.
And then I think the others, once we -- we're pretty cautious on CRE. Certainly, on new loans, we want to make sure that the occupancy rates are firm before we make a new loans -- before we make a loan to new borrowers.
Okay. So, it sounds like the resi book might stay stable and you could have a little bit of rundown in the commercial book based on the conservatism?
Yes.
Okay. And then -- thank you for that. And then in terms of the expenses, could you help us kind of what's the run rate going into the back half of the year? We talked about $8.5 million on the solar. I guess do you have the low income as well, that we should be adding to that? And then also the salary line, you talked about the movement there. What -- how do we think about just overall expenses in the back half of year?
Ye. We try to break it out on Slide 15. So the low-income housing was $6.3 million in Q2, and we think it will be about that rate. Solar, as I mentioned, $8.5 million per quarter.
And on the non-interest expense, that was -- all other non-interest expense that was $53.7 million. We think, in second half of the year, it might drift up a little bit to just under $55 million. But, we're working real hard on controlling the costs that we can.
Okay, great. And then last kind of a housekeeping question. The total modifications, I think, you provided the individual portfolios. I just want to make sure I have the total number of loan mods as of June 30th, please.
I think it's in our comments, but hold on. So, for C&I, it's $43 million, CRE is $1.269 billion and then for residential mortgage, it's $518 million.
Great, thank you very much.
Sure.
Thank you. Our next question comes from Lana Chan of BMO Capital Markets. Your line is open.
Thank you. Just a question on the margin, given the continued repricing of the CDs downward, do you think that that's going to be able to help offset or stabilize the margin in second half of the year?
Yes, yes. As I mentioned in my comments, we have $1.8 billion of CDs maturing in the third quarter and that rate is at 1.7%; and for retail CDs, we're renewing them to the 50 to 60 basis point range; for wholesale CDs, which we have, that's probably $200 million or so. For the ones that we're keeping, those are reprising down to around 20 basis points.
And then on the loan side, we're tracking our yields by month. The loans have been pretty stable for each of the three months in Q2. So, we would -- with the loans on their floors -- at their floors will primarily a fixed rate portfolio. So, that should continue into Q3.
And then lastly, residential mortgage, surprisingly, there was an article in today's Wall Street Journal about jumbo rates now not increasing, and so that's the case for us. We're renewing -- we're originating new loans at about a 4.3% average rate and that's very close to the current portfolio.
Great. Thanks. And then my final question is on the C&I side, the loans that have been modified on -- in commercial, are there any specific industries where you're seeing more stress?
Not particularly. I think we have one loan in there -- in that population that accounted for about half of that and that was really to do with, actually, the loan terms. It wasn't a payment model, in particular. It was just the sort of the receivables being delayed as a result of the COVID-19 situation. So, then the rest of it is mostly small business and so because then the rest of it is, on average, $500,000 and $600,000.
Okay. Thank you.
Thank you. Our next question comes from Matthew Clark with Piper Sandler. Your line is open.
Hey, good afternoon. On the renewals, I think you had mentioned one portion that were 81% of them kind of went back to normal payments. Do you have an overall number as it relates to the deferrals that have expired so far for the overall deferral buckets so we can get a kind of bigger picture?
That's a small population. So, we looked at -- we track the deferments for really April, May, and June, that kind of expired in June and that number was less than $200 million -- between $160 million to $200 million or so. The bigger population comes when it expires in July and we will track that number at that point in time, sometime in the month of August.
But that's certainly for us it's an indication of -- hopefully an indication of what the rest of the deferment population will look like as they roll off of the deferment period.
And how much of that is expiring here in July and just trying to get a sense for how large that slug is and what might be beyond that in August, September?
The July number--
Matthew, I think we'll call you on that rather than give you the wrong number.
Yes.
No worries. Okay. And then on the high-risk exposures in retail series, obviously, your largest bucket of concern, but drops off after that, but what about the office piece? Are you seeing any changes there, I'm sure it's much longer term in terms of the changes that will occur there, but have you -- I guess, how that portfolio looking of late?
Our office portfolio is holding up pretty strong, I think, we had a small -- we just have a small number of modifications there as a total percentage -- it's total percentage is probably about a little over 10% of the office portfolio that has asked for mods.
Okay, great. And then just on the CECL timing, any desire to adopt it early in 3Q and I think you had mentioned, we'll see the estimated impact in the Q, but if you happen to have that number or range, will take it now, I'm sure?
Well, we're still working on it, Matthew, but we will put in the Q. But I mean, hopefully, if Moody's doesn't -- if their September forecast isn't worse than what they had in June -- then on the CECL, if our charge-offs remain muted, then the loan loss provision should be fairly low in the third and fourth quarters. So, that's the hope.
Got it. Thank you.
Thank you. Our next question comes from David Chiaverini of Wedbush Securities. Your line is open.
Hi, thanks. I want to ask about credit quality. Could you talk about the increase in the net charge-offs in the quarter, what the driver was there? And then the same question, you mentioned about the migration from special mention to substandard, could you talk about the credits there?
Yes, that was -- the charge-off was one credit for $4.9 million. This was a credit that's originally in our Hong Kong branch. It had been on non-accrual for a few quarters, it's really unrelated to COVID itself because it was unsecured. We had the charge-off in the second quarter.
Then on the -- what was the second part of your question, Dave?
The migration from special mention to substandard, the driver there?
Yes, I -- there is one loan that's over $10 million, let's say, metal wholesaler. So, that one on non-accrual in the second quarter. It also went from -- went to substandard. We had a mailing company that we made a PPP loan to. That was substandard. We had a chain of juice bars that we also made a PPP loan to. So, I think those are really the three largest ones.
Got it. And then I had a follow-up question on the net interest margin. You mentioned about how the rates that you're originating at least on the resi mortgage side are close to the current portfolio and then you have so many loans that are at their floors, so it's behaving like a fixed rate portfolio as we move into the third quarter.
But yet you mentioned about the repricing opportunity on the CDs. So, would that translate into actual margin expansion or are you thinking more of stability rather than expansion from here?
We hope the margin will trend higher, mainly from the CDs repricing and we also have several hundred million of excess liquidity, which we're going to use to pay off brokered CDs. So, those will also help the margin.
And then lastly, probably in the fourth quarter we'll have -- we'll start to see the forgiveness on a PPP loans, which will help.
Got it. Got it. That makes sense. And then the last one for me is on -- the construction portfolio increased slightly in the quarter, and you mentioned about how there is some drawdown activity. Are there any new commitments that you guys are putting out in construction given that a lot of banks are pulling back and you see some opportunities or was this solely due to draw downs that we saw the increase there?
Yes, David, this is Chang. It's -- that's primarily due to draw downs of our existing commitments. While we do see a lot of opportunities for construction, that's coming in the door, but we're being very, very careful and very selective. As a matter of fact, I can't remember the last construction loan that actually went through committee and got approval.
We certainly recognize that there is opportunities for relationships out there, but we're looking to continue to expand and serve our current client base with the right credit quality in this sponsorship and the history that we have with them. But as far as any new potential relationships, we're being very selective.
Great. Thanks very much.
Thank you. Our next question comes from Gary Tenner of D.A. Davidson. Your line is open.
Thanks. Just a couple of questions on PPP. I don't think you disclosed it. Can you give us the average PPP loans outstanding for the quarter?
We just, at the period end -- I think the average probably will be two-thirds of that.
Okay. And then relative to the net fees recognized in the quarter, I know you said you're going to recognize fees and net of the comp expense over 24 months. Was it two months' worth of that recognition in the quarter?
Yes, yes.
All right, great. Thank you.
Yes. Thank you.
Thank you. [Operator Instructions]
I'm showing no further questions at this time. I'd like to turn the call back over to Pin and management for any closing remarks.
I want to thank everyone for joining us on our call. It has been a challenging time for our country, due to the pandemic. As previously announced, after over 20 years at Cathay, I'll be retiring as CEO effective September 30th, 2020. And Mr. Chang Liu will become the next CEO.
I wish Chang all the best in his new role and confidence that Cathay's unwavering legacy of strong commitment to customer satisfaction and increasing stockholders' value will continue to flourish under his leadership. It has been an honor and a privilege to have served and led the company. Chang and Heng, both look forward to speaking with you at our next quarterly earnings release call.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Have a great day.