Cathay General Bancorp
NASDAQ:CATY
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Ladies and gentlemen, thank you for standing by. And welcome to the Cathay General Bancorp's Third Quarter 2020 Earnings Conference Call. My name is Val, I'll be a 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 www.cathaygeneralbancorp.com.
Now, I'd like to turn the call over to Megan Cheung, Investor Relations of Cathay General Bancorp.
Thank you, Valerie, and good afternoon. Here to discuss the financial results today are Mr. Chang Liu, our President 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 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, 2019 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. 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. This afternoon, Cathay General Bancorp issued an earnings release outlining its third quarter 2020 results. To obtain a copy of our earnings release, as well as well as our third quarter earnings presentation, 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 President and Chief Executive Officer, Mr. Chang Liu.
Thank you, Megan, and good afternoon, everyone. Welcome to our 2020 third quarter earnings conference call.
While we acknowledge our third 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 $56.8 million for the third quarter of 2020, a 22% decrease when compared to a net income of $72.8 million for the third quarter of 2019. Diluted earnings per share decreased 22% to $0.71 per share for the third quarter of 2020, compared to $0.91 per share for the same quarter a year ago.
In the third quarter of 2020, our gross loans decreased by $42.5 million to $15.6 billion. The decrease in loans for the third quarter of 2020 was primarily driven by a decrease of $164 million or 6% in commercial loans due to unusually high pay downs from our commercial borrowers resulting from their strong cash flows. Commercial real estate loans increased by $67.8 million or 0.9% as a result of the origination of new loans, and construction loans increased by $50.9 million or 8.2% as a result of construction drawdowns.
During the third quarter, we again conducted credit reviews of our borrowers in industries particularly impacted by the economic impact of the pandemic. We are encouraged because 68.6% of our commercial real estate in single-family mortgages that were on payment deferral have returned to full schedule payment status as of September 30, 2020. Also many of our borrowers are reporting improved cash flows and many of our hotel borrowers are reporting higher occupancy levels during the third quarter. We are also encouraged by the low loan-to-value for these reviewed loans and of the outside liquidity that is held by the guarantors of these loans, which we expect could be used to support these loans.
As of September 30, 2020, our COVID-19 loan modifications were as follows. 48 C&I loans with an aggregate balance of $45.3 million as of September 30, 2020, or approximately 1.8% of our commercial loan portfolio, are still modified to provide relief on payment -- on repayment terms.
Turning to Slide 7 of our earnings presentation. As of September 30, 2020, 95 CRE loans with an aggregate balance of $428 million, or approximately 5.7% of our CRE loan portfolio, are still on loan modifications to provide relief on repayment terms. The average loan-to-value ratio at origination for these loans was 52%. On October 20, 2020, the balance of CRE loans still under loan modifications have further decrease to only $146 million, or approximately 2% of our CRE loan portfolio. We will provide some specifics about Cathay's hotel and retail loan portfolios of the two segments more impacted by the downturn. As of September 30, 2020, Cathay had 64 hotel loans that totaled $351.6 million, including $49.2 million of SBA loans. As of September 30, 2020, the remaining loans with loan mods were at $129 million or 37% of the total hotel portfolio. Among the 64 hotel loans, 59 are limited service and five are full service, three in Southern California and two in Texas.
Turning to Slide 8. We note that we reviewed 81% of the loans in our retail loan portfolio, which comprises 19% of our total commercial real estate loan portfolio and 9% of our total loan portfolio as of September 30, 2020. The majority, 62% of the $1.42 billion in retail loans reviewed is secured by neighborhood, community -- neighborhood, community or strip centers, and only 12% is secured by regional malls, power, or lifestyle or factory outlet properties. Among the $161 million of CRE retail loans still under loan modifications as of September 30, 2020, approximately 38% are paying interest-only.
Turning to Slide 9. As of September 30, 2020, 367 payment deferment requests with an aggregate balance of $180.6 million or approximately 4.3% of our residential mortgage loan portfolio remain on payment deferral status. As of October 20, 2020, the balance of our residential mortgage loans still under loan modifications had decreased to $139 million or approximately 3.3% of our residential mortgage loan portfolio. For the third quarter of 2020, we reported net charge-offs of $3.1 million compared to net charge-offs of $3.6 million in the second quarter of 2020. Our non-accrual loans increased by $20.7 million or -- $77.2 million, or 0.5% of period-end loans as compared to the end of the second quarter of 2020. The increase is a result of the placement of our only-two movie theater loans acquired through the acquisition of Far East National Bank going to non-accrual status during the third quarter of 2020.
We recognized $12.5 million loan loss provision in the third quarter of 2020, compared to $25 million in the second quarter of 2020. The $12.5 million loan loss provision in the third 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. Based on preliminary calculations, the CECL allowance for credit losses for the third quarter of 2020 will be approximately $15 million to $25 million less than the $12.5 million incurred loan loss provisions. The lower ACL provision is primarily a result of the improvement in the forecasted economic factors, shown in the Moody's September baseline case forecast compared to Moody's June's baseline forecast.
We also continue to monitor and evaluate the potential impact of the continuing tariffs from the partially-resolved trade dispute between the US and China to our loan portfolio. Borrowers that we believe could be adversely impacted by the current tariffs constitute approximately 1.6% of our total loans.
Turning to Slide 12. Total average deposits increased by $363 million or 2.3% during the third quarter. Average money market deposits increased by $363 million or 13.2% in part as a result of marketing efforts to large corporate depositors. Average time deposit decreased by $335 million or 4.4% due to the runoff of wholesale deposits. We plan to further address the excess liquidity brought by the growth in core deposits by reducing brokered deposits during the fourth quarter of 2020.
With that, I'll turn the floor over to our Executive Vice President and Chief Financial Officer, Heng Chen, to discuss the third quarter 2020 financial results in more detail.
Thank you, Chang, and good afternoon, everyone.
For the third quarter of 2020, net income decreased by $16 million or 22% $56.8 million, compared to the third quarter of 2019, which was primarily attributable to the $12.5 million loan loss provision due to COVID mentioned earlier. Net interest margin was 2.02% [ph] in the third quarter of 2020, as compared to 3.02% in second quarter of 2020. There were $2.4 billion of loans at the floor rate as of September 30, 2020. In the third quarter of 2020, interest recoveries and prepayment penalties added 8 basis points to the net interest margin compared to 3 basis points for the second quarter of 2020. Approximately $1.5 billion, $2.6 billion and $0.9 billion of our CDs will mature during the fourth quarter of 2020, and the first and second quarters of 2021, with average rates of 1.51%, 1.47% and 0.88% respectively. We are targeting renewing retail CDs in the 50 to 60 basis point range.
Non-interest income during third quarter of 2020 decreased by $0.4 million to $10 million when compared to the third quarter of 2019. Non-interest expense increased by $10 million or 15.9% to $76 million in third quarter of 2020, when compared to $65.6 million in the same quarter a year ago. Excluding the amortization of low income housing and alternative energy partnerships, non-interest expense only increased by $1.2 million or 2% through the third quarter of 2020 when compared to the third quarter of 2019. For the third quarter of 2020, the increase in non-interest expense was primarily due to a $7.5 million increase in amortization of investments in low-income housing and alternative energy partnerships, a $1.4 million increase in salaries and benefits, and $1 million increase in the reserve for unfunded commitments.
The effective tax rate for the third quarter of 2020 was 3.7%, compared to 22.4% for the third quarter of 2019. We completed our investment in a solar tax credit fund in the second quarter, which we project will lower our full-year effective tax rate to approximately 8%. Solar tax credit amortization was $10.8 million in the third quarter of 2020 and is expected to be $10 million in the fourth quarter of 2020. As of September 30, 2020, our Tier 1 leverage capital ratio decreased to 10.51% as compared to 10.83% as of December 31, 2019. Our Tier 1 risk-based capital ratio increased to 13.22% from 12.51% as of December 31, 2019. And our total risk-based capital ratio increased to 15.23% from 14.11% as of December 31, 2019. We expect to resume our stock buyback program during the fourth quarter of 2020.
Thank you, Heng. We will now proceed to the questions-and-answer portion of the call.
[Operator Instructions] Our first question comes from Michael Young of Truist Securities. Your line is open.
Thanks for taking the question. I appreciate the commentary on the share buyback reinstatement. Could you may be help size that or frame that for us, and kind of your expectations given there's not a lot standing on the remaining program, and how you guys would think about your kind of future programs and how much capital to deploy?
Yes Michael, right now, our plan is to hopefully complete the $10.7 million remaining here in the fourth quarter, and then we would go to our Board for a new authorization in 2021, and hopefully, we will announce in the January call. We hope that based on our excess capital generation that -- and the fact that our credit quality seems to have stabilized, that we could start buying back at a higher pace in 2021 than the $10.7 million that we hope to complete in Q4. But we're going to look at it every quarter, so that we don't -- we maintain our strong capital ratio.
Okay, that makes sense. And I guess the other side of that equation would be organic growth. Can you may be provide any outlook on organic growth expectation, and maybe the contributing factors whether it be residential or commercial? Any outlook on pipelines, etc., would be helpful.
Well, Michael, in light of the current economic uncertainties caused by COVID-19 pandemic, we're no longer able to update our current growth guidance. But we're hopeful that 2021 will have some more recoveries and we love to see more C&I growth in the future in our loan portfolio. And we continue to do fairly well with some CRE loan growth with our existing customer and existing relationships.
Okay. I guess, just overall, maybe -- I know it's kind of point in time, maybe not a view for 2021, but are you seeing kind of a return of demand from customers? Are you seeing any pipeline building in the construction area? Anything else like that would be helpful, if you have any color there.
Yes. As far as the construction side of the portfolio, we actually saw a slight decrease in the commitment. The increase in the construction outstanding balance is a result of the actual drawdowns from previously-approved commitments. So that's where we saw some of that increase in those numbers.
Michael, we have been adding a number of new team lenders. Chang, do you want to...
Yes. We added a team -- commercial banking team in the San Fernando Valley area through an external hire and put a team -- small team together and we're looking -- and they've got a pretty decent pipeline. So we're looking for that pipeline to get to some closings both by fourth quarter and well into 2021.
Okay. I'll step back. Thanks.
Thank you.
Our next question comes from Chris McGratty of KBW. Your line is open.
Great, thanks for the question. Heng, can we -- excluding the amortization in the quarter, could you talk about how you're thinking about expense growth in the environment that we're in right now relative to the adjusted number that you referenced in the deck?
Yes. The third quarter was a little bit higher because we had higher bonus accruals, also because we had some loan paydowns -- or the loan growth was a little bit weaker. We had lower deferred loan cost capitalize. But -- that's where we are. Could you rephrase the question, because I think I answered part of it?
If I'm looking at the trend on Slide 15 of your core non-interest expense over the past several quarters, I'm just trying to get a sense of what the right base rate is either into Q4 and into next year. How much growth will we see off of either the average of the last two quarters, or this quarter specifically?
Yes. We have that $1 million provision for loan commitments. When we restate or under-receive [ph] all that, that expense is going to be in the loan loss provision line. But our goal is -- it's Chang's goal. With what we know, it's a tough leverage environment. So we're doing many things such as -- I think, increasing the span of control, having fewer layers of management funds, trying to replacing staff -- certain staff people when they leave, if that [indiscernible]. So we're not in a position to give guidance as to 2021, but good we have a history of working hard on expenses.
And maybe on the margin, I guess two-part question. Number one, could you repeat the maturity schedule? I got the rates, but I missed the majority of the CDs that occur in the...
Yes. Yes, it's -- $1.5 billion will mature in the fourth quarter, $2.6 billion of CDs will mature in the first quarter, and $0.9 billion will mature in the second quarter.
Okay. And as it relates to just the outlook for margin, it seems like you've got additional downward repricing on the liabilities. Loan growth, obviously not great at the industry level. How do we think about margins from here, from the 3.02% level over the next quarter or so?
Well, I'm optimistic. One, the excess cash we have in the Fed, that added -- just in the fourth quarter, it added 7 basis to it. Yes. We had -- we had a slower deposit. Our average at the Fed was about $1.4 billion that's excess. And so, we have $400 million of brokered CDs that are maturing. Most of them in October. And that is just going to reduce the excess cash at the Fed. So not only will you have the benefit of reducing that CD expense, you also strength the [indiscernible] that's in the earning assets. And then we have some Federal Home Loan Bank borrowings, a couple of hundred million, which will mature in June of next year. So, we may, like many banks, prepay a portion of that and the cost is relatively low.
And Chris, if I could speak to the asset side of the equation. We've got approximately $2.4 billion or 15% of our total loans of our floating rate loans that are at their floor rates. Our residential mortgages, which is about 27% of our loan portfolio, they are generally fixed rate, or hybrid ARMs that are still in their fixed rate period, and also most of our CRE loans are fixed. So the majority of our loans are either fixed rate loans or at the floor rates.
Okay. So margin -- the message you're sending is, margin is going to likely expand from here, if I'm hearing you right?
We hope so.
Okay, got it. Thanks for all the color.
Thank you. Our next question comes from Gary Tenner of DA Davidson. Your line is open.
Thanks, good afternoon. A couple of questions. I guess, first, the $400 million in brokered CDs that you just mentioned, is that included in that $1.5 billion, or is that over and above the -- that's included in the $1.5 billion?
Yes, yes.
Okay, thanks. And then, Heng, you mentioned I think that part of the thought process around reinstating the buyback. It was kind of stabilization on the credit side. And NK [ph] is up a little bit, classified loans sequentially higher. Just curious kind of what the markers are, what you're seeing behind the numbers that gives you increased comfort?
I think we've kind of mentioned that for the last couple of quarters. We reviewed 81% of our retail loans, and we -- all of our hotel loans and -- we [indiscernible] and the personal guarantees.
Yes. So we looked at -- we did deeper dives in both of the last two quarters on our retail and hotel portfolios and kind of really looked at, just in addition to beyond the rent roll and what the collectability of the rent are, and kind of also looked at the principal guarantors, financials and their liquidities and really try to measure the burn rates and -- of how long these properties can continue to go and support the debt service, and we came away with some pretty positive feedback. And so, that's some color for you in terms of what we've been able to do behind the scenes.
Okay. And just to get some background numbers in terms of PPP, I didn't see it in your press release, but what the actual net fees that were created into NII we're on PPP this quarter?
It's about $1.2 million. We are amortizing the fees on a two-year [indiscernible]. Chang, you want to talk about submission...?
In terms of PPP forgiveness submissions, we started that process. And out of the about 1,200 PPP loans we have on our books, by the middle of the week, we'd probably will be about 12% into the forgiveness for the application process.
Great, thank you.
Thank you. Our next question comes from Matthew Clark with Piper Sandler. Your line is open.
Good afternoon. Just on the other income line item. It looks like a decent uptick from 2Q to 3Q. Can you just quantify what that was driven by, and whether or not sustainable?
Well, in the -- one, we have to exclude the mark-to-market for equity securities. But in terms of -- in the third quarter, we booked $1.4 million gain from the low income housing partnership that -- the investment was made back in the 2004. And so that was -- that's one time and that's the primary reason why it was a little bit stronger in September. And we don't expect that to be recurring. Most low income housing partnerships, particularly the [indiscernible] design that they close out at no gain to -- at the liquidation of the partnership.
Okay. I'm sorry, I see it on Slide 14 now. And then just on the amortization for 4Q, I think you mentioned $10 million. Was that just the energy piece?
Yes.
So, what was the -- what do you expect from low-income housing?
It should be the same. I think we're about $6 million a quarter.
Okay. And then just the increase in classified, I think there was some mention of a couple of commercial real estate properties. Can you give us some more color on the types of projects those are?
Yes. So on those, they were two theater loans that was acquired as part of the Far East National Bank acquisition. They -- we believe -- our latest update is that the majority of the theaters have now we opened during the secondary markets, but they are limited to a certain 25% capacity. They also have recently I believe liquidated an asset that gave them more cash and liquidity as well. So I believe they have more carrying power in terms of being able to continue to support their business.
And then the other, we had a $14 million downgrade for a C&I loan that was made by our Hong Kong branch.
Okay, got it. Thank you.
Sure.
[Operator Instructions] Our next question comes from David Chiaverini of Wedbush Securities. Your line is open.
Hi, thanks. The first question is on the residential mortgage portfolio. In terms of loan growth, the mortgage market has been booming. Low rates clearly are leading to pay downs given refi. Just curious as to what you're seeing in resi mortgage, and if you guys are experiencing a heavy level of paydowns and what the outlook is for resi mortgage growth.
We're definitely seeing a higher level of pay down compared to prior year at the same time period. We're seeing, however, an uptick in the demand as well. The question is really a bit of more about resource and applying sort of the right resource to the team so that they can be able to turnaround and fund the loans quicker, at a quicker pace. We were hopeful that the residential mortgage group will be able to continue to contribute to the -- slightly to the loan growth for the fourth quarter and going forward.
Okay, thanks for that. And in terms of your markets, is there anything that you're seeing that could lead to an increase in demand? Clearly, we're in the midst of a recession, or coming out of a recession, or going into a double dip, depending on who you talk to. Would a stimulus package help, or is it really ultimately seeing the case numbers come down and the vaccine being distributed and that's when we would see -- in your view, an increase in loan demand on the commercial side?
I think it's a little bit of both. I think it's really -- if you look at even the market today, market is down substantially over 600 points the last I checked, is because the vaccine cases are up, there is real no certainty about -- excuse me, the COVID cases are up and there is no certainty about vaccine yet. So I think it's a combination of both that -- people got to have more confidence in the economy to continue to get back to executing the business plan. We've had, as you noticed, substantial paydowns in our C&I book, it's because they've had -- some of them included some furniture, some medical supplies, and other parts of our industry that has been able to do quite well during this downturn, but I think that's sort of segment-specific. So it in terms of an overall recovery, I think it depends on both.
And the last one for me is on the provision. So clearly, it came down nicely this quarter. When we look out to 4Q and 1Q, and clearly a lot of uncertainty out there, but given the really positive trend on the deferral rates, is your expectation that we would kind of be in the same neighborhood of this low teens, or is it too tough to forecast? Just curious of your views there on the provision.
Well, I think it's hard to predict two or three months ahead. But in terms of one, our incurred loan loss provision is essentially the same as our ACL after you add the $17 million transition adjustment in January. So we're roughly at $200 million for the ACL as of 9/30. Based on -- hopefully, we should be booking just net charge-offs in the next few quarters. That's our hope, particularly even if we have -- even if we have more downgrades into non-accrual, the fact that the LTVs are 50% and there's personal guarantees, I think we're seeing, in many cases, our guarantors carrying properties out-of-of-pocket. So when they do go on the call [ph], there is not going to be any charge-offs because the LTVs are so low. So those are some of the macro factors that will impact our Q4 provision.
Got it. And actually that just reminded me about how you guys previously said about when CECL does get implemented to assume a $20 million bump to the reserve, but I think I heard you say $15 million to $25 million less. Were you referring to when CECL is implemented that your allowance could come down by $15 million to $25 million, or did I get that wrong?
Okay. That was for the third quarter. So had we been on CECL instead of booking $12.5 million expense, we would have been booking a negative provision of $5 million to $15 million.
I see. So is there an update for January 1, 2021? How much of a bump in allowance, or decrease in allowance?
There should be none. At 9/30, our incurred loss reserve after we add in the $17 million day one adjustment for CECL, the January 1, day one adjustment that goes to retain earnings, they should be the same, almost the same.
Got it. Okay, thanks very much.
Sure. Thank you.
Thank you. Our next question comes from Michael Young of Truist Securities. Your line is open.
Hey, thanks for the follow-up. Lot of good color already, but I was just curious, given that you guys have a pretty broad geographic overlay on the market and some of the major cities across the country, I was just curious if there's anything you could do in terms of geographic performance of your clients. I know that may not affect your actual loss content, given the low loan to values, but have you noticed a wide dispersion in mostly California versus New York, Chicago, etcetera?
Yes. The bulk of our kind of business in terms of C&I are mostly in California throughout South in North. The bulk of our commercial real estate is both California and New York. In New York, however, there is -- the bulk of that business is a lot of mixed use. Mixed use meaning residential over small retail in kind of the Queens, in Flushing area mostly. We don't have a lot of exposure in the main part of the city in Manhattan. Primarily we just try to stay out of the what we think is a high rent and high cost per square foot kind of a segment of the market in California. I think it's a mix of mostly apartments, retail and some industrial. We have very limited in terms of any of the exposure to the office segment.
And then historically, our New York group had pretty strong loan growth, even now because where they are. In the third quarter, a lot of our CRE growth was in Southern California.
And most of that growth in SoCal was multifamily and some owner-occupied commercial real estate.
Okay. But no broad -- I don't know, takeaway in terms of where you're seeing more rent collections, or just better performance generally between New York versus California at this point?
They're about the same, I think from a collection standpoint. I think they both closely do fairly well.
Okay, thanks for the follow-up.
Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to the management for any closing remarks.
I want to thank everyone for joining us on the call. It has been a challenging time for our country due to the pandemic. We look forward to speaking with you at our next quarterly earnings release call.
Ladies and gentlemen, thank you for participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.