Cathay General Bancorp
NASDAQ:CATY
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Good afternoon, ladies and gentlemen and welcome to the Cathay General Bancorp's fourth quarter and full year 2017 earnings conference call. My name is Sherry 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 www.cathaygeneralbancorp.com.
Now I would like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp.
Thank you Sherry 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 described in the company's Annual Report on Form 10-K for the year ended December 31, 2016, at Item 1A in particular and in other reports and filings we make 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 speaks only as of the date of this presentation. We undertake no obligations 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 fourth quarter and full year 2017 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 2017 fourth quarter earnings conference call. Today, we reported net income of $25.9 million for the fourth quarter of 2017, a 46% decrease when compared to the net income of $48 million for the fourth quarter of 2016. Diluted earnings per share decreased 46.7% to $0.32 per share for the fourth quarter of 2017 compared to $0.60 per share for the same quarter a year ago.
Fourth quarter results were impacted by the enactment of the Tax Cuts and Jobs Act. As a result of the new tax law, the bank recorded a one-time revaluation adjustment of $22.3 million to reduce its deferred tax asset and a $2.6 million pretax write-down of low income housing investments for a net impact of $0.29 per share. Adjusted for these two items, fourth quarter earnings per share were $0.61 share and were impacted by higher amortization expenses which Heng will discuss in his remarks.
We made significant progress in 2017 from organic growth and from the acquisition of Far East National Bank. The system conversion of the former Far East National Bank on to Cathay Bank systems is scheduled for April 2018, which will permit completion of the integration of our operations. In the fourth quarter of 2017, our gross loans, excluding loans held for sale, increased $274.9 million to $12.9 billion or an annualized increase of 8.7%.
Including the acquisition, we grew our loans by $7.7 billion or 14.9% when compared to December 31, 2016. The increase in loans for the fourth quarter of 2017 resulted primarily from residential mortgages and commercial mortgage loans, which grew by $139.5 million or 19.1% annualized and $107.7 million or 6.8% annualized respectively. Commercial loans increased $41.4 million or 6.8% annualized. We anticipate organic loan growth in 2018 to be around 8%.
For the fourth quarter of 2017, our total deposits increased $128.2 million or 4.1% annualized to $12.7 billion. Deposit growth of the fourth quarter of 2017 resulted primarily from time deposits which grew by $234.2 million or $18.2% annualized.
With that, I will turn the floor over to our Executive Vice President and Chief Financial Officer, Heng Chen, to discuss the fourth-quarter 2017 financials in more detail.
Thank you Pin and good afternoon everyone. For the fourth quarter, we announced net income of $25.9 million or $0.32 per share. Our net interest margin was 3.65% in the fourth quarter of 2017 as compared to 3.36% in the fourth quarter of 2016 and 3.75% for the third quarter of 2017. The change in the net interest margin the fourth quarter was due to interest recoveries and prepayment penalties which added seven basis points to the net interest margin compared to 16 basis points for the third quarter 2017 and eight basis points from the fourth quarter of 2016.
Noninterest income in the fourth quarter of 2017 increased $2.2 million to $10.2 million when compared to fourth quarter of 2016. The increase was primarily due to increase in net income for venture capital investments, wealth management commissions and other fees recorded in the fourth quarter. Noninterest expenses increased $12.9 million or 24.1% to $66.4 million in the fourth quarter of 2017 when compared to $53.5 million in the same quarter a year ago. The increase was due to a $5.8 million increase in amortization of low income housing and alternative energy investments, $3.5 million in salary and employee benefits expenses and a $1.2 million increase in professional services expenses offset by a decrease in other real estate owned expense of $2.6 million.
In addition to the $2.6 million write-down of low income housing investments as a result of the Tax Cuts and Jobs Act, the company booked a $1.8 million catch-up adjustment to the amortization of certain older low income housing investments as a result of the new tax act, $900,000 in solar tax credit impairments as a result of the new tax act and $950,000 in legal settlements. In addition, there were $844,000 of immigration expenses related to Far East National Bank.
As mentioned previously, the Tax Cuts and Jobs Act was enacted into law and as a result during the fourth quarter of 2017, the company recorded a one-time revaluation adjustment of $22.3 million to reduce its deferred tax assets. We plan on making new investments in 2018 in solar tax credit investments which would bring our effective tax rate in 2018 to between 17.5% to 18.5%. We expect solar tax credit amortization of about $20 million in 2018, most of which will be in the second half of 2018.
At December 31, 2017, our Tier 1 leverage capital ratio decreased to 10.31% as compared to 11.57% at December 31, 2016. Our Tier 1 risk-based capital ratio decreased 12.14% from 13.85% at December 31, 2016 and our total risk-based capital ratio decreased to 14.07% from 14.97% at December 31, 2016. Our ratios significantly exceeded well-capitalized minimum ratios under all the regulatory guidelines. At December 31, 2017, our common equity Tier 1 capital ratio was 12.14%.
Net recoveries for the fourth quarter of 2017 was $1.7 million compared to $1 million in the fourth quarter of 2016. Our nonaccrual loans, excluding loans held for sale, decreased by $25.3 million or $16.6 million to $48.8 million or 24% of period end loans as compared to the fourth 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 Michael Young with SunTrust.
Hi. How are you doing?
Good, Mike.
I wanted to start maybe just with credit cost actually. Full year 2017 ended up still in the negative with net recoveries. As we look out at 2018, should we expect that the return deposit provisioning and any other color you could provide on that?
Yes. Michael, this is Heng Chen. We think that our loan growth would be about $1 billion. And absence any large net charge-offs, we probably would try to provide around $10 million for 2018, which it probably would start in Q2 based on when we know right now as to our levels.
Okay. Great. And maybe just on the deposits, the growth was good this quarter but what's kind of the outlook for next year in terms of deposit pricing pressure that you may see? And does that influence your NIM outlook of gradually increasing throughout the year?
Yes. I think it's a new world for us in terms of the Fed increasing, the fed funds futures imply three primary increases. And so far we have not had to increase our core deposit levels rates. And for the incremental funding, we have gone to the broker deposit market. I would think, at some point as we would, us and other banks will start to increase deposit rates, particularly in jumbo CDs and some of the larger money market balances. So we are sure and that's why I think our guidance, it's in that range of 3.7% to 3.8%.
Okay. Thank you.
Yes. Thank you.
Thank you. Our next question comes from Chris McGratty with KBW.
Hi. Good afternoon. Thanks for taking the question. Heng, as we start the year, could you help us, there is obviously a lot of moving parts in the fourth quarter, with how we should be thinking about expenses? I think in the call you said, in the prepared remarks you said, $20 million of amortization. I assume that's separate from the CDI. But any color on core expense growth? Thanks.
Yes. Well, first on the solar amortization, that looks to be almost all in the second half of the year based on the ramp up. Then on long term housing, we think it will be $5.5 million of expense per quarter starting in Q1. And then as to overall expense levels, our fourth quarter run rate has just a modest amount of cost saves from Far East. We think once the system conversion is completed and during the course of 2018 we would save around $8 million from Far East and one-time expenses, severance and conversion of $1.5 million to $2 million. So while there are a lot in there, we are thinking our core expenses, excluding the amortization, will go up around 4% for next year because we are getting the savings from Far East.
Okay. That's very helpful. Maybe a follow-up on the securities yield, the improvement in the quarter. I am interested in whether any of that was driven by prepayment, material changes in prepayment fees? And also maybe how we should be thinking about the size and where incremental money is being put to work given the move up in rates? Thanks.
Yes. We have switched mainly to a 15-year MBS portfolio. We are gradually shifting to that and that tends not have a lot of prepayments versus 30-year MBS. And then in terms of the size, we have about $300 million in treasuries at the end of the year. So we are going to move $100 million of the treasuries into MBS. And in terms of the pace of investments, for the first half of the year, we are going to invest about $50 million per month. So that would imply a net growth in the securities portfolio of about $200 million. And as a result, the cash at the Fed would go down by about $200 million.
Okay. So your loan growth was 8%, your earning asset growth might be a little bit below that just because of not a lot of growth in the securities books, net?
Yes.
Okay. Great. Thanks. Thanks for taking the question.
Sure. Yes.
Thank you. Our next question comes from Lana Chan with BMO Capital.
Hi. Good afternoon.
Hi Lana.
I just wanted to clarify a couple of things, Heng, that you spoke about. The expenses, you rattled off a couple of nonrecurring items. And I just wanted to, I couldn't keep up with the numbers, I want to see what the core expense run rate is for fourth quarter so we could grow off of that for 2018?
Yes. So in terms of the unusual expenses, we have the first $2.6 million write-down of low income housing. Most banks are on a proportionate amortization for low income housing. So that shows up in income tax expense. We are on equity method. So that shows up in noninterest expense.
Okay.
And then we have a $1.8 million catch-up adjustment for low income housing. And then $900,000 in solar tax credit investments where we made those investments when they were at 35% federal tax rate. And if you factor in 21% federal tax rate, those impairment there was $900,000. And then we had a one-time legal settlement in the fourth quarter from some long-standing claims of $950,000. So those are the general one-time things.
And there were immigration expenses, you said. That was also one-time?
Yes. It's in the income statement on the press release, but it's $844,000.
Okay. And in terms of the margin, the 3.70% to 3.805, what are you assuming in terms $fed rate hikes in that range?
3%, that's what the Fed fund future is showing, yes.
3%, you said?
3%.
Okay. And then lastly, in terms of capital return, obviously you guys still have very strong capital ratios. Can you talk about priorities in terms of capital deployment?
Well, Pin may add in, but I think, first, we think we have pretty good loan growth. So that's our first priority. If we can have higher than 8% loan growth, we would be good. Then the second one is, we would increase our dividends probably in the second half of the year. We normally payout 40% of our earnings and with the higher, because the tax rate is lower, our earnings are going to be higher. And then I think acquisitions are a possibility, but we are focused, we want franchises with true longevity and customer base, particularly in deposits. And so there aren't that many that would be Chinese. And then buyback. I think we are probably not going to be buying back our stock at the current levels.
Okay. Thank you.
Thank you.
Thank you. Our next question comes from Aaron Deer with Sandler O'Neill.
Hi. Good afternoon guys.
Hi Aaron.
Maybe just a follow-up on that. You have certainly talked about M&A strategy for a while. It sounds as though maybe there are names that you have in mind that could be potential take-out candidates. Is that true? Or is this something that you guys are thinking strategically? Or is just kind of, I don't know, more abstract?
Well, we are always open to possibility of acquisition. However, we are very carefully picking the target. We want to make sure that it is good match for us. It's synergy acquisition to earnings. So given all these condition, there aren't too many in the marketplace right now.
Okay. And then with respect to the expectations for loan growth, I think you said around 8% again this year is kind of what you are looking for? Any change in terms of the mix in terms of which portfolios you expect to see the best growth? Or is it going to be similar to what we saw in 2017 based on where your focus is today?
I think the most promising in terms of growth is residential mortgage. We did very well in 2017. And we still have a very good solid pipeline. Another area of growth is C&I. We probably see results from our expansion into oil and gas industry and also we are acquiring, recruiting experienced relationship managers. So we start to see the outcome, results coming up on those new hires.
That's great. Okay. Thank you for taking my questions.
Thank you.
Thank you. Our next question comes from Matthew Clark with Piper Jaffray. Mr. Clark, if you are on mute, please unmute your line.
Got it. Thank you. Good afternoon. Just a question on loan pricing. It looks like your core loan yields were up a basis point linked quarter. You talked about the source of loan growth going forward. But just trying to get a good sense for kind of what you are seeing in terms of new business and rates? And also whether or not you are shying away from some sectors or asset classes?
I think it's still very competitive in terms of the loan market. So we see a new squeeze in the interest margin for the new loan coming in. There's many banks sitting on the new loans. So I would say, even the great pricing environment, we see income slope in new loan asset. But it won't be too significant, I guess, is our guess based on the competition.
Yes. I think sometimes I get involved in loan pricing as well, but one of the good things about our loan base is that so many of our loans are longer-term loans like residential mortgage. You know, we haven't seen much, it's a normal pricing that links to five-year treasuries which is kind of where we land. And then on CRE, bulk of our loans tend to be five-year or multiyear loans. So we may see places where there is fairly competitive pricing on a couple of customers. But we have a big legacy book that will carry pretty good spreads. So we want to do what's right for the shareholders in terms of offering leverage and having net interest income continue to grow.
Okay. And then the types of mortgage you are putting on you are putting on balance sheet, I assume they all ARMs, 5/1s, 3/1s, 7/1s?
For residential mortgage, yes, primarily 3/1 and 5/1 offers. We do some 15-year fixed.
Okay. And just on the reserve coverage relatively stable at 96 basis points, but I think you have spoken in the past given the source of loan growth and the coverage you provide on residential mortgages, that coverage ratio should still come down. Could you just remind us what you are providing on the new family resi mortgage and CRE and C&I?
Well, for new single-family residential mortgage, it's probably about 40 basis points. And then I think C&I is probably closer to 1% all-in. And same thing with CRE. And then construction, it's a little bit higher because of our historical losses.
Got it. Okay. Thank you.
Thank you. [Operator Instructions]. Our next question comes from Jon Arfstrom with RBC Capital Markets.
Thanks. Good afternoon.
Hi. Thanks. Good afternoon.
Just as long as we are on the credit topic. It looks like nonaccrual loans were down nicely this quarter. Can you talk a little bit about what drove that improvement?
Well, we have sold off two notes. That's probably the primary driver. One was sold off in November from our Eastern region. And the second one, we moved to held for sale. And that sale closed a couple of weeks ago. Those are both par deals. We are happy.
Okay. Good. The one from the Eastern region, was that the one that popped up a couple of quarters ago?
Yes. They are both from the Eastern regions.
Okay. Good. That's good to hear. The CD growth, Pin, I think you talked about it a little earlier in terms of good growth there. It looks like there is little bit of pressure on the time deposit cost but not that material. Can you talk a little bit about how you are driving that growth?
Well, that's where we are using broker CDs that keep our net loans to deposit ratio at 100%. Because we have such strong loan growth in December, we went a little over 100%. But the CD market, it's a very broad market. We block out the two main states that we are in, California and New York. And so if we need to, we can generate easily $100 million per month. But we are at market rates which tend to be of treasuries plus 10 basis points or thereabouts.
Okay. Good. And then I guess last one for me, it seems like Far East is going well. Any surprises so far, positively or negatively? Or you should get the forecast, as was expected?
So far, there's no surprises. So it's ongoing. And then we will have the systems conversion in April. And then we will be able to generate more cost savings.
Yes. And then we also have some, I believe we moved one of the branches last week. It's right across the street from us. And then their main branches in downtown, it's pretty expensive in terms of operating expense because it's a whole four-story office building. So we moved most of the people out of there. And that branch is scheduled to close in the middle of February. So starting then, we will report those idle facilities as integration expense. So you will get, some investors will get ideas of the clean run rate.
Yes. Okay. Good. That makes sense. Thank you very much.
Thank you.
Thank you.
Thank you. I am showing no further questions in queue at this time. Thank you for your participation. I will 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 at our next quarterly earnings release date.
Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect and have a wonderful day.