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Executives

Monica Chen - IR

Dunson Cheng - Chairman, President and CEO

Heng Chen - EVP, Treasurer, and CFO

Analysts

Aaron Deer - Sandler O'Neill

Joe Morford - RBC Capital Markets

Brett Rabatin - Sterne Agee

Herman Chan - Wells Fargo Securities

Julianna Balicka - KBW

Cathay General Bancorp (CATY) Q3 2013 Earnings Conference Call October 21, 2013 6:00 PM ET

Operator

Good afternoon ladies and gentlemen, and welcome to the Cathay General Bancorp's Third Quarter 2013 Earnings Conference Call. My name is Philip, and I will 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, I would like to turn the call over to Monica Chen, Investor Relations for Cathay General Bancorp.

Monica Chen

Thank you, Philip, and good afternoon. Here to discuss the financial results today are Mr. Dunson Cheng, our Chairman of the Board, 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 of this call may make forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 concerning future results and events, and that these statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are further described in the company's Annual Report on Form 10-K for the year ended December 31, 2012, at Item 1A in particular; and in other reports and filings with the Securities and Exchange Commission from time-to-time. As such, we caution you not to place undue reliance on such forward-looking statements, which speak only as of the date of this presentation. We undertake no obligation to update any forward-looking statements or to publicly announce any revision of any forward-looking statements to reflect future developments or events, except as required by law.

This afternoon, Cathay General Bancorp issued an earning release outlining its third quarter 2013 results. To obtain the copy, please visit our website at www.cathaygeneralbancorp.com. After comments by management today, we will open up this call for questions.

I will now turn the call over to our Chairman of the Board, President, and CEO, Mr. Dunson Cheng.

Dunson Cheng

Thank you, Monica, and good afternoon. Welcome to our 2013 third quarter earnings conference call. This afternoon, Cathay General Bancorp reported net income of $32.5 million for the third quarter of 2013 or $0.38 per common share. That compared to a net income of $30.4 million or $0.33 per common share for the third quarter of 2012, and $29.9 million or $0.35 per common share for the second quarter of 2013.

We are very pleased that our retained earnings and liquidity are sufficient to allow ourselves to complete the repayment of the Bancorp's remaining TARP preferred stock on September 30, 2013. After repayment, our capital ratios remain strong. Our Tier 1 risk-based capital ratio was 14.9%, total risk-based capital of 16.67% and Tier 1 leveraged capital ratio of 12.35%.

In the third quarter, we experienced solid loan growth. Gross loans increased $138 million in the quarter or a 7.2% increase from the second quarter of 2013. For the first nine months of 2013, loans increased by $403 million or 5.4%. In the third quarter, our commercial loans increased by $27 million, construction loans by $36 million, commercial mortgage loans increased by $12 million, and residential mortgages increased by $69 million.

Originations on residential mortgages were about the same for the second and third quarter, but there was a slowdown in payoff in the third quarter, so the net growth of residential mortgages in Q3 exceeded that of the same quarter of $41 million. New CRE origination was good, but payoffs reduced the net increase. Our current expectation for loan growth for the entire year is still 7%.

For the third quarter of 2013, our total deposits increased $208 million or 2.7% from $7.7 million at June 30, 2013, most of the increase centered around MMA accounts. In July, we signed an agreement to open an additional branch in Brooklyn, which is expected to take place in the first quarter of 2014. Our other new branches, West Covina, is projected to open before the end of this year.

Net recoveries for the third quarter of 2013 was $3.6 million compared to net charge-off of $7.7 million in the same quarter a year ago. Our loan loss provision was a credit of $3 million for the third quarter compared to zero in the second quarter a year ago. Our non-accrual loans increased 4.4% or $4.2 million during the third quarter of $99.9 million or --- during the third quarter to $99.9 million or 1.27% of period-end loans.

On July 15, we successfully completed a 24-month effort to upgrade our computer system to a new core. We expect the new system will provide quicker functionality and allow us to streamline our internal processes in all of our operational areas; and therefore, to improve our efficiency ratio as well.

With that, I’ll turn the call over to our Executive Vice President and CFO, Heng Chen, to discuss the third quarter 2013 financials in more detail.

Heng Chen

Thank you, Dunson, and good afternoon everyone. For the third quarter, we announced net income of $32.5 million or $0.38 per share. Included in third quarter results were $6.9 million in prepayment penalties as well as $8.7 million in security gains. Our net interest margin was 3.35% in the third quarter of 2013 compared to 3.30% in the second quarter of 2013 and compared to 3.26% for the third quarter of 2012.

During the third quarter, interest recoveries and adjustments added 6 basis points to the net interest margin, whereas during the second quarter, interest recoveries only added 3 basis points to the margin. In the third quarter of 2013, we prepaid $150 million of structural repos with an average rate of 3.43% with a prepayment costs of $6.9 million.

Looking forward, from July 2014 to January 2015, $400 million of structural repos, with an average rate of 3.85% are scheduled to mature, which will help improve our future net interest margin.

Non-interest income during the third quarter of 2013 was $16.7 million, including $8.7 million of securities gains, which offset the $6.9 million prepayment penalties incurred during the third quarter. Non-interest expense, excluding costs associated with redemption of debt increased $0.6 million to $43.8 million in the third quarter of 2013, compared to $44.4 million in the same quarter a year ago. The decrease was due to $5.6 million decrease in litigation accrual expense in the prior year, which was partially offset by $4.3 million increase in salary, bonus, and employee benefits expense.

During the third quarter, expenses related to the core conversion were $1.1 million, compared to $2.6 million for the second quarter. At September 30, 2013, our Tier 1 leveraged capital ratio decreased to 12.35% and our Tier 1 risk-based capital ratio decreased to 14.9% and total risk-based capital ratio decreased to 16.67% as a result of repayment of the remainder of our TARP preferred stock. All ratios significantly exceeded well-capitalized minimum ratios under all the regulatory guidelines.

At September 30, 2013, our Tier 1 common risk-based capital ratio was 13.35%. Our classified assets ratio for Cathay Bank increased to 32.2% at September 30, 2013, compared to 31% at June 30, 2013. Loans rated substandard or worse decreased from $411 million at June 30, 2013, to $402 million at September 30, 2013. Net recoveries for the third quarter of 2013 totaled $3.6 million or 0.18% of average loans compared to net recoveries of 0.05% of loans during the second quarter of 2013. The provision for credit losses was a negative provision of $3 million compared to zero for the second quarter of 2013 and zero in the same quarter a year ago. Total non-accruals increased by 4.4% or $4.3 million to $99.9 million at September 30, 2013, compared to $95.6 million at June 30, 2013.

Dunson Cheng

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

Question-and-Answer Session

Operator

All right. Ladies and gentlemen, we are ready to open the lines up for your questions. (Operator Instructions). Your first question comes from the line of Aaron Deer from Sandler O'Neill and Partners. Please proceed.

Aaron Deer - Sandler O'Neill

Good afternoon guys.

Dunson Cheng

Hi Aaron.

Heng Chen

Hi.

Aaron Deer - Sandler O'Neill

It looks like your residential mortgage and construction books showed some good growth, and you gave some color on the residential mortgage where that was a little better. But C&I and CRE slowed a lot. I am wondering, what kind of pipelines you are seeing for each of those categories, and can you talk a little bit about what types of construction opportunities you are seeing?

Dunson Cheng

Yes. First of all, the single-family mortgages, the origination, as I mentioned was about the same for two quarters, and you may know that the bank has a smart mortgage program which is a limited verification program, and that has been going on for a number of years, and this doesn't seem to slow down in the third quarter, and so -- also, that program, we have experienced very small delinquency, and the way that we understand from the most pronouncement from CFPB on qualifying mortgages, that there might be some flexibility in retaining our Smart Mortgage program in the future with some modifications.

At this point in time, we are in the process of discussing how our smart mortgage program can be modified, so that it would satisfy the requirement of CFPB. So with regard to single-family mortgages, there is some flexibility at this point in time, but we are not yet ready to say that how this program may change in the future.

With regard to the pipelines of the other types of loans that we have and typically for C&I loans, we are pretty much focused on import-export, trading (inaudible) area and the selling season of our stocking up season typically is in the second and third quarter and the selling season of course during Christmas. So what we see is that the C&I portfolio would most likely stay about the same at the third quarter and then experience payoff later in the fourth quarter and in the first quarter of every year.

And with regard to commercial loans, we have good growth in the third quarter and we are projecting that in the future, this quarter and beyond, we should still be seeing more origination in construction loans.

With regards to CRE term loans, the loan demand is still quite good, but we are seeing a heavier payoff in the third quarter because of competition, and so on one hand, we are busy doing new loans and on the other hand, we are busy defending our existing portfolio.

So in whole, as I mentioned in my prepared statement, we still project our loan growth for the entire year of 7%.

Aaron Deer - Sandler O'Neill

Okay. That's great. Thank you. And then on the credit side, even though you have got very big reserves and have obviously been booking recoveries, it seems like the non-accruals maybe aren't coming down as fast, as I am sure, you'd like. What do you think is holding up the pace of improvement, and can we expect that to start to trend downward at a better pace going forward?

Heng Chen

Yeah Aaron, this is Heng Chen. We had a couple of -- three -- several loans that went non-accrual. The biggest one was a commercial real estate project in West Hollywood, that was about $9 million. Since – it went non-accrual late in the third quarter, and that we paid -- it was paid off a few weeks ago. So -- and we are hopeful that we will have another $10 million or so of paydowns in the fourth quarter on top of that. So there will be, I think, a decent reduction in non-accruals in the fourth quarter.

Dunson Cheng

This is Dunson Cheng. The other one that went under non-accrual is a loan regarding solar project, but this one is on the way of being worked down, and the reason why -- the key was in some of the non-accrued loans, it's because many of them are CRE in nature, and they have to go through the bankruptcy process, and that would most likely take a little bit over two years, and at this point in time, the time is up for many of those loans, we are hopeful that in the future, we will see a bigger reduction in our non-accruals.

Aaron Deer - Sandler O'Neill

That's great. Thanks for taking my questions.

Dunson Cheng

Thanks Aaron.

Operator

And your next question comes from the line of Joe Morford from RBC Capital Markets. Please proceed.

Joe Morford - RBC Capital Markets

Thanks. Good afternoon everyone.

Dunson Cheng

Hi Joe.

Heng Chen

Hi Joe.

Joe Morford - RBC Capital Markets

Hi there. I was just, I guess looking for little additional thoughts on the outlook for the margin, and should we continue to see some further debt repayments in the fourth quarter, any restructurings there, and are you still looking for about a four basis point pickup from TARP?

Heng Chen

Joe, in sort of a -- in kind of the order of your questions; one, we don't think we are going to prepay any more in the fourth quarter or in the first half of next year, except if we have a lot of -- if we have a onetime credit -- a favorable credit event. One, we still have security gains, but they are getting fewer, so we don't want to spend all of that; and two, just by itself, we have $400 million that if we don't do anything by the January of 2015, they will be paid off and there will be a pretty good sized improvement in the margin. I did some back of the envelope estimates, that $400 million right now, we have -- about $400 million are treasury securities that are yielding only 10 basis points. So when that all matures, there is a 33 basis point improvement in the margin, by Q4 next year.

So we don't need to do much, I think time will just take care of that. I think I have missed something, and the TARP repayment, that's only two basis points to the margin, Joe. Four basis points was for all $258 million.

Joe Morford - RBC Capital Markets

Right. Okay. Then lastly, with the follow-up expenses on the conversion, are you still targeting about a $2.5 million total quarterly cost savings on that, and -- maybe I missed what you captured this quarter?

Heng Chen

Yeah. It went down to $1.6 million in the third quarter, and so in the fourth quarter, it should be zero. So we will just have a clean run-rate, with no conversion expense. So $1.6 million to zero in the fourth quarter, yeah, go ahead, yeah.

Joe Morford - RBC Capital Markets

No, that's all I needed. Thanks so much.

Heng Chen

Yeah. Thank you, Joe.

Operator

Okay. And your next question comes from the line of Brett Rabatin from Sterne Agee. Please proceed.

Brett Rabatin - Sterne Agee

Hi. Good afternoon.

Heng Chen

Hi Brett.

Dunson Cheng

Hi Brett.

Brett Rabatin - Sterne Agee

Wanted to ask -- maybe a follow-up to Joe's question on just the margin, and thinking about that at least -- $450 million reprice of the borrowings over the next six months. Do you just let those roll-off and then replace some, or what are your plans with the relative size of the balance sheet and do you plan to continue to shrink the securities book and if not, what's the plan for excess capital?

Heng Chen

Yeah it's -- Brett, it's actually $400 million and they start maturing in July of next year, and then they finish maturing, like on January 15 of 2015. So we are not going to enter the new borrowings, because we think interest rates are going to go up. So that will help the leverage ratio, but it won't have much of an impact on risk-based capital. So in terms of what we will do with the capital, first, we like to raise the dividend, starting in the fourth quarter. We are in the process of devaluing that to $0.05 a quarter, for a couple of quarters, and then go back to our historical rate of $0.105.

Then, we have buybacks, but with bank stock prices at four or five years high, that's a less attractive use of capital. So we will continue to try to grow our loans and selectively look at cash acquisitions of smaller banks.

Brett Rabatin - Sterne Agee

Okay. And maybe as a follow-up, just your thoughts on the M&A market, as you see new opportunities?

Dunson Cheng

Yeah, this is Dunson Cheng. As I mentioned, we are more interested in looking at the smaller banks, and there's always some conversation going around, but although at this time, there is nothing that we can announce.

Brett Rabatin - Sterne Agee

Right, okay. Thanks for the color.

Dunson Cheng

Thank you.

Operator

(Operator Instructions). Your next question comes from the line of Herman Chan from Wells Fargo Securities. Please proceed.

Herman Chan - Wells Fargo Securities

Thanks. Another question on credit. With narrowing credit losses, you are seeing a pickup in recoveries and also your healthy reserve, how should we think about provision expense in 2014?

Heng Chen

Herman, this is Heng Chen. I think generally, if we have net recoveries, we would book a negative provision equal to that amount, and if things go well, we are hopeful that at fourth quarter, we will have net recoveries, and then we have -- we still have about $40 million or $50 million of these B, AB note splits, where the B note has been charged-off. So we think they will come in over time. This quarter we had two of them, I believe, one or two of them. So that was the bulk of the recovery.

So in terms of reserve need, we are moving to, where more and more of the reserve is supported by general environmental factors, because the migration itself is off of the last four quarters of net charge-offs, and that number is pretty low for us. So long story short, as our loans grow, we don't think we will have to provide for a while, and that percentage of the reserve to loans will [drift] down over the next couple of years.

Herman Chan - Wells Fargo Securities

Understood. Thanks for that. And can you give us an update on pricing and what you are seeing there from new originations? Have you seen some improvement on pricing with the pickup of the belly at the curve?

Dunson Cheng

No. We have not seen any improvement in pickup of pricing. The competition is still very keen outside and -- especially for C&I loans. So -- however, I don't think that deterioration is going to be significant from this point onwards. However, it's really difficult to tell, but the competition is still there and there are not that many new businesses formations, I think that's one of the problem.

Heng Chen

Yeah Herman, we are generally giving 300 basis points over the five year treasury for fixed rate loans, that's sort of our target, and to the extent that the five year moves up in the future, that will make things better. But there has been a recent pullback in interest rates, so that has had a factor as well.

Herman Chan - Wells Fargo Securities

Understood. Thanks a lot.

Dunson Cheng

Thank you.

Operator

(Operator Instructions). And your next question comes from the line of Julianna Balicka from KBW. Please proceed.

Julianna Balicka - KBW

Good afternoon.

Dunson Cheng

Hi Julia.

Heng Chen

Hi Julia.

Julianna Balicka - KBW

I have a couple of questions. One, in terms of just kind of elaborating more on your recovery expectations driving your net negative provision credit, do you have a pipeline where you can size up the expected recovery opportunity next few quarters, that you can share with us?

Heng Chen

Well, it's $40 million to $50 million, but that's a two to three year process. So it's not -- I mean, there is scheduled maturity dates, but some times the borrowers, even when you get there, they can't refinance and pay us off in full. But we are just waiting for the (inaudible) to continue to improve to realize all those B notes.

Julianna Balicka - KBW

Okay. Then on the expenses side, the $1.6 million flowing out next quarter is an immediate benefit, but kind of more going forward, the benefit from your improved operational streamlining that you referenced in your press release. Is there any additional expense optimization that we should be looking for?

Heng Chen

Yeah Julianna, it's Heng Chen, it's probably toward Q2 and Q3. It's the second half of next year. It's a new system, where we are kind of learning how to get familiar with it. Everything is -- there is quite a few differences and so in terms of prices, it should help us lower our headcount in our branch system, as well as how we underwrite credit, in terms of everything that is now being converted to -- all electronic format. But it will take time for that to show up in the expense level.

Dunson Cheng

Julianna, this is Dunson Cheng. Yes, there is a projected savings in expenses because of the (inaudible), on the other hand, we are seeing more and more new regulation coming down online, and that requires to put in little more defaulters in the backroom, and of course, we would like to see the bank to go on adding new branches, and that also offset part of the process in our new system.

Julianna Balicka - KBW

Makes sense. Okay. Then final question, for the two new branches that you have scheduled opening, and just kind of generally looking at your deposit kind of trajectory, what are your thoughts about sizing up the opportunity for new branches, and also, what kind of deposit growth are you thinking about for the next few quarters?

Dunson Cheng

Typically, we are projecting, in order to get to $30 million, $40 million in deposit, it would probably take two or three years, and that's why, we have been pretty active in trying to find branches that we can buy -- existing branches that we can buy with the existing customer base. So at this point, I think our projection for deposit growth for next year, organically, probably about 5% or so of the budget. We are trying to push the line units to hit 7%. Hopefully, we are not (inaudible). But it's 7%, that's the budget instructions at this time.

Julianna Balicka - KBW

Understood. Thank you very much.

Dunson Cheng

Thank you, Julianna.

Operator

Your next question comes from the line of Aaron Deer from Sandler O'Neill and Partners. Please proceed.

Aaron Deer - Sandler O'Neill

Hi. Just a quick follow-up on the expenses. If I am not mistaken, I think the CDI amortization from general bank comes to an end at the end of this year, what's the benefit of that going to be? I think it's around 1 million a quarter, is that right?

Heng Chen

Yes its -- the third quarter we had -- let's see. It's $1.4 million roughly. So that -- almost all of that goes away. I mean, we still have a little bit from the Las Vegas branch. But you can figure out that, let's say $1.3 million a quarter.

Aaron Deer - Sandler O'Neill

Okay. Very good. Thanks for the help.

Operator

Thank you everyone for your participation. I will now turn the call back over to Cathay General Bancorp’s management for closing remarks.

Dunson Cheng

Thank you for joining us on this call and we look forward to talking with you at our next quarterly earnings release that will be 2014.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation, and you may now disconnect. Have a great day.

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