Cathay General Bancorp's (CATY) CEO Dunson Cheng on Q2 2016 Results - Earnings Call Transcript

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Cathay General Bancorp (NASDAQ:CATY)

Q2 2016 Earnings Conference Call

July 20, 2016 06:00 PM ET

Executives

Monica Chen - IR

Dunson Cheng - Chairman of the Board and CEO

Heng Chen - EVP and CFO

Analysts

Aaron Deer - Sandler O'Neill and Partners

Chris McGratty - KBW

Matthew Clark - Piper Jaffray

Joe Morford - RBC Capital Markets

Lana Chan - BMO Capital Markets

Operator

Good afternoon, ladies and gentlemen, and welcome to Cathay General Bancorp's Second Quarter 2016 Earnings Conference Call. My name is Latif and I'll 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 will like to turn the call over to Monica Chen, Investor Relations for Cathay General Bancorp.

Monica Chen

Thank you, Latif, and good afternoon. Here to discuss the financial results today are Mr. Dunson Cheng, our Chairman of the Board 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, 2015, 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 earnings release outlining its second quarter 2016 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 Chairman of the Board and CEO, Mr. Dunson Cheng.

Dunson Cheng

Thank you Monica, welcome to our 2016 second quarter earnings conference call. This afternoon we reported net income of $34.8 million for the second quarter of 2016, a 23% decrease when compared to a net income of $45.2 million for the second quarter of 2015. Diluted earnings per share decreased 21% to $0.44 per share for the second quarter of 2016 compared to $0.56 a share for the same quarter a year ago. The decrease in net income compared to the same quarter a year ago is primarily due to an increase of $20.8 million in amortization of investment in alternative energy partnerships as a result of the rapid installation of solar systems from our investments made in March 2016. The actual alternative energy partnership amortization was $8.8 million higher than the $15 million estimate in the first quarter conference call but our estimate for this amortization for the second half of 2016 is lower by around the same amount. This change in timing of amortization expense reduced second-quarter earnings per share by $0.06.

On July 8, 2016 we signed a sign purchase agreement to acquire SinoPac Bancorp, the U.S. holding company of Far East National Bank for $340 million subject to certain adjustments. We are very excited about the transaction to acquire Far East National Bank and the additional scale strengthens our branch networks and franchise in California and the opportunity to deploy a portion of our capital to generate strong returns. Cathay bank and Far East National Bank share similar attributes and business value and we look forward to servicing customers of Far East National Bank and hope they will enjoy the additional product and services at Cathay bank has to offer. The transaction is priced at $1.26 of stated book value at March 31, [indiscernible] and expected to be approximately 4% to 5% accretive to Cathay's GAAP earnings per share for 2018, excluding any one-time transaction costs and restructuring charges.

Also in the second quarter of 2016, our total loans grew $162 million to $10.5 billion or an increase of 6% on annualized basis. The net increases in loan resulted primarily from commercial real estate and residential mortgage loans which grew by $103 million or 20% annualized and $68 million or 6.2% annualized respectively. And construction loans grew by $28 million or 25% annualized. Commercial loans decreased by $53 [ph] million or 11.2% annualized as new loan originations were lower than continued high pay downs and payoffs. We still expect total loan growth to be in the range of 7% to 8% for the full year of 2016. For the second quarter of 2016, our total deposits increased by $147 million or 1.4% to $10.5 billion, due to an increase in non-interest bearing demand deposit of $129 million and an increase in our money market deposits of $143 million compared to the first quarter of 2016. Our core deposit also grew by $230 million or 8.6% annualized.

With that, I will turn the floor over to Executive Vice President and CFO Heng Chen to discuss the second quarter results in more detail.

Heng Chen

Thank you Dunson and good afternoon everyone. For the second quarter, we announced net income of $34.8 million or $0.44 per share. Our net interest margin was 3.38% in the second quarter of 2016 as compared to 3.51% in the second quarter of 2015 and 3.42% for the first quarter of 2016. In the second quarter of 2016, interest recoveries and prepayment penalties added 4 basis points to the net interest margin compared to 9 basis points for the first quarter of 2016 and 9 basis points for the second quarter of 2015. The net interest margin also decreased due to the impact of the special federal home loan bank dividend received in the second quarter of 2015. And decreased 5 basis points due to higher cash balances at the Federal Reserve Bank in the second quarter of 2016. In late August 2016, we will have $50 million of structured repos at a rate of 2.69% that will mature.

Also in January 2017, we will have $200 million of structured repos at 5% which will mature and would improve the net interest margin by 13 basis points on a run rate basis. Non-interest income in the second quarter of 2016 was $9.1 million. Non-interest expense increased by $21.3 million or 44.7% to $68.9 million in the second quarter of 2016 as compared to $47.6 million in the same quarter a year ago. The increase was mainly due to an increase in amortization of alternative energy investment of $20.8 million during the second quarter of 2016. For the full year 2016, we expect amortization of alternative energy funds of approximately $27 million of which $1.2 million was recorded in the first quarter, $23.8 million was recorded in the second quarter and approximately $2 million will be recorded in the third quarter.

The effective tax rate for the second quarter of 2016 was 26.1% and we expect that the effective tax rate for the remaining two quarters of 2016 would be approximately 26.5%. At June 30, 2016, our tier 1 leverage capital ratio decreased to [ph] 11.8%, our tier 1 risk-based capital ratio decreased to 13.84% and our total risk-based capital ratio decreased to 15.02% as compared to December 31, 2015. All ratios significantly exceeded well capitalized minimum ratios under all the regulatory guidelines. At June 30, 2016, our common equity tier 1 capital ratio was 12.77%. Net charge offs for the second quarter of 2016 was $6.5 million or 25 basis points of average loans. Net charge offs were $501,000 in the second quarter of 2015 and $8.1 million in the fourth quarter of 2015. Our gross loan loss recoveries during the second quarter of 2016 were $1.2 million and our gross charge offs were $7.6 million. Our loan reversal was $5.2 million for the second quarter of 2016 compared to $2.2 million for the second quarter of 2015 and $3.0 million for the fourth quarter of 2015. Our non-accrual loans increased by 10.3% or $5.3 million during the second quarter to $57.5 million or 0.55% of period end loans as compared to the fourth quarter of 2015.

Dunson Cheng

Thank you Heng, we now will proceed to the Q&A portion of the call.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Aaron Deer of Sandler O'Neill and Partners. Your line is open.

Aaron Deer

Dunson, you gave your expectations with the guidance kind of the same for full-year loan growth. So I'm just kind of wondering what the - how are you thinking about what the mix is likely to be, it seems like recently it's mostly been on the commercial real estate and single family side, as you kind of look at the pipeline and what's coming in, should we expect any sort of improvements in terms of the C&I growth going forward?

Dunson Cheng

Aaron, my expectation of loan growth for the year remains about the same and the mix as you observe is that much of the growth would center around CRE and also single family [indiscernible] has been quite challenging to go to C&I portfolio for several reasons. Of course the economy going so slowly, does not induce a quick loan growth in C&I. We also noticed the retail sector of the economy has been quite slow and we do you have a number of our customers that are in the trade business and connected with apparel industry and some of the consumer electronics. We are seeing them use - the usage of their lines being a little bit slower. On the other hand, we mentioned last year that we have formed a new C&I team under the leadership of Kelly Wu, who we moved from a different bank and Mr. Wu is in the ramp up phase of his team and we expect that he and his team will contribute in the second half of this year and so we are hopeful that the C&I portfolio will be stabilized and will grow slowly from there on.

Aaron Deer

That's great. Thank you, Dunson. And then for a second question, Heng, I know last quarter there was, in the first quarter, there was some kind of outsized numbers, outsized operating expenses in the comp line. But even kind of adjusting for, I thought those were, the compensation was much lower than I expected this quarter. Is there anything unusual there or what should we kind of expect for a run rate going forward?

Heng Chen

Yeah. I think the run rate for the comp expense should be a couple of million higher in Q3 and Q4. We accrue our, I mentioned in the first quarter that, because the pre-tax income was very strong, we accrued more than normal for the 2016 bonuses. We also had about 2.5 million adjustment for the 2015 bonuses that were not fully accrued. So, the first quarter was higher for those reasons. The second quarter, because of, once again, this large charge for the amortization we accrued less in the way of 2016 bonuses and then in the third and fourth quarter, we'll go to a more normal run rate, which would be a couple of million per quarter higher.

Aaron Deer

Got you. Thank you very much.

Heng Chen

Sure. Thank you.

Operator

Thank you. Our next question comes from Chris McGratty of KBW. Your line is open.

Chris McGratty

Hi, good afternoon. Thanks for taking the question. Maybe we start with credit quality. Can you, obviously, the reserve ratio impacted when the deal closes, but interested in your commentary about near term provisioning requirements, whether the pipeline for recoveries is still there at all and where you're comfortable in this environment, taking the reserve. Thank you.

Heng Chen

Yeah. We see, we are on a five year migration system. So as the losses from 2011 drop off, we would get some pressure to reverse the - to lower the allowance. So we see that continuing in the third quarter and then the - our charge-offs, both in the third and fourth quarter last year as well as so far this year have mainly been in commercial loans. So, we think those, for the most part are unique situations. So we don't, particularly here in the second quarter, we had a large charge-off that came out of a Hong Kong branch. So it was kind of unique to what happened there.

So, we think our domestic portfolio is holding up, domestic C&I portfolio is holding up well. So, before I have said that any gross recoveries will result in a negative provision and so we still generally see around 1 million a quarter of gross recoveries and then to the extent that the migration in our loss factors would force us to book a negative provision, we see some trend continuing for the rest of this year. But in 2017, that's not going to happen again.

Chris McGratty

Okay. So lower negative provisioning for the back half of the year and then at some point in ‘17, we turn positive again. Is that a right way to think about Heng?

Heng Chen

Yes. Yes. Hopefully not too much.

Chris McGratty

Understood. Maybe we switch to the margin, if you don't mind. I'm interested, could you repeat the, I got the 200 million of structured borrowings at 5%, that roll off in January. There was another one you mentioned, could you repeat that for me?

Heng Chen

Yes. It was 50 million that rolls off in late August and that's a 2.69%

Chris McGratty

Okay. So if I think about those and then also kind of what's happened in the yield curve, getting flatter and bets on futures market really indicating not much movement, how should we, as analysts and investors, be thinking about the trajectory of your NIM looking out over the next few quarters? Thank you.

Heng Chen

Well, I think I try not to give guidance too much on the NIM, because it's been tough to get to close to 3.40, but we're optimistic that we'll hold there until January and then we'll get this 13 basis points pop. We were holding a higher excess cash balances at the fed for a couple of months in Q2. So, we're gradually investing that and also hopefully having a stronger loan growth.

Chris McGratty

Great. Thanks for taking the question.

Operator

Thank you. Our next question comes from Matthew Clark of Piper Jaffray. Your question please.

Matthew Clark

Good afternoon. Hey, Heng, maybe just as we look out in to next year and thinking about the tax credit investments that you probably re-up and how should we think about that related amortization in the tax rate next year?

Heng Chen

Well, we were surprised at how fast our investment got put to work. So next year, we will split that in two. So we will - hopefully, it will be in Q1 and Q3. So the amortization will be closer to maybe 6 million each quarter. And then, we have been ramping up our low income housing investments. So that's going to help our tax rate. So we think that the tax rate will be probably about 27.5% next year for the full year.

Matthew Clark

Okay, great. And then on the buyback, I think on the call you had mentioned, suspended until the deal closes, fair to assume that re-up in the second half of next year.

Heng Chen

Yes. It's dependent on our stock price, but we are, that the Far East National Bank transaction uses up about 110 basis points of our capital ratio, but we want to target a higher cap or some portion of our total return to shareholders will come in the form of buyback. So, it should come in in the second half of next year.

Matthew Clark

Okay. And then just also the increase in non-performers this quarter, just curious?

Heng Chen

I think I'm trying to think it was CRE from what I recall. There is nothing really unique that I could think of.

Matthew Clark

Okay, thank you.

Operator

Thank you. Our next question comes from Joe Morford of RBC Capital Markets. Your line is open.

Joe Morford

Thanks. Good afternoon. Really, my questions have been asked already. I guess just the one follow-up would be on the C&I loan growth. You talked about some softness in the, I think you said, in manufacturing and apparel business. I just wondered if, is that something you see continuing for a while and as back half as you see growth, is that just from the new team or do you see some of this activity picking up as well?

Dunson Cheng

Joe, from my perspective, I'm seeing the C&I portfolio as currently instituted should be stabilizing over the third quarter and then hopefully also at the same time that our new team will be contributing to the loan growth. So I'm really hoping that the third quarter will be stabilized and in the third quarter, typically, we see our trade customer reduce their lines to pay for their inventory AR. So, I believe the second half of this year, the C&I loans should be stabilized and perhaps growing a bit.

Joe Morford

Okay. Thanks so much.

Operator

[Operator Instructions] Our next question comes from the line of Lana Chan of BMO Capital Markets. Your question please.

Lana Chan

Hi, good afternoon. Just one quick question on the securities portfolio, took that down a bit this quarter, I'm assuming just given the rate environment here, what should we expect in terms of investments there and as the structured repos matures that also paying down some of the securities further or letting those runoff?

Heng Chen

Yeah. Lana, we've been buying one-year treasuries here in the second quarter, because you can tell from the security gains, we sold about 150 million of MBS to book the gains. It wasn't so much, it was part of keeping ourselves fairly asset sensitive. But we have, between the August maturity and the January maturity, we will have 250 million of borrowings that will mature and we'll, I think most likely, we'll just - unless rates increase, we'll shrink our securities portfolio. And then to the extent we need to maintain certain liquidity ratios, we'll just leave it in cash at the fed because given how flat the yield curve is going out to 5 years.

Lana Chan

Yes. Okay. And any change recently again with the flatter yield curve, any change recently in loan pricing, specifically on the CRE resi mortgage side?

Heng Chen

No. We'd still target 315 basis points over treasuries for our 5-year fixed rate loans and I guess the good news is that, that demand has sort of spread out. So, we don't, interest rates were very low around the BREXIT time. We didn't have hundreds of millions of dollars of loans rate-locked. So they're generally spread out throughout the quarter. The - we're generally in other portfolios, we're maintaining our past pricing.

Lana Chan

Okay. Thanks, Heng.

Operator

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

Dunson Cheng

Thank you and thank you again for joining us for this call and we look forward to talking to you again next quarter. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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