Cathay General Bancorp: Mid-50% LTV Ratio Across All Real Estate Loans Is Attractive

Aug. 01, 2022 10:00 AM ETCathay General Bancorp (CATY)

Summary

  • Cathay General Bancorp focuses on the Asian population in California and New York.
  • The majority of its loan book appears to be low-risk, with a 52-55% average LTV ratio.
  • The dividend yield is relatively low at 3.2%, but that's mainly due to the low payout ratio of approximately 30%.
  • The premium of about 50% to the tangible book value is not low, but I think this premium valuation is warranted.
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Introduction

When I last discussed Cathay General Bancorp (NASDAQ:CATY) about six months ago, I liked the bank's low LTV ratio in both the commercial real estate portfolio as well as the residential mortgages portfolio (both are focused on California and New York). Of course, a lot has happened since that last article. Russia invaded Ukraine, interest rates have been hiked, and the economy is shrinking. While the share price is down just about 10% since my previous article, this is an opportune time to have a look at how the bank performed in the first semester.

Chart
Data by YCharts

The EPS remains strong thanks to low loan loss provisions

Looking at the Q2 results, the very first thing you see is the massive increase in the net interest income. We see an increase in excess of $17.5M in the interest income, while the total interest expenses increased by just over $1.5M. This caused the net interest income to increase by more than 10% to just over $175M. An impressive result.

Income Statement

Cathay General Bancorp Investor Relations

On the other hand, Cathay saw its net non-interest expenses increase from $52M to just under $60M. That's mainly due to the fact the bank was able to record a $6M gain on equity securities, while it lost almost $1M on securities during the second quarter. This $7M delta almost single-handedly explains the 'deteriorating' non-interest results, although we should just conclude there was a non-recurring benefit in the first quarter and the situation is now just normalizing.

Cathay General Bancorp recorded a $2.5M loan loss provision in the second quarter which resulted in a pre-tax income of $113.2M and a net income of just under $89M which worked out to be $1.19 per share.

The book value per share: surprisingly stable

While most other banks see their equity value (and thus book value per share) being hit by the lower value of the portfolio of securities classified as 'available for sale' due to the mandatory mark-to-market principle, Cathay seems to be immune for this. While the net book value is slightly lower than as of the end of FY 2021, keep in mind Cathay has been buying back stock and has been paying a dividend.

The current quarterly dividend is $0.34 per share which means the payout ratio is less than 30% but more importantly, it also means that given the EPS of $2.18 in the first semester, the book value per share would have increased by about $1.50.

This didn't happen. While there likely was some impact on the securities available for sale, we should also keep in mind the company repurchased in excess of 1.3 million shares in the first semester which would have carried a total cost of around $55-60M and keeping that in mind, the decrease of the book value by $15M is not bad at all.

In fact, it boosted the total book value per share as the share count decreased at a faster pace than the equity value did and as of the end of H1, Cathay's book value per share came in at $32.67. Keep in mind that in excess of 15% of the book value consists of goodwill and if we would deduct the $383M in goodwill and intangible assets from the $2.43B equity value, we end up with a tangible equity of $2.05B which works out to just over $27.5/share.

I'm also not too worried about the $17.8B loan book, despite seeing about 48% of the loans being classified as commercial real estate.

Total Loan Portfolio

Cathay General Bancorp Investor Relations

As explained in a previous article, Cathay's average LTV ratios are low. In the CRE portfolio, the average LTV ratio is just around 52% with only 28% of the loans exceeding an LTV ratio of 60%. We see a similar percentage in the residential mortgage portfolio, where the average LTV value of the $5.4B portfolio is just 55%. So even if all homes would suddenly drop in value by 50%, Cathay General would still be able to walk away without too much of a haircut. This means Cathay's loan book appears to be safer than most of its peers.

LTV Ratio

Cathay General Bancorp Investor Relations

Investment thesis

Cathay General's first semester was much stronger than I had anticipated. Much to my surprise, the bank was able to avoid the (sometimes big) hits to the equity value from the higher interest rates, causing the value of the securities available for sale to decrease. Other banks have suffered from this evolution, but Cathay's performance appears to be pretty robust.

While a share price of approximately 1.5 times the tangible book value may appear high, keep in mind Cathay is trading at an earnings multiple of less than 10 while the current 3.2% dividend yield only requires about 30% of the earnings to be spent on dividends. This means that - excluding the impact from changes in the value of securities, the book value will increase at a pace of $2.5-3 per share per year, and this rapidly reduces the premium to the tangible book value per share.

I currently have no position in Cathay General Bancorp, but I may try to write put options in the near future, although I should perhaps just buy the stock outright.

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This article was written by

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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