Cathay General Bancorp Q2 FY2021 Earnings Call

Good afternoon, ladies and gentlemen. And welcome to Cathay General Bancorp’s Second Quarter 2021 Earnings Conference Call. My name is Paula, 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. 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, Paula, 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, 2020 at Item 1A in particular, and in all 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 second quarter 2021 results. To obtain a copy of our earnings release, as well as our earnings presentation, please visit our website at www.cathaygeneralbancorp.com. After comments by management today, we will open this call up for questions. I will now turn the call over to our President and Chief Executive Officer, Mr. Chang Liu.

Thank you, Georgia, and good afternoon, everyone. Welcome to our 2021 second quarter earnings conference call. This afternoon we reported net income of $77.2 million for the second quarter of 2021, a 5.2% increase, compared to a net income of $73.4 million for the first quarter of 2021. Diluted earnings per share increased 42.6% to $0.97 per share for the second quarter of 2021, compared to $0.68 per share for the same quarter a year ago. In the second quarter of 2021, our gross loans excluding PPP loans increased by $134.4 million to $15.5 billion, which represents an annualized growth rate of 3.4%. The increase in loans for the second quarter of 2021 was primarily driven by increases of $72.3 million or 11.1% annualized in commercial loans excluding PPP loans and $65.6 million or 3.5% annualized in commercial real estate loans. We continue to expect full year loan growth excluding PPP loans of between 3% and 5%. During the second quarter of 2021, $118.5 million of PPP loans were forgiven. As of June 30, 2021, our deferred PPP loan fees were $8.8 million. We continue to monitor our commercial real estate loans. Turning to slide seven of our earnings presentation, as of June 30, 2021, the average loan to value of our CRE loans was 51%. As of June 30, 2021, CRE loans with an aggregate balance of $92 million or approximately 1.2% of our CRE loan portfolio remain on loan modifications to provide relief on repayment terms. All loans under loan modification continue to make interest payments. As of June 30, 2021, our retail property loan portfolio comprises 23% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. The majority, 61%, of the $1.72 billion in retail loans is secured by neighborhood mixed-use or strip centers and only 10% secured by shopping centers. For the second quarter of 2021, we reported net charge-offs of $7.3 million, compared to net charge-offs of $7.8 million in the first quarter of 2021. Our second quarter charge-offs included an oil and gas loan charge-off of $4.4 million and a commercial loan charge-off of $1.7 million from our Hong Kong office. Our non-accrual loans were 0.42% of total loans as of June 30, 2021, decreased by $26.7 million to $67.8 million as compared to the end of the first quarter of 2021. The decrease was primarily due to a sale of an $18.8 million oil and gas loan at a discount of $4.4 million and a payoff of a $10.1 million commercial real estate loan in April 2021. Our total oil and gas loan portfolio was $113 million as of June 30, 2021, and no loan was rated substandard. Please see page 11 of our earnings presentation. We recognized a reversal for credit loss of $9 million in the second quarter of 2021, as compared to $13.6 million reversal provision for credit losses in the first quarter of 2021. The reversal for credit losses of $9 million reflected a continuing improvement in economic forecast made in June 2021 compared to the forecast made in March 2021 by the economic forecasts used in our CECL process. Turning to slide 12, total average deposits increased by $348.7 million or 8.7% during the second quarter of 2021. Average time deposit decreased by $369.5 million or 23.1% due mainly to the run-off of broker CDs. Under the company’s $75 million April 1, 2021 buyback program, we repurchased 1.5 million shares of our stocks at an average cost of $41.46, totaling $63.5 million in the second quarter of 2021. We continue to work on the integration and conversion plan for the purchase of the 10 branches and select West Coast loans and deposits from HSBC. This transaction will broaden the reach of our Northern and Southern California branch network, in addition to acquiring $1 billion in low-cost deposits and $0.8 billion in residential loans. The transaction is expected to be completed during the first quarter of 2022.

Thank you, Chang, and good afternoon, everyone. For the second quarter of 2021, net income increased by $3.8 million or 5.2% to $77.2 million compared to the first quarter of 2021. This increase was primarily attributable to reversal of provision for credit losses and higher net interest income. Our net interest margin was 3.24% in the second quarter of 2021, as compared to 3.20% in the first quarter of 2021. In the second quarter of 2021, interest recoveries and prepayment penalties added 3 basis points to the net interest margin as compared to 2 basis points for the first quarter of 2021. There were $2.9 billion of loans at the floor rate as of June 30, 2021. Approximately $1.6 billion and $1.4 billion of our CDs matured during the third quarter and fourth quarter of 2021 with average rates of 0.82% and 0.68%, respectively. We are targeting renewing retail CDs in the 40-basis-point to 50-basis-point range. Given the results of the second quarter of 2021, we are maintaining our expectations of our net interest margin for 2021 to be between 3.2% to 3.3%. Net interest income during the second quarter of 2021 increased by $2.6 million to $12.6 million when compared to the first quarter of 2021, primarily due to reduced losses in equity securities and a one-time BOLI benefit of $1.2 million. Non-interest expense decreased by $1.7 million or 2.4% to $69.7 million in the second quarter of 2021, when compared to $71.4 million in the first quarter of 2021. The decrease was primarily due to a decrease of $0.9 million in amortization of low-income housing and solar tax credit funds and $0.7 million in costs associated with debt redemption. The effective tax rate for the second quarter of 2021 was 22.7%, as compared to 21.9% for the first quarter of 2021. We expect the full year 2021 effective tax rate to be between 22% and 22.5%. Solar tax credit amortization was $3.8 million in the second quarter of 2021 and is expected to be $3 million in the second half of 2021. At June 30, 2021, our Tier 1 leverage capital ratio decreased to 10.85%, as compared to 11.06% as of March 31, 2021; our Tier 1 risk-based capital ratio decreased to 13.77% from 13.94% as of March 31, 2021; and our total risk-based capital ratio increased to 15.47% from 15.8% as of March 31, 2021.

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

Hey. Good afternoon.

Hi.

The first question on the other non-interest income, I think it was up to $10.3 million this quarter from $8.8 million last quarter. Anything unusual there or is that a good run rate?

No. We had about $1.3 million BOLI tax benefit. So that should be non-recurring.

Okay. Got it. Okay. And then the contribution from PPP revenue in net interest income this quarter?

Yeah. It’s in our press release.

Okay. Never mind. I think I will find it. Okay. And then on the buyback, good to see you guys are pretty proactive this quarter. What are your appetite for re-upping another buyback assuming you complete the latest one this quarter?

We will probably assess the request and approval, given the fact that our capital ratios are among relatively high and loan growth is moderate. We think buybacks are good use of our excess capital.

Okay. And then just on the reserve ex-PPP, I think we are down to 90 basis points, looking back...

84 basis points. Yeah, 84 basis points. Yeah.

Yeah. I guess I am excluding PPP.

Correct.

But looking back to pre-COVID, you guys were in the 80s. I mean it is kind of the low 80s where you think it will probably stabilize or you think you can dip below that?

I think for now that’s probably the number, the range for us to the extent that our substandard loans are non-accrual for us significantly. We would see for the model leaves us.

Okay. Thank you.

Thank you.

Thanks. Good afternoon.

Hi.

I just wanted to ask about commercial real estate growth. I know you got into the full year loan growth range of 3% to 5%, so unchanged. But in terms of the CRE segment, can you talk about specifically where you saw the growth this quarter and if there were any particular geographic areas that were driving growth?

Sure, Gary. We observed increased activities in mixed-use and apartment developments, particularly in transitional and repositioning projects. Most of this activity was concentrated in California, although we did see some growth on the East Coast, with the majority originating from the West Coast.

Okay. Thank you. And then just to go back on PPP for a second, just to kind of put a fine point on it. In terms of average PPP balances for the second quarter, in terms of outstanding loan balances, Heng, do you have that number handy?

Yeah. This is based on the month end balance, $304 million.

I am sorry, $204 million.

No, $304 million.

Okay. Thank you.

Yeah. Thank you.

Hey. Good afternoon.

Hi, Brandon.

Hey. So I thought it was a decline in revenues and mortgage loans. So could you just discuss what your expectations are for residential mortgage going forward and what type of activity you are seeing in the market from your customers?

In terms of mortgage loans for us, we are continuing to see activities; a lot of it is still on the sales side, although that has slowed down. We are definitely getting hit on the VFI side of our portfolio, seeing a higher rate of payoffs as we have seen from the prior year. So from a growth perspective, I think the contribution to the revenue in the loan growth overall from our mortgage portfolio is going to be probably smaller than what we have seen in years past.

Okay. And then I saw loan yields are pretty stable, are you seeing continued stability going into the latter half of the year or are you still seeing potentially competitive pressures where loan yields have been bottom yet?

I think there is still competitive pressure whether or not has bottom or not. I think that remains to be seen. But we do what we can to maintain current existing loan relationships with our clients, even though we will have to suffer a little bit on the yield side. And for new business we are as competitive as it can be, obviously keeping an eye on the overall net interest margin for the entire portfolio.

Okay. Lastly, with HSBC depositors coming online early next year, do you plan to be more aggressive in managing time deposits or adjusting pricing with customers as we approach that growth?

I think you mentioned that HSBC has a strong deposit franchise. Time CDs account for only 10% of that $1 billion portfolio. On our end, we expect to reduce brokered deposits by about $500 million to $600 million between now and the end of the year.

Okay.

And that would come out of our excess liquidity at the Fed.

Okay. And just even for those time deposits that we knew, would you be more aggressive in pricing those potentially?

Gradually, some of the smaller chains. Thanks. I am seeing promotions, one-year since growth of CDs at 60 basis points. So if I am seeing it, our customers, our depositors are more likely to see it. So, that’s once get us from another ethnic Chinese bank.

Okay.

Okay.

Yeah. This is Chris O'Connell filling in for Chris McGratty. I know it’s a difficult line to project. I appreciate the color on the solar tax credit. But is it fair to say that the total amortization tax credit line holds going through year end, which is coming down a bit in the solar tax for that you mentioned in opening comments?

We will send a copy of our investor slides to Chris, and you can also find it online. On page 15 of our investor slides, we have detailed the results by quarter for the last five quarters. Over the last three quarters, the long-term housing has averaged approximately $6.5 million. Regarding solar, those numbers have decreased; it was $5 million, then $3.8 million in Q2, and we expect $1.5 million in both Q3 and Q4. We plan to reenter that market next year as we gain more clarity on the Biden administration's stance regarding the corporate minimum tax. Thus, those expenses will begin to increase again in 2022.

Got it. I appreciate the color there. Thank you. And then given the earlier comments around the reserve and credit, so it sounds like it’s fair to say that pending any major changes there, did the reserve levels selling the whole from here. Do you see any scenario where the reserve begin to drop down kind of the lower it was in 4Q 2019 around that 82 basis point or so level?

We might see a situation where our residential mortgage loans account for a larger percentage. However, if our substandard loans decrease to low levels in our non-accruals book, we would consider that a reason to rely on the model number. The model will continue to slightly impact our performance each quarter.

Hi. Thanks. A couple of questions for you, starting with the C&I loan growth. Can you talk about the demand environment and if possible utilization rates of your borrowers?

I think on the commercial and industrial side, we are observing increased activity from various industries. We have recently formed a new team that has fostered new relationships for the bank. Regarding utilization rates, they are currently modest through the first few quarters of the year, but we have discussed with some customers who we believe will see an increase in utilization rates in the third and fourth quarters.

Great. And then on the deposit side, can you talk about the deposit environment, you guys put up pretty decent core deposit growth this quarter. Can you talk about the outlook on deposits?

The focus is to decrease our reliance on CDs and instead concentrate more on business commercial accounts and transactional deposits. This approach will not only help increase our core deposits but also aims to reduce the cost of deposits.

Great. And then looking at you guys have been able to pay down your borrowings to pretty low level and at the same time add to the securities portfolio in the most recent quarter. So low should we expect securities purchases to pick up?

I believe it's challenging for fixed income investors. In the last call, it seemed like the tenure would reach 2% in three to four months, but now it's actually at 1.28%. We're attempting to maintain our buying strategy each quarter, but we'll proceed with caution due to the ongoing inflation debate, which could significantly influence people's expectations and labor costs. At some point, the Fed may need to act. If they fall behind in managing inflation, they'll likely have to raise rates quickly to control it. We're evaluating each quarter and aiming to purchase a consistent amount as we did in the first two quarters.

Yeah. But I think last quarter you were talking about how you were getting, I think, it was $50 million or so of maturities per quarter and you are purchasing maybe $75 million per quarter. Is that still the case or is it really dependent on the rate environment?

No. We bought $150 million, which is what we stated, and the maturities of MBS were $75 million. For the third quarter, that's still our plan.

Thanks. I just wanted to clarify on your deposit comments, the brokered deposits, I think you mentioned $500 million to $600 million that run-off, I am sure the back half of this year. Is that included in the $3 billion or so time deposits, you have mentioned previously?

Mostly we had some brokered money market, so in that number is $150 million of brokered money market.

Okay. And of those broker deposits, what’s the rate on those that will put the rate you gave us on the CDs?

Well, of the brokered money market we are fortunate, we have got $100 million at 1 basis point that was in last December. And then the other $50 million that’s 18 basis points and then the brokered CD rates, they tend to be in the $150 million range, because they were made a year ago.

Hey. Just wanted to follow up on the core expense run rate, you guys have done a good job of holding that run rate pretty flat since last year, just under $59 million. What are your thoughts on that run rate going forward and any kind of reinvestment needs or savings?

We are working to maintain our current position. We may experience a significant increase in our bonus accruals, especially as we approach the fourth quarter and evaluate our budget performance. Additionally, we are continuing with process improvements. We closed two branches in June, and for 2022, with inflation at 3%, we expect to be around 2.5%.

Got it. Okay. Thank you.

I want to thank everyone for joining us on our call and we look forward to speaking with you at our next quarterly earnings release call.

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