Cathay General Bancorp Q1 FY2022 Earnings Call

Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp's First Quarter 2022 Earnings Conference Call. My name is Andrew 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. 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 Megan Cheung, Investor Relations of Cathay General Bancorp.

Thank you, Andrew 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 31st, 2021 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. Any forward-looking statements speak 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 first quarter 2022 results. To obtain a copy of our earnings release, as well as our first quarter earnings presentation, 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 President and Chief Executive Officer, Mr. Chang Liu.

Thank you, Megan and good afternoon, everyone. Welcome to our 2021 first quarter earnings conference call. This afternoon we reported net income of $75 million for the first quarter of 2022, a 2.2% increase as compared to the net income of $73.4 million for the first quarter of 2021. Diluted earnings per share increased 7.6% to $0.99 per share for the first quarter of 2022 compared to $0.92 per share for the same quarter a year ago. In the first quarter of 2022, our gross loans increased $1.1 billion, or 25.8% annualized; organic loan growth excluding PPP loans and HSBC acquired loans increased by $431.8 million to $16.8 billion, which represents an annualized growth rate of 10.6%. The increase in loans for the first quarter of 2022 was primarily driven by increases of $181.6 million, or 25.1% annualized in commercial loans, excluding PPP and HSBC loans; $258.5 million or 12.7% annualized in commercial real estate loans; $33.4 million or 3.2% annualized in residential mortgage loans, that excludes HSBC acquired loans. The overall loan growth for 2022 is expected to range between 9% to 13%, including approximately $646.1 million of loans from the acquisition of certain HSBC West Coast branches. Without the HSBC acquisition, we project loan growth to be between 5% and 8% in 2022. During the first quarter of 2022, $37.4 million of PPP loans were forgiven. As of March 31st, 2022, our deferred PPP loan fees were $49,000. We continue to monitor our commercial real estate loans. Turning to slide eight of our earnings presentation, as of March 31st, 2022, the average loan-to-value of our CRE loans was 51%. As of March 31st, 2022, our retail property loan portfolio shown on slide nine comprises 23% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. The majority, 88% of the $1.93 billion in retail loans is secured by retail store buildings, neighborhood, mixed-use, or strip centers, and only 11% is secured by shopping centers. For the first quarter of 2022, we reported net recoveries of $100,000 compared to net charge-offs of $300,000 in the fourth quarter of 2021. Our non-accrual loans were 0.5% of total loans as of March 31st, 2022, increased by $20.5 million to $86.3 million as compared to the end of the fourth quarter of 2021. A $14 million commercial loan was placed on non-accrual. Turning to slide 12, we were pleased to see that our classified loans decreased during the quarter from $266 million to $219 million at March 31st, 2022. And our special mention loans decreased during the quarter from $499 million to $389 million at March 31st, 2022. We recorded a provision for credit loss of $8.6 million in the first quarter of 2022 as compared to a $3.5 million provision for credit losses in the fourth quarter of 2021 and a $13.6 million reversal of provisions for credit losses in the first quarter of 2021. The provision for credit losses of $8.6 million reflected the growth in loans during the first quarter, which included a $2.3 million Day 2 CECL charge for the loans acquired from the HSBC acquisition. Turning to slide five, total average deposits, excluding HSBC acquired deposits increased by $318.6 million or 7.4% annualized during the first quarter of 2022. On slide 13, average money market deposits increased $421.8 million, or 35.6% annualized during the first quarter of 2022 compared to the fourth quarter of 2021. Average time deposits decreased by $214.8 million or 17.4% annualized due partly to the run-off of broker CDs and partly due to a migration of CDs to money market deposits. For 2022, the overall deposit growth is expected to range between 9% and 12%, which includes approximately $0.6 billion of low-cost deposits from the HSBC acquisition. Excluding the acquired deposits from HSBC, we project deposit growth to be between 5% and 8% in 2022. We repurchased 704,927 shares of our stock at an average cost of $46.67, totaling $32.9 million in the first quarter of 2022, completing the September 2021 stock repurchasing program. We are working on a new stock buyback program. The acquisition of certain West Coast branches from HSBC was successfully completed on February 7th, 2022. We welcomed the new customers and the HSBC associates in the 10 branches. We acquired $646 million in loans, $575 million in deposits, and 10 branches expanding our Northern and Southern California branch network. I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen to discuss the first quarter 2022 financial results in more detail.

Thank you, Chang and good afternoon everyone. For the first quarter of 2022, net income increased by $1.6 million or 2.2% to $75 million compared to the first quarter of 2021. The increase was primarily attributed to an increase in net interest income due to continued strong loan growth in the first quarter of 2022. Our net interest margin was 3.26% in the first quarter of 2022 as compared to 3.2% for the first quarter of 2021. In the first quarter of 2022, interest recoveries and prepayment penalties add up four basis points to the net interest margin as compared to six basis points for the fourth quarter of 2021 and three basis points for the same quarter a year ago. There were $2.3 billion of loans at the flow rate as of March 31, 2022, reducing from $3.1 billion at December 31, 2021. Based on the year-end fixed fund's target of 2.25%, we have increased our net interest margin expectation for 2022 to be between 3.3% to 3.40%. Net interest income during the first quarter of 2022 increased by $10.2 million to $20.2 million when compared to the first quarter of 2021, primarily due to an increase of $8.7 million in mark-to-market gains on equity securities, and the increase of $1.3 million in swap income. Non-interest expense increased by $1.3 million, or 1.8% to $72.7 million in the first quarter of 2022 when compared to $71.4 million in the first quarter of 2021. The increase was primarily due to an increase of $3.2 million in acquisition of the HSBC branches and $2.8 million in higher salaries and bonuses due to additional personnel as a result of the acquisition of the HSBC branches, offset by a $3.3 million increase in amortization of solar tax credit investments, and a $1.9 million decrease in marketing expense due to timing. The effective tax rate for the first quarter of 2022 was 23.5% as compared to 21.9% for the first quarter of 2021. For the second quarter of 2022, we expect an effective tax rate of around 19.5%. For the second half of 2022, we expect an effective tax rate of between 21% and 22%. We expect solar tax credit amortization of $0.5 million in the second quarter, $1.5 million in the third quarter, and $7.5 million in the fourth quarter of 2022. As of March 31, 2022, our Tier 1 leverage capital ratio decreased to 10.11% as compared to 10.40%. As of December 31st, 2021, our Tier 1 risk-based capital ratio decreased to 12.37% and 12.8% as of December 31, 2021, and a total risk-based capital ratio decreased to 13.97% from 14.1% as of December 31, 2021.

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

Thank you. Our first question comes from the line of Brandon King with Truist Securities.

Thank you. Good evening.

Hi.

Hi Brandon.

So, I wanted to first discuss the loan growth guidance. So, it was pretty strong in the quarter and it seems that was such a strong quarter, we're expecting kind of softer growth throughout the year. So, if you could just talk about that what you're seeing in your market and what your customer base that went into your loan growth updated guidance?

Sure, as the economy continues to improve, I think you saw that we had experienced a surge in our loan demand, which was also caused by the perceived interest rate hikes for the remainder of 2022. We expect that the overall growth for 2022 to continue to range between 9% to 12%, that includes the growth from HSBC, with a 5% to 8% excluding HSBC. But we also expect the loan demand to soften or slow later on in the year as a result of the higher interest rates.

Okay. And have you benefited from any increase in C&I utilization?

Slightly, we looked at utilization rate, it probably increased by 2% or 3%.

Okay. And then, for deposits, it seems like you're matching your loan growth with deposits, and a lot of banks that have reported already are experiencing slower deposit growth. So, could you talk about what you're seeing in your ability to grow deposits and what gives you confidence that you can grow deposits at the same pace as loan growth?

On the deposit side, I think it's a little bit of both; it's both the Fed increasing the rates, we have to kind of look at that. But I think we have a tendency to lag behind our beta expectation on that, it's been about 30%. And also, at the same time, I think we're continuing our business promotions, so we're marketing for business deposits and continuing to look for growth there as well.

Are you planning to offer any more certificate of deposit specials or secure any long-term funding within your deposit strategy for the year?

No, no. We may start going back to the broker CD market, but we're not going to run any specials in our relationships seeing the market. I think our customers are uncertain as to how fast the Fed will increase. So, they're going to be reluctant to jump at anything being offered because many people think rates will be much higher.

Thank you very much.

Thank you.

Thank you. And our next question comes from the line of Matthew Clark with Piper Sandler.

Hey, good afternoon. I’d like to start by discussing the increase in non-accruals, specifically the $20 million rise in C&I. I believe you mentioned a $14 million credit was added. Can you provide more details on the factors that contributed to this increase in specific cases?

Sure. It's a C&I loan, collateralized with the assets of the business and we also have a residential home that's part of the collateral in the Pacific Palisades of Southern California, which is a strong area. We provided a small reserve for the loan; the loan was substantially collateralized in our opinion at this point.

Okay. And then you built reserves in the quarter, I think part of that at least within SFR was related to HSBC, but there was some additional building in commercial real estate. Can you give us a sense for, what drove the increase in reserves? How much of it was macro-driven versus more specific? Or any other Q factors?

Yes, Matthew, it's primarily driven by macro factors. We examined the Moody's forecasts closely, which were prepared around March 10th. For instance, in their base case, they anticipate a year-end fixed funds rate of 85 basis points. We have accounted for this alongside Moody's projections, especially considering the higher interest rates we expect in June, which may lead to considerably lower GDP—a key variable in our econometric models. We believe we've addressed most of these factors. Additionally, as Chang pointed out, we set aside reserves for the non-accruals that arose in the first quarter.

Okay, great. Switching to the tax credit amortization, you provided information on solar. I believe low-income housing tends to be more stable. Can you share your expectations for low-income housing tax credit amortization for the upcoming quarter in the second half of the year?

Yes, it should be about $6.5 million a quarter for each of the next three quarters.

Okay, great. Thank you.

Yes. Thank you.

Your next question comes from the line of David Chiaverini with Wedbush Securities.

Hi, thanks. I wanted to follow up on the $14 million credit that seems to be well covered. Can you share what industry it was related to? Are you noticing any systemic issues in that industry?

Sure. It's an office furniture industry and the principles of the company was trying to launch a new one.

I think we are in the office furniture industry, and the principles of the company are trying to launch a new one.

Okay.

Yes, that's helpful. Yes, and it seems very COVID-specific, the office market, so that makes sense. Thank you for that. And then over on the loan growth front, you mentioned about your expectations and assumptions of slower growth, kind of towards the back half of the year with higher rates. Are you seeing any signs of an economic slowdown or any signs of a slowdown in loan demand as you sit here today?

Some of the slowdown in the commercial real estate market is likely due to rising interest rates, which may prevent some of the bridge or reposition strategies in multifamily from being successful. This segment has experienced a slight decline for us. However, we are still observing some purchases and other activities in commercial real estate, although the multifamily reposition segment has also slowed down a bit for us.

Got it. Thanks very much.

Thank you. Your next question comes from the line of Andrew Terrell with Stephens.

Hey, good afternoon.

Hi Andrew.

Hi.

Hey, I wanted to follow up on the net interest margin guidance of 3.30% to 3.40% for the full year 2022 with year-end Fed funds at 2.25%. Can you remind us what your assumptions were for year-end Fed funds and the previous net interest margin guidance?

The net interest margin guidance was 10 basis points lower. We haven’t updated our NIM forecasts frequently. That guidance was based on a 725 basis point increase. Now, it seems that May will see a 50 basis point increase. I would anticipate the NIM improvement. If we reach 50 basis points by the May Fed meeting, our loans will exceed the floors, as the average is around 50 basis points for the loans on floors.

Yes. Okay. Got it. And then within that kind of margin guidance, do you assume any kind of further earning asset mix change away from cash into securities or loans? And can you just talk about how we should think about just the size of the bond book as we work throughout the year?

Yes, I think well there's a target about a $1 billion in cash at the Fed. We may move some of that into, let's say, nine-month treasuries because the yield curve is so flat. And then in terms of the bonds, it's only 5% of our total assets. So, our mark-to-market AFS adjustment was relatively light, and we're going to be cautious in terms of doing much more investing except in shorter duration securities, such as treasuries. We may buy some MBS, but we want to wait till it's clear that that is closer to the top. So, we don't get any more unrealized AFS losses.

Understood. Okay, thank you for taking my questions.

Yes. Thank you.

Thank you.

Thank you. At this time, there are no questions in the queue. And I'm showing we have a question from the line of Chris McGratty with KBW.

Hey, how's it going? This is indiscernible on for Chris McGratty.

Yes.

So, on the expense guidance, I was just wondering, can you remind us where the base starting point is for that 4% expense growth?

Well, we're guiding to 3.5% and then 4% for the HSBC acquisition, but the guidance is for the full year 2021.

Yes, if you have the actual number that you're basing that off of?

If you look at our slide 17, the quarters and core expense growth are typically around $60 billion. In Q4, we reported $61.1 billion, and in Q1, it was $60.2 billion. You could take the Q4 figure of $61.1 billion, annualize it, and our guidance would be based on that.

Okay, great. Thank you.

Okay.

And then with your loan to deposit ratio at 96% and given where your loan and deposit guidance is, should we assume that that loan to deposit ratio is staying fairly stable from here?

Can you repeat the last part?

Should we assume that that 96% loan to deposit ratio is going to stay fairly stable?

Yes, we have a maximum limit of 100%, but 96% or 97% is likely the appropriate level for us.

Thank you. Can you remind us what the deposit days were last cycle and what you expect for this upcoming cycle? Thank you.

It was about 30% for the last cycle, and we expect it to be around 30% this cycle as well. We have become less reliant on CDs over the past few years, which might provide some cushion. However, the rate of Fed increases is relatively fast compared to the last 20 years.

Okay, thank you. That's all the questions I have.

Okay. Thank you.

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

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. Refer to the slide.