Cathay General Bancorp Q2 FY2022 Earnings Call

Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp's Second 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 Georgia Lo, 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 31, 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 second quarter 2022 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 up this call 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 2022 second quarter earnings conference call. This afternoon, we reported net income of $89 million for the second quarter of 2022, a 15.3% increase as compared to a net income of $77.2 million for the second quarter of 2021. Diluted earnings per share increased 21.6% to $1.18 per share for the second quarter of 2022, compared to $0.97 per share for the same quarter a year ago. In the second quarter of 2022, our gross loans increased $389.5 million or 9.5% annualized. The increase in loans for the second quarter of 2022 was primarily driven by increases of $94.6 million or 13.1% annualized in commercial loans, excluding PPP loans, $161.3 million or 7.9% annualized in commercial real estate loans, and $210.6 million or 20.1% annualized in residential mortgage loans. The overall loan growth for 2022 is expected to range between 10% to 12%, including approximately $646.1 million of loans from the acquisition of certain HSBC West Coast branches. Excluding the HSBC acquisition, we project loan growth to be between 6% and 8% in 2022. During the second quarter of 2022, $25.3 million of PPP loans were forgiven. We continue to monitor our commercial real estate loans. Turning to Slide 8 of our earnings presentation, as of June 30, 2022, the average loan to value of our CRE loans was 52%. As of June 30, 2022, our retail property loan portfolio comprises 23% of our total commercial real estate loan portfolio and 9% of our total loan portfolio. The majority 90% of the $1.94 billion in retail loans is secured by retail store buildings, neighborhood mixed-use or strip centers and only 9% is secured by shopping centers. For the second quarter of 2022, we reported net recoveries of $0.2 million compared to net recoveries of $0.3 million in the first quarter of 2022. Our non-accrual loans were 0.35% of total loans as of June 30, 2022, increased by $25.7 million to $60.6 million as compared to the end of the first quarter of 2022. Turning to Slide 11, classified loans increased slightly during the quarter from $219 million to $244 million as of June 30, 2022 and our special mention loans increased during the quarter from $289 million to $295 million as of June 30, 2022. We quartered a provision for credit loss of $2.5 million in the second quarter of 2022, as compared to an $8.6 million provision for credit losses in the first quarter of 2022 and a $9 million reversal of provision for credit losses in the second quarter of 2021. Total deposits increased by $227.1 million or 5% annualized during the second quarter of 2022. On Slide 12 average money market deposits increased by $465 million or 38.6% annualized during the second quarter of 2022, compared to the first quarter of 2022. Average time deposit increased by $408 million or 30.9% annualized due to migration of CDs to money market deposits and deposit runoff. 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. In May 2022, the board of directors adopted a $125 million new share repurchase program. We repurchased 750,000 shares of our stock at an average cost of $40.78 per share following a $30.6 million repurchase in the second quarter of 2022 with $94.4 million remaining in the May 2022 stock repurchase program. I will now turn the floor to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen to discuss the second quarter 2022 financial results in more detail.

Thank you, Chang and good afternoon, everyone. For the second quarter of 2022, net income increased by $11.8 million or 13.3% to $89 million compared to the second quarter of 2021. This increase was primarily due to net interest margin expansion and strong loan growth during the second quarter of 2022. Our net interest margin was 3.52% in this quarter, up from 3.24% in the same quarter of 2021. In the second quarter of 2022, interest recoveries and prepay penalties contributed two basis points to the net interest margin, compared to four basis points in the first quarter of 2022 and three basis points a year ago. Based on a year-end fed funds target range of 3.25% to 3.5%, we have raised our net interest margin expectation for the full year of 2022 to a range of 3.5% to 3.65%. Non-interest income for the second quarter of 2022 rose by $2 million to $14.6 million compared to the same quarter in 2021, mainly due to a $0.9 million increase in loan fees. Non-interest expenses rose by $4.4 million or 6.3% to $74.1 million in the second quarter of 2022, up from $69.7 million in the second quarter of 2021. The increase was largely driven by $4.5 million in higher salaries and bonuses, partly due to the acquisition of certain HSBC West Coast branches, and $1.9 million in increased professional and legal expenses, which was partially offset by a $3.4 million decrease in the amortization of solar tax credit investments. The effective tax rate for the second quarter of 2022 was 21.4%, compared to 22.7% for the same quarter in 2021. For the second half of 2022, we anticipate an effective tax rate between 21.5% and 22.5%. We expect solar tax credit amortization to be $1.5 million in the third quarter of 2022 and $7.5 million in the fourth quarter of 2022. As of June 30, 2022, our tier one leverage capital ratio increased to 10.15% compared to 10.11% as of March 31, 2022. Our tier one risk-based capital ratio decreased to 12.18% from 12.37% as of March 31, 2022, and our total risk-based capital ratio decreased to 13.74% from 13.97% as of March 31, 2022.

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

And our first question comes from Matthew Clark with Piper Sandler.

Maybe first on the fee income, the core fee income in the other noninterest income, can you give us a sense for what drove the increase from last quarter in other noninterest income?

It's very low, it's $900,000 in loan fees that include some regular loan fees and we collected $350,000 from the Far East national loan and we booked that in the other income category.

Okay. I'm just making sure, because I thought the comparison was from a year ago.

Are you asking if you're comparing it to last year or the first quarter?

The first quarter?

Oh yeah. We also had a death benefit here in the second quarter. So that was, yeah, I'm sorry that was on the linked quarter basis. That was about $1.5 million.

Okay, great. And then I guess a similar question in expenses linked quarter, the increase in other operating expense again from last quarter.

We had a few one-time items. Our marketing expense increased by approximately $800,000. It tends to vary between quarters, and we also incurred about $700,000 to $800,000 in annual director fee retainers for the director group.

Okay, great. Sounds good. And then shifting, also within expenses you gave the guidance on solar tax credit amortization, can you just fine-tune what you expect for low-income housing in the third and fourth quarter?

We keep on making new investments, so probably $7.5 million per quarter would be good for low-income housing.

Okay, great. Do you have the spot rate on interest-bearing deposits as of June 30?

It's not exact. I did a quick calculation because many people have been asking for it. Let me see if I can find that information. Normally, we don't provide this, but I pulled it from a general ledger, and I believe it was about 46 basis points for June.

Okay. Okay. And then last one for me on the buyback, your appetite to continue repurchasing stock and potentially re-up another program, just given the increased uncertainty in the economy.

We still intend to do about the same amount in the third quarter. Our authorization goes into the first quarter of 2023 and we have $94 million left. So you can probably figure. It's maybe $35 million a quarter about.

Okay, great. Thank you.

Thank you. And our next question comes from the line of Brandon King with Truist Securities.

So I wanted to touch on deposits. You're able to generate deposit growth in the quarter, and I noticed you didn't change your guidance for the year, which expands our relative to peers. So I just want to get a sense of what gives you the confidence of generating deposits along with loan growth for the back half of the year?

Well, first we think our loan growth in the second quarter, second half of the year, it's in our guidance or it's implied. We'll probably drop to 5% annualized in the second half and then we would match deposit flow to that including using brokerage CDs as needed.

Oh, sorry. Just say using broker CDs to kind of fund that growth and that's included, I guess that's incorporated in the new guidance as well. So I guess should see kind of a smaller benefit to increasing interest rates going forward. Is that projecting in that?

Yeah, we had a very good increase from Q1 to Q2 and that only has half a month of June's 75 basis point. So that momentum will continue in the second half. But these very rapid interest rate increases are unprecedented in recent history, but we do think our NIM portfolio is going to be better than our prior guidance.

Okay. Do you have the numbers for June?

Yes. Some of this was affected by May. I think it was 3.66.

Okay. All right. And then just lastly, on loan growth, as you're anticipating slower loan growth in the back half of the year, are there any categories that should see slower loan growth relative to others that you participate in?

We're not expecting, if anything, the residential mortgage might slow down a little bit given where rates are. I think we've booked the first half all the applications that were in the pipeline as a result of the sales activities, but I think now the interest rate impact will kind of slow down that segment a little bit going forward.

Okay. Thanks for all the answers.

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

Hey, just wanted to follow up on the last point. I was curious on whether you've seen kind of a similar slowdown in commercial real estate volumes as we've worked into the third quarter of this year?

We're seeing slower refinance activities, of course, because of the higher rates. But there are still people who for example, are kind of flipping from a fixed to float that they don't want to see the floating rate. So they're worried about that given where the short-term rates are. So there is still some activity; it's not completely dead. Purchase activity has flowed as well, given where the rates are particularly on some of the apartment acquisitions, but we're still seeing a fairly healthy pipeline and we're being selective and careful about our current relationships and our current clients. I think we're definitely more careful going forward about what kind of commercial real estate deals that we're doing.

I have one more question about the deposit growth we experienced this quarter. I didn't see any information on this in the release, but I was wondering if any of the growth in money markets was from brokered deposits.

Yes. It was a $100 million out of that total growth.

Okay.

That's period end to period end.

Yep. Okay. Got it. Thank you. And then one last one for me, I think last quarter, we discussed a $14 million commercial credit that was placed on non-accrual. Was just curious, any kind of status update that you can share on this loan?

We don't like to talk about specific customers, but I understand it's public knowledge. There's been a receiver appointed. So we feel we have better control of that credit and ultimately, we'll get some collection from the assets of the business and then the rest will come from the house on the West side that's securing it. And we have also reserved for the loan for a reasonable amount.

Okay. Understood. Well, I appreciate you taking my questions.

Yeah. Thank you.

Thank you. Our next question comes from the line of Chris McGratty with KBW.

Heng or Chang, last quarter, you talked about I think a 30% through the cycle beta. Do you feel any different about this, given the speed at which the Fed is now moving? Is that number is moving higher?

We don't know. We still believe it's 30%. In the second quarter, it was much lower than that in part because of a shift in our deposit mix, as our customers were uncertain whether to renew for one-year CDs, which is a traditional term, or stay in money market funds. However, we experienced about 90% retention of maturing CDs. I also heard the one-year CD renewal rate was around 1%, which is much better than our beta of 30%. We assume the beta for CDs will be 100%. These rate hikes are quite unusual, and so far, we are performing better than our projected beta.

Yeah, for sure. Regarding the expense, I want to ensure I fully understand the expense guide, which hasn't changed. Can you provide the starting level of expenses for 2021? Are those your reported expenses or reported excluding amortization? I want to make sure I get it right.

Yeah. It's reported full year 2021 ex amortization.

Our next question comes from the line of an unidentified analyst with DA Davidson.

Heng, I just wanted to kind of go back over that loan and deposit guide. You kind of mentioned in your answer to a question that you were looking to sort of match loan growth with deposit growth, but even at the low end of that deposit guide of 9%, it would suggest, I think second half of the year deposit growth that far on strip the projected loan growth based on your guidance. So is that accurate or am I misunderstanding something in your comments?

We aim to maintain our loan to deposit ratio at 96%, which has been consistent over the past two quarters. If necessary, we will utilize wholesale broker CDs or broker money markets to support this. Our goal is to match loan growth for the remainder of the year and keep the loan deposit ratio around 96%. It may increase slightly, but we hope it won't be too much.

Okay. All right. Thank you. And then in terms of just overall balance sheet management, you're down to, I don't know, $1 billion or so of liquidity versus $2.5 billion at the end of 2021. So, is that a level that you'd like to maintain from a balance sheet liquidity perspective? Would you run it tighter than that and deploy some of that cash to loans or securities at this point?

It should be right around $1 billion. We have about $120 million in treasuries, which have a final maturity of less than one year. These are considered cash equivalents for regulatory ratios, but we may see that $1 billion cash balance decrease if we allocate some into treasuries. Overall, we're not planning to significantly reduce that balance.

You're going to run the short-term investment balance, then that's a $1 billion.

No, no.

I thought you said you're not going to reduce that balance significantly.

Yes, sir.

Thank you. Our next question comes from the line of an unidentified analyst.

Hi. Thanks. I wanted to follow up on the brokered CD topic. I was curious, what's the rate on the brokerage CDs versus your core CD portfolio rate?

This month, the rate for a three-month brokerage CD is around two and a quarter to two and three-eighths percent, and for June, the rate on our core time deposits was about 45 basis points.

And can you talk about the competitiveness in the market for core CDs? Are you seeing some competitors push that up? Do you guys plan on doing any kind of specials, because it seems like you'll get a better sort of deal with your core CDs versus the brokerage CDs. Can you talk about that a bit?

We don't believe there's a need for any special certificates of deposit. No one in the market seems to be offering them, as banks generally still have quite a bit of excess liquidity. Earlier in the second quarter, we did lose some significant deposit customers who were seeking better rates. If those customers approached us today wanting a 2% rate for a one-year CD, we would accept that. However, we've been monitoring the published rates from our peers in Southern California, and no one has increased rates for any products since the Federal Reserve raised theirs. It appears that banks are tailoring rates specifically to attract larger depositors.

Got it. Thanks for that. And then shifting to credit quality, can you talk about the health of your borrowers, clearly, your LTVs are very, very low. But I'm curious about the healthier borrowers and then related to that, can you talk about what you are seeing based on talking to customers, the economic outlook, and if you're seeing anything recessionary in your outlook.

So David I'll take that first. On the CRE side, we've done a deeper dive into not just the LTV side, but into the cash flow side and the debt service side, assuming higher interest rates and higher debt service payments what the portfolio will look like from a debt coverage standpoint. So we've done a pretty significant review of that and we feel pretty good, pretty comfortable about those. On sort of the economic and recession side, I think it's the GDP numbers, I think later in the week will kind of tell us a little bit more, but the unemployment numbers are still very low. The last, I think hiring report was something about $400,000 and was the total of $1.1 million over three quarters with and so those are all strong numbers that I think we've seen. In addition to that, our C&I customers, I think we were also looking at them and kind of looking at their balance sheet and their aging more carefully kind of looking at some of their inventory just to make sure that their numbers are strong. We don't have any concerns there at this point. So if there is one, there's probably a mild concern. I think there was a report in the Wall Street about how there is an expectation for Fed cuts that may come as quickly as the next 12 months.

Great. Thanks very much.

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.

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