Cathay General Bancorp Q3 FY2022 Earnings Call

Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp's Third Quarter 2022 Earnings Conference Call. My name is Matt 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. This 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, Matt 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 its earnings release outlining its third 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 third quarter earnings conference call. This afternoon, we reported net income of $99 million for the third quarter of 2022, a 36.8% increase as compared to a net income of $72.4 million for the third quarter of 2021. Diluted earnings per share increased 45.2% to $1.35 per share for the third quarter of 2022 compared to $0.93 per share for the same quarter a year ago. In the third quarter of 2022, our gross loans increased by $318.9 million or 7.8% annualized. The increase in loans for the third quarter of 2022 was primarily driven by increases of $193.4 million or 26.8% annualized in commercial loans, excluding PPP loans and a $114.7 million or 5.6% annualized in commercial real estate loans, and $85.3 million or 8.2% annualized in residential mortgage loans. The overall loan growth for 2022 is expected to range between 11% to 12.5%, including approximately $646.1 million of loans from the acquisition of certain HSBC West Coast branches in February 2022. Excluding the HSBC acquisition, we project loan growth to be between 7% and 8.5% in 2022. We continue to monitor our commercial real estate loans. Turning to Slide 7 of our earnings presentation, as of September 30, 2022, the average loan to value of our CRE loans was 51%. As of September 30, 2022, our retail property loan portfolio, as shown on Slide 8, comprises 22% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. The majority, 89% of the $1.95 billion in retail loans is secured by retail store buildings, neighborhood mixed use or strip centers, and only 10% secured by shopping centers. For the third quarter of 2022, we reported net charge offs of $0.6 million compared to net recoveries of $0.2 million in the second quarter of 2022. Our non-accrual loans were 0.38% of total loans as of September 30, 2022, increased by $7.5 million to $68.1 million as compared to the end of the second quarter of 2022. Turning to Slide 11, classified loans decreased slightly during the quarter from $244 million to $240 million as of September 30, 2022, and our special mission loans increased slightly during the quarter from $295 million to $205 million as of September 30, 2022. We recorded a provision for credit loss of $2 million in the third quarter of 2022 as compared to a $2.5 million provision for credit losses in the second quarter of 2022 and $3.1 million provision for credit losses in the third quarter of 2021. Total deposits increased by $288.4 million or 6.4% annualized during the third quarter of 2022. Time deposits increased by $686 million or 49.7% annualized and interest-bearing demand deposits increased by $76 million or 12% annualized during the third quarter of 2022 compared to the second quarter of 2022. Money market deposits decreased by $287 million or 33.6% annualized, due primarily to a migration back to CDs from money market deposits and deposit runoff. For 2022, the overall deposit growth is expected to range between 8% and 9.5%, which includes approximately $600 million of low-cost deposits from the HSBC acquisition. In May 2022, the Board of Directors adopted a $125 million new share repurchase program. We repurchased $1.08 million of shares of our stock at an average cost of $42.88 totaling $46.3 million in the third quarter of 2022, with $76.9 million remaining in the May 2022 stock repurchase program. I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the third quarter of 2022 financial results in more detail.

Thank you, Chang and good afternoon, everyone. For the third quarter of 2022, net income increased by $26.6 million or 36.8% to $99 million compared to the third quarter of 2021. The increase was primarily attributable to net interest margin expansion and continued strong loan growth in the third quarter of 2022. Our net interest margin was 3.83% in the third quarter of 2022 as compared to 3.22% for the third quarter of 2021. In the third quarter of 2022, interest recoveries and prepayment penalties added three basis points to the net interest margin as compared to five basis points for the second quarter of 2022 and four basis points for the same quarter a year ago. Based on the year-end fed funds target range between 4.5% and 4.75%, we have increased our net interest margin expectation for 2022 to be between 3.6% and 3.7%. Non-interest income during the third quarter of 2022 decreased by $2.3 million to $9.9 million when compared to the third quarter of 2021, primarily due to an equity securities loss of $3.7 million in Q3 2022. Non-interest expense increased by $3.2 million or 4.3% to $75.4 million in the third quarter of 2022 when compared to $72.2 million in the third quarter of 2021. The increase was primarily due to a $1.2 million increase in higher salaries and bonuses, $0.8 million in higher occupancy expenses due in part to the acquisition of certain HSBC West Coast branches, and $1.1 million in higher marketing expenses. The effective tax rate for the third quarter of 2022 was 23.8% as compared to 19.1% in the third quarter of 2021, which included a $1.2 million true-up adjustment for 2021 K1. For the fourth quarter of 2022, we expect an effective tax rate of between 22.5% and 23%. We expect solar tax credit amortization of $7.5 million in the fourth quarter of 2022. As of September 30, 2022, our tier one leverage capital ratio decreased to 10.02% as compared to 10.05% as of June 30, 2022. Our tier one risk-based capital ratio decreased to 12.06% from 12.18% as of June 30, 2022, and our total risk-based capital ratio decreased to 13.59% from 13.74% as of June 30, 2022.

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

Thank you. Good afternoon. So first question, I appreciate the NIM guidance for the full year, but wanted to get a sense of what your NIM outlook is beyond this year and into next and do you potentially see NIM topping out next year and kind of like what is the trajectory you see the NIM going to beyond this year?

Well, we think our NIM will still gradually increase in the fourth quarter and then it's hard to tell as of 2023, but if our NIM's at 4% for the full year of 2023, we feel pretty good about it.

Okay. And, for the fourth quarter of this year, are you expecting a similar increase in the interest margin as it was in Q3 or do you still see that kind of slowing down a bit based off of where rates stand today?

It should be a little bit less primarily from the mix of deposits. We're seeing a lot of customers going into CDs now that rates are more attractive compared to the past.

Okay. And then my last question before I step back in the queue, I just want to understand the deposit guidance, the growth guidance backing into it, it seems like for the fourth quarter you're expecting pretty decent size growth outside the growth in deposit balances, and I want to just make sure I'm interpreting that correctly, and if so, what gives you the confidence that you can achieve that sort of deposit growth in this current environment?

Well, Brandon, I think it could be in the rounding as we get to the end of the year, but we are targeting deposits to match loan growth. So to the extent, we expect loan growth to be slower in Q4 than in Q3, mainly because the higher interest rates will dampen loan growth and it will just match loan growth.

Thanks. Good afternoon. Wanted to follow up on actually that deposit question Heng, you're talking about 8% to 9.5% full year deposit growth of an $18.1 billion base. So that would, even at the low end of that growth range would suggest about $19.5 billion at year end, which is almost a $1 billion over the September 30 number and, obviously well above, I think where most would project your loan growth in the fourth quarter. So just again, I know the question's been asked, but I'm still a bit confused by the guidance in the slide deck versus I guess your previous answer.

I think, I looked at it; it seemed fine, but we expect about $300 million of deposit growth in the fourth quarter.

Okay, great. Thank you. And then on the deposits at quarter end, could you give us the spot rate at September 30 for interest-bearing deposit costs or total deposit costs?

Yes. Yeah, this is total interest-bearing deposits. So it doesn't count DDA, it's 1.06%.

Okay, thank you. And then final question for me in terms of loan growth, I know you're not giving guidance for 2023 at this point, but as you think of well, we have an idea what the fourth quarter might look like, of course, but as you're thinking about the segments of growth or headwinds in 2023, reasonable to expect continued sort of runoff in the construction and equity lines of business and slower growth in commercial mortgage, is that generally how you would think about 2023?

Yes. Yes.

Maybe just to circle back on the funding, looks like you brought on some FHLB advances during the quarter, just curious whether those were term advances or just overnight funding. And I guess just given kind of what you're expecting for loan and deposit growth in the fourth quarter, should we expect those borrowings to remain relatively stable from here? Do you have any flexibility to pay the FHLB down?

We anticipate that to decrease. It was merely the timing of how deposits arrived at the end of the quarter. Currently, those FHLB borrowings have reduced to approximately $150 million.

Okay. And then on the CD side, can you just remind us how much in CD deposits you have maturing in the fourth quarter? Do you have what the costs are rolling off at and what kind of the going-on rate for a new CD? Is it at Cafe right now? And then also of that kind of $300 million of deposit growth that you referenced, what kind of portion of that do you expect to be represented by CD deposits?

Well, okay. I'll get back to you on the CD roll-off, Andrew. And then I left that schedule in my office and then your second part of the question was.

Just of the, you referenced kind of $300 million or so of anticipated deposit growth in the fourth quarter. Just how much of that you expected to be represented by CD deposits as opposed to money market or IB checking or non-interesting?

We would expect most of it to be CDs. It's hard to predict, some new depositors, they prefer money market because if there's further, they're not locked into a rate for the next year. So if they still think that the fed is going to continue to increase into 2023, they'll want to stay in money market, but my expectation is that most of that fourth quarter deposit growth will be in CDs.

Hey, good afternoon. Maybe just on the outlook around your deposit beta through the cycle, what are you assuming for your cumulative deposit beta similarly we get to, 4.50, 4.75 fed funds?

Well, Matthew, it was, according to our slides that deposit beta in Q3 was 23%. That's on Page 15, I'm basing that on average fed funds we think the overlap cycle deposit beta should be about 30%. It might be a little bit higher but 30% would be good enough for us.

Okay, great. And then the lower comp expense this quarter, can you give us a sense for what drove that relative to last quarter and how sustainable is that run rate?

In the second quarter, there was a notable value fluctuation due to seasonal vacation patterns, leading to an increase in commission expenses. For Q4, I suggest adding a million to our Q3 rate to account for these results.

Okay, great. And then your guidance on low income housing tax credit amortization for the fourth quarter. I know you gave us solar.

Yeah, it's probably going to be $8 million. We've been adding investments, so as sees that the amortization increases.

Great. Thanks for the question. A lot of attention this quarter's been on TCE ratios for the industry given OCI moves. You obviously, you don't have a big bond portfolio. So you've been largely immune to that. I'm interested in kind of the outlook for capital return given where your capital level stand and the growth outlook.

Yeah, we still have a portion left in our current buyback authorization. So we would expect to, given the pace of our capital generation and the fact that loan growth is going to be slower, we are thinking of buying back a million shares in the fourth quarter. And then we'll likely have a new buyback authorization in the first quarter of 2023.

Okay, great. And then maybe to follow up on Matt's question more broadly on expenses, the inflationary pressures that are out there, your core expenses are up 5% year-on-year. How should we think about kind of the incremental headwinds to run the business as we go into 2023?

Well, let me start. Chang can add some more, but the one, we closed several branches in 2022 some because of the HSBC branch acquisition, where we have branches that are close to theirs and their location is better located. So we should save a small amount from that. Then we're just starting our 2023 budget process. So we don't want to give guidance until the January earnings call, but Chang do you want to add?

The only other thing I'll add to that is, Chris, we're very mindful of, kind of the talent that we need and the people we need to retain to build the relationships and we got to compete with the marketplace in terms of what they can get out there. So we're selectively looking at people in their performance and kind of year to date and doing what we need to retain them while at the same time managing our costs as carefully as we can.

At this time, there are no questions in the queue. 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.