Earnings Call Transcript - CATY Q3 2023

Operator, Operator

Good afternoon, everyone, and welcome to Cathay General Bancorp's Third Quarter of 2023 Earnings Conference Call. My name is Rocco, and I will be your coordinator for today. Today's call is being recorded and will be available for replay at www.cathaygeneralbancorp.com. I would now like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp. Please go ahead.

Georgia Lo, Investor Relations

Thank you, Rocco, and good afternoon. Here to discuss the 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 10-K for the year ended December 31, 2022, 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 they are 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 third quarter 2023 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.

Chang Liu, CEO

Thank you, Georgia, and good afternoon, everyone. Welcome to our 2023 third quarter earnings conference call. This afternoon, we reported net income of $82.4 million for the third quarter of 2023, an 11.6% decrease as compared to a net income of $93.2 million for the second quarter of 2023. Diluted earnings per share decreased 11.8% to $1.13 per share for the third quarter of 2023 compared to $1.28 per share for the second quarter of 2023. In the third quarter of 2023, our gross loans increased $71 million or 1.6% annualized, primarily driven by increases of $218 million or 9.9% annualized in commercial real estate loans, and $143 million or 10.9% annualized in residential mortgage loans, offset by a decrease of $227 million or 27.4% annualized in commercial loans. The slower loan growth during the third quarter resulted in part from paydowns of several large commercial loans originated in the second quarter of 2023. We continue to monitor our commercial real estate loans. Turning to Slide 7 of our earnings presentation. As of September 30, 2023, the average loan-to-value of our commercial real estate loans was 50%. As of September 30, 2023, our retail property loan portfolio at Slide 8 comprises 23% of our total commercial real estate loan portfolio or 11% of our total loan portfolio. 89% of the $2.2 billion in retail loans is secured by retail store, buildings, neighborhood, mixed-use or strip centers, and only 10% secured by shopping centers. At Slide 9, office property loans represent 16% of our total commercial real estate loan portfolio or 8% of the total loan portfolio. Only 34% of the $1.5 billion in office property loans are collateralized by pure office buildings, and only 4% of the office property loans are in central business districts. Another 25% of office property loans are collateralized by office retail stores, office mixed-use and medical offices. The remaining 28% of office loans are collateralized by office condos. For the third quarter of 2023, we reported net charge-offs of $6.6 million, of which $4.3 million have been reserved for in prior quarters, compared to net charge-offs of $2 million in the second quarter of 2023. Our nonaccrual loans were 0.41% of total loans as of September 30, 2023, which increased by $8.3 million to $77.3 million as compared to the end of the second quarter of 2023. Turning to Slide 12. As of September 30, 2023, classified loans increased slightly to $202 million from $193 million as of June 30, 2023, and our special mention loans also increased slightly to $278 million from $260 million as of June 30, 2023. We recorded a provision for credit loss of $7 million in the third quarter of 2023 as compared to a $9.2 million provision for credit losses for the second quarter of 2023. We are pleased that total deposits increased by $539 million or 11.6% annualized during the third quarter of 2023. As a result, we were able to reduce our borrowings from the Federal Home Loan Bank by $800 million during the quarter to $15 million as of September 30, 2023. Total uninsured deposits were $9 billion, but excluding $0.8 billion in collateralized deposits, the uninsured and uncollateralized deposits were reduced to $8.2 billion or 41.7% of total deposits as of September 30, 2023. Our unused borrowing capacity from the Federal Home Loan Bank was $7.2 billion, and unplaced securities were $1.4 billion. These sources of available liquidity were more than 100% of uninsured and uncollateralized deposits as of September 30, 2023. Total time deposits increased $237 million or 31.2% annualized during the third quarter of 2023 compared to the second quarter of 2023. Total core deposits increased by $301 million or 10.5% annualized, primarily due to organic growth and seasonal increases. I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the third quarter 2023 financial results in more detail.

Heng Chen, CFO

Thank you, Chang, and good afternoon, everyone. For the third quarter of 2023, net income decreased by $10.8 million or 11.6% to $82.4 million compared to $93.2 million for the second quarter of 2023, primarily due to a $6.2 million unrealized loss on equity securities or $0.06 per share in the third quarter of 2023 as compared to a $10.7 million unrealized gain on equity securities or $0.10 per share in the second quarter of 2023. Our net interest margin was 3.38% in the third quarter of 2023 as compared to 3.44% for the second quarter of 2023. In the third quarter of 2023, interest recoveries and prepayment penalties added 6 basis points to the net interest margin as compared to 2 basis points for the second quarter of 2023. We have revised our net interest margin expectations for 2023 to be between 3.45% to 3.50%. Noninterest income during the third quarter of 2023 decreased by $15.3 million to $7.8 million when compared to $23.1 million in the second quarter of 2023. The decrease was primarily due to a $16.9 million decrease in unrealized gains on equity securities offset in part by a $1.5 million increase in commissions from wealth management when compared to the second quarter of 2023. Noninterest expenses increased by $1.2 million or 1.2% to $94 million in the third quarter of 2023 when compared to $92.8 million in the second quarter of 2023. The increase was primarily due to $1.7 million in higher salaries and benefits and $1.4 million in higher amortization of solar tax credit investments, offset by $1 million in lower professional expenses. As a result of expenses incurred in 2023 to strengthen the bank's information security infrastructure, enterprise risk management, and from higher FDIC insurance premiums, we expect core noninterest expense, excluding tax credit and core deposit intangible amortizations in OREO expense to increase between 8.5% to 9.5% from 2022 to 2023. This excludes the impact of any special FDIC assessment for bank failures expected to be finalized during the fourth quarter of 2023. During the first nine months, approximately $3 million in nonrecurring professional expenses related to information security, enterprise risk management, and internal control processes were incurred. In addition, we are taking a hard look at our other expenses during the fourth quarter of 2023 and aim to reduce the rate of noninterest expense growth in 2024. The effective tax rate for the third quarter of 2023 was 11% as compared to 9.2% for the second quarter of 2023. For full year 2023, we expect an effective tax rate of between 12.5% and 13%. We expect solar tax credit investment amortization of $12 million in Q4 of 2023. As of September 30, 2023, our Tier 1 leverage capital ratio decreased to 10.44% as compared to 10.45% as of June 30, 2023. Our Tier 1 risk-based capital ratio increased to 12.7% from 12.38% as of June 30, 2023, and our total risk-based capital ratio increased to 14.21% from 13.88% as of June 30, 2023.

Chang Liu, CEO

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

Operator, Operator

Your first question today comes from Matthew Clark at Piper Sandler.

Matthew Clark, Analyst

I have a couple of questions regarding the margin. Were you able to quantify the prepay fees and any recoveries in the loan yield? It seems like the loan yield increased slightly, about 20 basis points this quarter. I'm just curious if there was anything unusual contributing to that.

Heng Chen, CFO

Well, we had about $2 million of interest recoveries. As I mentioned, it was 6 basis points of NIM, but the rest of it would be just improved pricing for loans.

Matthew Clark, Analyst

Got it. And I think you had about $1 million last quarter. Is that right?

Heng Chen, CFO

A little less than that. Yes.

Matthew Clark, Analyst

Okay. I can come back to that later. And then if you have the spot rate on deposits, interest-bearing or total and the average margin in the month of September?

Heng Chen, CFO

Yes. The spot rate on total interest-bearing deposits at September 30 was 3.28. What was the next part of your question, Matthew?

Matthew Clark, Analyst

If you had the average margin in September, I'd take it.

Heng Chen, CFO

Yes, the average was 3.42, though it's a bit noisy due to interest recoveries throughout the quarter.

Matthew Clark, Analyst

Okay. Understood.

Heng Chen, CFO

For the month of September, yes.

Matthew Clark, Analyst

Okay. Great. And then just maybe one more housekeeping item, and then I'll get back in the queue. The low-income housing amortization for the year, I know you gave solar, but is it still about $41 million?

Heng Chen, CFO

Let's see, yes, yes.

Operator, Operator

Our next question today comes from Gary Tenner at D.A. Davidson.

Gary Tenner, Analyst

First, I had a question on expenses. I may have misheard what you were saying in terms of the expected core expense run rate, I heard 8.5% to 9.5%, which I thought you were saying for 2023, but you said it excluded any potential, I guess, special assessment. So I was confused if you're talking about '23 or '24?

Heng Chen, CFO

We're talking about '23. As you know, there is a proposal that's not final. And under GAAP, whenever finalized, banks are expected to accrue it.

Gary Tenner, Analyst

All right. I just wanted to clarify that. In terms of the loan pipeline at your guidance still looks like it suggests still a solid level of loan growth for the fourth quarter. I just wonder if you could give any kind of updates in terms of kind of where the pipeline strength is coming from, areas that you'd expect loan growth to kind of continue through the fourth quarter?

Chang Liu, CEO

Sure, Gary. We're still seeing unexpected strength in the residential mortgage market. The pipeline is holding up well, and about 90% of that organic pipeline comes from purchases, which aligns with the current market conditions. Activity remains fairly strong in the states we're operating in. In contrast, commercial real estate is definitely slowing, but we're observing ongoing activity primarily from our existing clients and cautiously exploring some new relationships. On the commercial and industrial side, we're focused on supporting our clients and monitoring their credit metrics to ensure they're prepared for 2024, though we aren’t seeing much new activity or business coming in. However, if we come across good prospects, we will continue pursuing that avenue.

Gary Tenner, Analyst

I appreciate that. And just one last question. I think in the prepared remarks, there was a note of some larger commercial loans that were originated in the second quarter, paid off during the third quarter. Were those anticipated payoffs? Correct me, if you talked about it previously, and I don't recall.

Chang Liu, CEO

They were commercial lines of credit that were drawn down during the second quarter, and we had some paydowns, not payoffs, but paydowns during the third quarter.

Heng Chen, CFO

Yes. And then vulnerable borrowers borrowed again here in October.

Operator, Operator

And our next question comes from Brandon King at Truist Securities.

Brandon King, Analyst

So just wanted to get how you're thinking about deposit growth near term in the fourth quarter? And also, could you give some context around the growth you saw in DDA? And how you expect DDA trends or non-interest bearing deposit trends to play out in the fourth quarter?

Heng Chen, CFO

Yes, we were pleasantly surprised by the deposit growth in the third quarter. There is a small portion that is temporary. We had a customer who deposited funds pending a real estate purchase, and that deposit will be withdrawn in late October. However, I believe there is nothing significant about the DDA.

Chang Liu, CEO

It's really a collective effort, I think, of our retail network, and they know that bringing in CDs and retaining them that's part of the job. But really, the key is driving the DDA deposits, and we're getting hit enough as it is on the cost of funds on the CDs, even the money markets, but the DDA growth is really where we need to concentrate in order to offset some of that cost increase just on our funds.

Brandon King, Analyst

Got it. And for that outflow, how much of that are you expecting to outflow in the fourth quarter?

Heng Chen, CFO

Oh, that one, it was $65 million.

Brandon King, Analyst

Okay. I see that was money market?

Heng Chen, CFO

Yes. It was a money market. Yes. It's a long-term deposit. Yes.

Brandon King, Analyst

Okay. Okay. And then going back to the question on loan yields. How are you expecting that to trend near term? Are you expecting kind of a similar sort of increase in the fourth quarter? What are your expectations?

Heng Chen, CFO

We believe that is the case. In residential mortgages, which are quite significant, we have nearly $6 billion. For each of the three quarters in 2023, that loan set has increased by 20 basis points each quarter. In the third quarter, residential mortgages reached 4.96%. We are originating a few hundred million in loans every quarter, approximately $250 million in the nearly 7% range. This contributes to the increase, and we continue to observe prepayments from our 3/1 and 5/1 adjustable-rate mortgages, which tend to pay off after the initial fixed-rate period. Additionally, for commercial real estate, we are aiming for rates in the 7% range.

Chang Liu, CEO

For commercial real estate, we are pricing them at approximately 250 basis points above if we can secure them over a 5-year term with a 3-year lock-in. That's the rate range we are considering. We are still observing some activity, including purchases and refinancing from floating rates, so things are steady.

Brandon King, Analyst

Got it. And just to summarize, you expect a similar increase in the fourth quarter. Did I hear that correctly?

Chang Liu, CEO

Probably pretty close to what we had in the third quarter. Yes. Yes.

Operator, Operator

And our next question today comes from Andrew Terrell with Stephens.

Andrew Terrell, Analyst

Just maybe just square out the discussion on the loan yields, up 20 basis points this quarter, but that did include the impacts from the interest recovery or prepayment that was 2 basis points to the NIM last quarter, 6 basis points this quarter. I guess, are you assuming that prepay or interest recovery continues at 6 basis points to the margin whenever you talk about loan yields going up a similar amount in 4Q? Or should that normalize lower going forward?

Heng Chen, CFO

Yes, it should. We don't see any big nonaccruals paying off. So you just subtract maybe $1.5 million from it, yes, for the one-time nonaccruals.

Andrew Terrell, Analyst

Understood. Okay. I appreciate it. And then on credit quality, I just ran asked around the construction nonaccruals went up from zero to, I think, right around $17 million or so. Can you just talk about the underlying credit or credits that drove that increase this quarter? And then similar question for the OREO addition this quarter. It looks like about $10 million addition to the OREO asset?

Chang Liu, CEO

Sure. Regarding the construction portfolio, I can provide some insights. One project is in the Southern California Inland Empire hospitality sector. This involves an existing asset that is undergoing a rebranding and significant renovations. We are over 90% complete. However, due to some considerable delays, there has been a dispute among partners. We feel confident about the asset as it has a low loan-to-value ratio, is well situated, and has a solid operating history. Unfortunately, the partnership dispute has impacted our current situation.

Heng Chen, CFO

Yes, that's because that loan between 90 days past maturity. That's why we had to put it on nonaccrual.

Chang Liu, CEO

The other is a NorCal office building. We've got a buyer that's been identified and that we've got some reserves set against it, and that one was also sort of a reposition play there as well.

Heng Chen, CFO

And then the OREO, it's a single-family house in Pacific Palisades. It came out of nonaccrual.

Andrew Terrell, Analyst

Okay. Understood. I appreciate the color there. And then if I could sneak one more in. The wealth management fee income this quarter was really strong. Can you just talk about what drove this quarter? And then is that low $5 million a quarter number kind of a good run rate to think about the wealth management fees moving forward?

Chang Liu, CEO

They are still on budget for this year. In the first half of the year, they were somewhat behind budget. So, essentially, the third quarter was a catch-up period for their business volume and the backlog in their pipeline. That's where we observed the increase.

Heng Chen, CFO

Yes. I think see volume there's a lot of deals that close in the third and fourth quarter.

Andrew Terrell, Analyst

Okay. So maybe a fair way to think about it. Is this more on an annual basis around like an $18 million number?

Heng Chen, CFO

Yes, yes. Yes.

Operator, Operator

Today's next question comes from Chris McGratty at KBW.

Nicholas Moutafakis, Analyst

This is Nick Moutafakis on for Chris. Maybe just a higher level just given where capital levels are at and your stock price, any appetite at all for a buyback in the near term in the next 12 months or so?

Heng Chen, CFO

Absolutely. We mentioned this briefly during our second quarter conference call. The approval process is taking a bit longer than it used to. However, we will move forward on this in the coming months. Once the Fed approves it, we won't issue a press release. The way I understand it, capital accumulates there, allowing us to proceed with buybacks when conditions are more stable.

Nicholas Moutafakis, Analyst

Okay. And then maybe just on the tax rate as well. If you look out longer term into 2024, do you think the 12.5% to 13% tax rate for next year is a good run rate as well?

Heng Chen, CFO

It's probably a little low. We had a bottom and two solar tax credit plans that overlap this year. Next year, we'll see some runoff from the second fund we provide and then we'll transition into a new one. However, it should increase a bit. We'll offer guidance in January for 2024. If you're modeling with a higher tax rate, the solar amortization is lower, almost dollar for dollar.

Operator, Operator

And our next question is a follow-up from Matthew Clark at Piper Sandler.

Matthew Clark, Analyst

Can you remind us what your SNC exposure is Shared National Credits?

Heng Chen, CFO

It's less than 5% of our total loans, Matthew.

Matthew Clark, Analyst

Okay. Got it. And then, I guess, an update on office CRE and the related reserve and the amount that might be criticized, I'm assuming the reserve is consistent with the commercial real estate reserve, but I'm not sure if you guys tweaked anything this quarter. But again, the reserve and the amount criticized?

Heng Chen, CFO

Well, our office reserve is we're reserving at about 85 basis points. What was the other part of your question? The amount that's criticized. We now have a couple of amounts that's criticized I don't have that handy. I can tell you, in non-accruals, we have about $10 million in CRE loans at office.

Operator, Operator

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

Chang Liu, CEO

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

Operator, Operator

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