Cathay General Bancorp - Q2 2023

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and welcome to Cathay General Bancorp Q2 of 2023 earnings conference call. My name is Vaishnavi, 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. If you would like to participate in this portion of the call, please press star followed by one at any time during the conference. If assistance is needed any time during the call, please press star followed by zero, and a coordinator will be happy to assist you. 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. Please go ahead.

Georgia Lo (Assistant Secretary and Investor Relations)

Thank you, Vaishnavi, 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, 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 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 Q2 2023 results. To obtain a copy of our earnings release as well as 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 (President and CEO)

Thank you, Georgia. Good afternoon, everyone. Welcome to our 2023 Q2 earnings conference call. This afternoon, we reported net income of $93.2 million for the Q2 of 2023, a 2.9% decrease as compared to a net income of $96 million for the Q1 of 2023. Diluted earnings per share decreased 2.3% to $1.28 per share for the Q2 of 2023, compared to $1.32 per share for the Q1 of 2023. In the Q2 of 2023, our gross loans increased $635.5 million, or 13.9% annualized.

The increase in loans for the Q2 of 2023 was primarily driven by increases of $377 million, or 17.1% annualized in commercial real estate loans. $158 million or 12.1% annualized in residential mortgage loans, and $165 million or 19.9% annualized in commercial loans, offset by a decrease of $38 million in construction loans. With the strong loan growth in the Q2, we have revised our guidance for overall loan growth for 2023 to between 5%-7% from our previous guidance of 1%-3%. Our strong loan growth during the Q2 included advances from a handful of commercial loan borrowers.

In addition, we have increased the loan spreads for fixed-rate commercial real estate loans to help improve the returns. We continue to monitor our commercial real estate loans. Turning to slide seven of our earnings presentation, as of June 30th, 2022, the average loan-to-value of our CRE loans was 50%. As of June 30th, 2023, our retail property loan portfolio, at slide eight, comprises 22% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. 88% of the $2.1 billion in retail loans is secured by retail store, building, neighborhood, mixed use, or strip centers, and only 11% is secured by shopping centers. At slide nine, office property loans represent 17% of our total commercial real estate loan portfolio and 8% of the total loan portfolio.

Only 34% of the $1.6 billion in office property loans are collateralized by pure office buildings. Only 3% of the office property loans are in central business districts. Another 38% of office property loans are collateralized by office, retail stores, office mixed use, and medical offices. The remaining 28% of office property loans are collateralized by office condos. For the Q2 of 2023, we reported net charge-offs of $2 million, compared to net charge-offs of $4.9 million in the Q1 of 2023. Our non-accrual loans were 0.36% of total loans as of June 30, 2023, which decreased by $4.6 million to $69 million as compared to the end of the Q1 of 2023. Turning to slide 12.

As of June 30th, 2023, classified loans decreased to $193 million from $240 million as of March 31st, 2023. Our special mention loans increased slightly to $260 million from $251 million as of March 31st, 2023. We recorded a provision for credit losses of $9.2 million in the Q2 of 2023, as compared to an $8.1 million in provision for credit losses for the Q1 of 2023. We are pleased that total deposits increased by $448.1 million, or 9.7% annualized during the Q2 of 2023. Total uninsured deposits were $8.4 billion as of June 30th, 2023.

Excluding $0.9 billion in collateralized deposits, the uninsured and uncollateralized deposits of $7.5 billion was 39.2% of total deposits as of June 30, 2023. Our unused borrowing capacity from the Federal Home Loan Bank as of June 30, 2023, was $6.1 billion, and unplaced securities at June 30, 2023, was $1.3 billion. These and other sources of available liquidity were more than 100% of uninsured and uncollateralized deposits as of June 30, 2023. Total time deposits increased $325 million or 18.6% annualized during the Q2 of 2023, compared to the Q1 of 2023. Total saving deposits increased by $241 million, or 196.2% annualized, primarily due to a promotional campaign.

For 2023, the overall deposit growth is expected to range between 5% and 7%. I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the Q2 2023 financial results in more detail.

Heng Chen (CFO and EVP)

Thank you, Chang. Good afternoon, everyone. For the Q2 of 2023, net income decreased by $2.8 million, or 2.9% to $93.2 million, compared to $96 million for the Q1 of 2023. The decrease was primarily attributable to net interest margin compression due to the increase in the cost of deposits and because most of the loan growth during the Q2 was from fixed-rate loans. Our net interest margin was 3.44% in the Q2 of 2023, as compared to 3.74% for the Q1 of 2023. In the Q2 of 2023, interest recoveries and prepayment penalties added 2 basis points to the net interest margin, as compared to 8 basis points for the Q1 of 2023.

With an anticipated Fed rate hike in July 2023 and no rate cuts after that during 2023, we have revised our net interest margin expectations for 2023 to be between 3.5%-3.6%. Non-interest income during the Q2 of 2023 increased by $8.9 million to $23.1 million when compared to the Q1 of 2023, due to an increase of $5.8 million in gain on equity securities and from a $3 million write-off of a corporate bond security in the Q1. Non-interest expense increased by $9.6 million, or 11.6% to $92.8 million in the Q2 of 2023, when compared to $83.2 million in the Q1 of 2023.

The increase was primarily due to $6.5 million in higher amortization, solar tax credit investments, $1.6 million of seasonally higher marketing expenses, $1.5 million in higher professional expenses, offset by $1.2 million in lower salaries and bonuses, due mainly to higher FICA taxes paid in the Q1. We expect our non-interest expense, excluding tax credit and core deposit intangible amortization and HSBC integration expenses, to increase 3.5% from 2022 to 2023. The effective tax rate for the Q2 of 2023 was 9.2%, as compared to 21.4% for the Q1 of 2023, due mainly from additional investments in solar tax credits, in solar tax credit funds. For 2023, we're expecting the effective tax rate of between 13% and 14%.

We expect 2023 solar tax credit investment amortization of $42 million, including $16 million for Q3 and $11 million in Q4 of 2023. As of June 30, 2023, our Tier 1 leverage capital ratio increased to 10.45% as compared to 10.27% as of March 31, 2023. Our Tier 1 risk-based capital ratio decreased to 12.38% from 12.42% as of March 31, 2023, and our total risk-based capital ratio decreased to 13.88% from 13.94% as of March 31, 2023.

Chang Liu (President and CEO)

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

Operator (participant)

Ladies and gentlemen, if you have a question at this time, please press the star key and then number one on your touchtone telephone. We ask that you please limit yourself to one question and one follow-up question. You may return to the queue. If your question has been answered or you wish to remove yourself from the queue, please press star then two. To prevent any background noise, we ask that you please place yourself on mute once your question has been stated. The first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Matthew Clark (Managing Director and Senior Research Analyst)

Hey, good afternoon.

Heng Chen (CFO and EVP)

Hi.

Matthew Clark (Managing Director and Senior Research Analyst)

First one for me on the margin, if you can give us the spot rate on interest-bearing deposits at the end of June and the average margin in the month of June?

Heng Chen (CFO and EVP)

Yeah, the average margin for the month of June was 3.41%. It was up slightly from the margin for the month of May. The spot rate of total interest-bearing deposits at June 30th was 3%.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay, great. Getting from that 341 back up to that 350, well, you have the benefit, I guess, year-to-date of 359 in terms of the first half margin.

Heng Chen (CFO and EVP)

Right.

Matthew Clark (Managing Director and Senior Research Analyst)

it seems like you're, you expect that 3.41% June margin to hang in there. Can you just speak to, you know, what you're assuming on deposit costs and any kind of pay down borrowings?

Heng Chen (CFO and EVP)

Yeah, we think the loan growth in Q3 and Q4 will be quite a bit lower than in Q2. That will make it easier for us to fund the loans. I think between that and the additional Fed rate hike that we assume will happen on Wednesday, will help improve the margin. We do expect a interest recovery between now and the end of the year, you know, slightly over $1 million. That's kind of added to that.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay, great. Just around expenses, the core or adjusted expense outlook of 3.5%, which is unchanged off the $255 million last year, that implies some relief here in the second half. Can you just speak to what do you expect to come out of the expense run rate?

Heng Chen (CFO and EVP)

Well, Matthew, in Q2, we had, as we mentioned in our comments, we made most of our contributions in the Q2. We had probably about $1 million+ of one-time items, that's in the Q2. Lastly, Well, we think we might accrue lower bonus expenses in the second half, but, you know, if it's slightly higher than $3.5, I don't think it'll be much higher than that.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay. Then the low-income housing tax credit amortization for the Q3 and Q4, do you have those numbers?

Heng Chen (CFO and EVP)

It should be about $10 million per quarter.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay. Thank you.

Heng Chen (CFO and EVP)

Yeah, thank you.

Operator (participant)

The next question comes from Andrew Terrell with Stephens. Please go ahead.

Andrew Terrell (Managing Director)

Hey, good afternoon.

Heng Chen (CFO and EVP)

Hi.

Andrew Terrell (Managing Director)

Just to follow up on Matt's question there. On the expenses, I guess to get to 3.5% core expense growth for 2023, it implies that the core expense run rate steps down to about just a little over $63 million per quarter in the back half of the year. Does that sound right to you?

Heng Chen (CFO and EVP)

No, I, we kind of think it should be close to the, 67, I guess.

Andrew Terrell (Managing Director)

Okay. got it. Similar to the Q1 run rate?

Heng Chen (CFO and EVP)

Yeah.

Andrew Terrell (Managing Director)

Okay. Understood. On the, on the loan growth front, it sounded like last quarter on the conference call when the loan growth guidance was lowered, it was mostly predicated on uncertainty within the economy. I guess I'm surprised that after the revision last quarter, just surprised to see such strong loan growth here in the Q2. I guess, have your views around certainty in the economy improved? Where'd you see growth opportunities in the Q2, and just what gives you confidence in the growth put on in the Q2?

Chang Liu (President and CEO)

Andrew, during our Q2, the C&I loan growth was really from just a handful of large clients, on the tech side and the pharmaceutical side, that drew down on their advances of the line. That was not the case in the Q1. In addition, we had some pull-through on the commercial real estate side that really kind of, you know, started the process in the, in the latter part of the Q1, but it didn't close until sometime in the Q2. We don't expect, and particularly with the increase in the margins on the CRE side, we're not expecting, you know, to see continued demand at that pace in the Q2.

We think there's gonna be more of a muted, sort of pickup on any loan growth in the second half of the year.

Andrew Terrell (Managing Director)

Yep. Understood. Okay. Then in terms of,

Heng Chen (CFO and EVP)

... you know, of that, Chang mentioned we had an infrequent tech borrower that drew down on their line. They have since paid that off in the third quarter. That will help, well, it'll make the third quarter loan growth lower, just from the payoff.

Andrew Terrell (Managing Director)

Understood. Okay, I appreciate it. If I'm reading it right, it seems like that the guidance would be for the deposit growth to maybe slightly outpace loan growth in the back half of the year. I guess, is the plan gonna be to pay down the FHLB, in 3Q or 4Q? Or at least a portion of them?

Heng Chen (CFO and EVP)

Yeah. I mean, we're gonna try to target a 90% loan-to-deposit ratio. One reason it crept up is we had very strong loan growth in the month of June. It was hard for us to match that loan growth in the short time where it happened. Similarly, the Federal Home Loan Bank borrowings, they also jumped up in the second half of June. We since paid down about $250 million of those Federal Home Loan Bank borrowings to where it's now a more stable level for the second half.

Andrew Terrell (Managing Director)

Okay, got it. Thank you for taking the questions.

Heng Chen (CFO and EVP)

Thank you.

Chang Liu (President and CEO)

Thanks.

Operator (participant)

A reminder to limit yourselves to one question and one follow-up question. Our next question comes from Christopher McGratty with KBW. Please go ahead.

Andrew Leischner (AVP)

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

Heng Chen (CFO and EVP)

Hi.

Andrew Leischner (AVP)

I was just wondering, have you started to see any stabilization in your non-interest-bearing deposit outflows? I guess, should we continue to expect further mix shift from here? Thank you.

Heng Chen (CFO and EVP)

Yeah, we think it's stabilized. you know, just giving you the month-end balances, it was $3.7 billion in, at the end of April, $3.7 billion, rounded, at the end of May, and then, $3.6 billion at the end of June. you know, Chang, do you?

Chang Liu (President and CEO)

Yeah, we're not seeing any additional sort of outflows. I think at this point, given the rate hikes and, you know, some of the sensitive clients with the cash and liquidity that had them in checkings or money market, they, to the extent they wanted to move them into higher yielding accounts, they've already done so at this point. We believe that the non-interest-bearing core should remain relatively stable.

Andrew Leischner (AVP)

Okay, great. Thank you. That's truly helpful. On credit, have you started to see any credit migration within the office portfolio? Can you also just remind us what reserve you have on that portfolio?

Chang Liu (President and CEO)

Sure. Just kind of on the credit portfolio a little bit, you know, we kind of, there's a, there's a page on page nine on the, of the deck. You know, it's, it's all-encompassing. It's about $1.55 billion in total. The, the average loan size of these is about $2.1 million. Average property size is only about a little over 12,000 sq ft. Only 3% of it is in the commercial business district, so truly downtown core. The rest of it is 66% in urban, 31% in the suburban space.

If you exclude some of the portion of that, 28% of that was in office condos, which, you know, might have, might skew the balance towards lower balance and, you know, lesser of a square footage. Even if we exclude the office condos, the average loan size is still just about a little over $3 million, with an average property size, just a little over 21,000 sq ft. We're not in the big Class A, you know, 300,000 downtown core. That's not what we are. Some of these, a lot of these are sort of office over retail and some of our, the medical office space as well.

As far as the, at the average occupancy, we're about 84% across the board, and the average debt cover on these is about 1.8 or higher.

Heng Chen (CFO and EVP)

We don't have any special reserves on office, so it's the same as our CRE reserves, which is the CRE reserves are about the same. It's, you know, 0.8% of loans. We did build up our reserve this quarter, you know, by about $7 million. That wasn't for office. It was for general reserving.

Andrew Leischner (AVP)

Okay, great. thank you for the questions.

Chang Liu (President and CEO)

Yeah. Thank you.

Operator (participant)

As a reminder, if you have a question, please press star, then one to be joined into our queue. The next question comes from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner (Managing Director and Senior Research Analyst)

Thanks. Good afternoon. most of my questions-

Heng Chen (CFO and EVP)

Hi

Gary Tenner (Managing Director and Senior Research Analyst)

-were asked, just on the, on the capital front, just wondering, you know, given strong capital ratios and, you know, you've beefed up a little bit this quarter or the ACL this quarter, any thoughts on, you know, resuming buyback at this point?

Heng Chen (CFO and EVP)

Not for a while, Gary. We wanna see how the economy shakes out, you know, hopefully, very late in the year or early next year.

Gary Tenner (Managing Director and Senior Research Analyst)

Thank you.

Heng Chen (CFO and EVP)

Yeah.

Operator (participant)

At this time, there are no questions in the queue. Again, to ask a question, please press star, then one. As we see no questions, this ends the Q&A session. I will now turn the call back over to Cathay General Bancorp's management for closing remarks.

Chang Liu (President and CEO)

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