Cathay General Bancorp — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Unless otherwise noted, financial amounts are in U.S. dollars; balance-sheet comparisons are with December 31, 2016. The company provides banking and related financial services through Cathay Bank and other subsidiaries.
Business context and material developments
- On July 14, 2017, Cathay acquired SinoPac Bancorp, parent of Far East National Bank (FENB), expanding its California presence by nine branches. The acquisition added approximately $1.2 billion of assets and $813.9 million of deposits. Cathay Bank completed the FENB merger on October 27, 2017.
- Acquisition accounting remains preliminary and subject to adjustment during the one-year measurement period. The filing reports a $5.4 million bargain-purchase gain; acquisition-related expenses were $3.3 million in Q3.
- Q3 loans increased approximately $1.0 billion sequentially, partly reflecting the acquisition. Period-end gross loans were $12.6 billion, up 12.5% from year-end 2016.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income before credit-loss reversal | $133.2 million | $103.8 million | $362.7 million | $308.0 million |
| Net income | $49.7 million | $46.1 million | $150.1 million | $127.1 million |
| Diluted earnings per share | $0.61 | $0.58 | $1.86 | $1.59 |
| Net interest margin | 3.75% | 3.36% | 3.63% | 3.39% |
| Efficiency ratio | 41.91% | 45.05% | 43.71% | 51.35% |
| Return on average assets | 1.29% | 1.38% | 1.39% | 1.29% |
| Return on average equity | 9.77% | 10.30% | 10.46% | 9.66% |
- Q3 net interest income rose 28.3%, primarily due to higher loan interest income and lower repurchase-agreement expense. Management attributed the sequential margin improvement partly to $5.6 million of interest recoveries and loan prepayment penalties; these may not recur.
- Q3 non-interest income was $13.0 million, including the $5.4 million acquisition gain. Non-interest expense was $61.2 million, up 20.7% year over year, reflecting higher compensation and acquisition costs.
- The Q3 effective tax rate was 41.4%, versus 25.5% a year earlier. Lower-than-expected tax credits from the slower deployment of alternative-energy investments led management to raise its expected full-year effective tax rate to 34% from 29% at June 30. A $2.6 million share-based tax benefit reduced tax expense during the first nine months.
Balance sheet, funding, and cash flow
- Total assets were $15.7 billion, up 8.3% from year-end 2016. Deposits were $12.6 billion, up 7.6%; non-interest-bearing deposits were 21.7% of deposits.
- Loans, net of allowance and deferred fees, were $12.5 billion; the allowance for loan losses was $121.5 million. Available-for-sale securities were $1.37 billion. Cash and due from banks totaled $167.9 million, while short-term investments and interest-bearing deposits totaled $573.1 million.
- Total equity was $2.0 billion, up $140.2 million from year-end, reflecting earnings and acquisition-related stock issuance, partly offset by $50.5 million of dividends and shares withheld for tax settlement. The quarterly dividend was $0.21 per share.
- At September 30, borrowings included $595 million of FHLB advances, $100 million of repurchase agreements, $119.1 million of junior subordinated debt, and $136.1 million of deferred acquisition payments. FHLB advances included $450 million overnight; $490 million of advances were due in October 2017. Repurchase agreements matured in June and July 2018.
- For the first nine months, operating cash flow was $123.6 million, investing cash outflow was $159.1 million, and financing cash outflow was $14.6 million. Cash and cash equivalents decreased $50.1 million to $167.9 million.
- Management reported an average monthly liquidity ratio of 14.0%, compared with 12.6% at year-end 2016. The two subsidiary banks had a combined $5.5 billion approved FHLB credit line; approximately $1.1 billion of investment securities were unpledged and available for liquidity or collateral.
- Regulatory capital ratios remained above minimums; Cathay Bank was categorized as well capitalized. At September 30, its common equity Tier 1 ratio was 12.34%, total risk-based capital ratio 13.40%, and leverage ratio 10.54%.
Credit quality, risks, and outlook
- Non-performing assets rose 25% from year-end to $87.4 million, or 0.6% of assets; non-accrual loans increased 31.6% to $65.4 million. The allowance for loan losses was 0.96% of gross loans and 175.5% of non-performing loans, down from 1.06% and 239.5%, respectively, at year-end.
- Net recoveries were $5.1 million for the first nine months, compared with $5.4 million of net charge-offs in the prior-year period. The company recorded no Q3 loan-loss provision or reversal; it reported a $2.5 million reversal for the first nine months.
- Commercial real estate loans were 305% of the Bank’s risk-based capital, above the supervisory concentration criterion of 300% but below the Bank’s internal limit of 400%. Construction, land-development, and other land loans were 40.7% of risk-based capital. Loan concentrations, collateral values, extensions, and deterioration in real estate conditions are relevant credit risks.
- Management anticipated minimal runoff of time deposits at maturity, citing historical experience and expected replenishment through normal deposit growth, but noted keen competition. About 87% of time deposits matured within one year. Management stated available liquidity sources should meet operating needs.
- Interest-rate sensitivity modeling estimated that a 200-basis-point increase could raise 12-month net interest income 8.9%, while a 200-basis-point decrease could reduce it 4.7%. The filing cautions that model assumptions may differ from actual outcomes.
- The filing provides no quantitative earnings or growth guidance. Risks identified include economic and real-estate conditions, credit losses, interest-rate changes, liquidity, regulation, integration of acquisitions, cybersecurity, and legal proceedings. Management did not expect routine litigation to materially affect the company; it reported no material change to previously disclosed risk factors.
Most important facts for investors to verify
- How FENB integration, final purchase accounting, deferred consideration, and post-merger costs affect future earnings and capital.
- Whether Q3 margin benefits from recoveries and prepayment penalties persist, and how deposit pricing and borrowing costs respond to interest rates.
- Trends in non-accrual loans, non-performing assets, TDRs, allowance coverage, and commercial real estate concentration.
- Liquidity and refinancing needs, particularly the October 2017 FHLB maturities and short-dated time deposits.
- The basis for the revised 34% full-year tax-rate expectation and the pace of alternative-energy investment deployment.