CATHAY GENERAL BANCORP quarterly report, Q3 FY2013

Cathay General Bancorp — Q3 2013 Form 10-Q

Reporting period: Three and nine months ended September 30, 2013. Cathay General Bancorp is the holding company for Cathay Bank, operating across multiple U.S. markets and in Hong Kong, with representative offices in Shanghai and Taipei. Financial amounts below are in U.S. dollars; “million” and “billion” are used for readability.

Financial performance and condition

Metric	Q3 2013	Q3 2012	Nine months 2013	Nine months 2012
Net interest income, before credit provision	$82.6 million	$80.4 million	$242.7 million	$240.2 million
Net income attributable to Bancorp	$32.5 million	$30.4 million	$91.2 million	$89.1 million
Net income available to common stockholders	$30.0 million	$26.2 million	$81.6 million	$76.8 million
Diluted earnings per common share	$0.38	$0.33	$1.03	$0.98
Net interest margin, fully taxable-equivalent	3.35%	3.26%	3.33%	3.28%
Efficiency ratio	51.01%	49.82%	52.09%	52.12%

Q3 provision for loan losses was a $3.0 million credit, compared with no provision or credit in Q3 2012. For the first nine months, the provision was a $3.0 million credit versus a $9.0 million credit in 2012.
Q3 return on average assets was 1.22% and return on average equity was 8.37%, versus 1.14% and 7.62%, respectively, a year earlier. Nine-month figures were 1.16% and 7.78%, versus 1.12% and 7.65%.
At September 30, total assets were $10.82 billion, up 1.2% from year-end 2012. Gross loans were $7.83 billion, up 5.4%; deposits were $7.92 billion, up 7.3%. Loans were led by commercial mortgages, which represented 50.1% of gross loans.
Cash and due from banks was $201.8 million. Total equity was $1.44 billion, down $194.2 million, primarily reflecting redemption of $258 million of TARP Series B preferred stock and $21.6 million of after-tax unrealized losses on available-for-sale securities, partly offset by $91.7 million net income.
Operating cash flow for the first nine months was $92.4 million, compared with $126.4 million in 2012. Investing activities used $83.6 million, versus providing $12.8 million; financing activities provided $48.1 million, versus using $142.4 million. Cash and cash equivalents ended at $201.8 million.
Interest-bearing and other funding included $800 million of repurchase-agreement borrowings, $376.2 million of FHLB advances, and $171.1 million of long-term debt. Repurchase-agreement borrowings declined from $1.25 billion at year-end 2012; FHLB advances increased from $146.2 million.
The Bank’s September 30 regulatory capital ratios were 14.46% Tier 1 risk-based, 16.20% total risk-based, and 12.02% Tier 1 leverage. The Bank remained “well capitalized” under then-applicable standards.

Material changes and notable items

Common-stockholder earnings increased 14.5% year over year in Q3 and 6.2% for the first nine months. Management attributed the quarterly increase mainly to lower litigation and OREO expenses, a credit for loan losses, higher net interest income, and stronger wealth-management commissions; higher compensation and debt-redemption costs partly offset the gains.
Net interest margin improved year over year despite lower asset yields, as funding costs fell. Q3 interest income declined to $102.5 million from $106.7 million, while interest expense fell to $19.9 million from $26.3 million.
Non-interest expense rose 5.9% in Q3 to $50.7 million. Compensation increased $4.3 million, partly due to bonuses, hiring, and temporary staff supporting a core-system conversion. Debt-redemption prepayment penalties were $6.9 million in Q3. Management also cited a $5.6 million reduction in litigation accrual expense and $1.3 million lower OREO expense.
The Company redeemed the remaining $129 million of TARP preferred stock on September 30, completing the redemption of $258 million in two installments during 2013. It incurred a $1.6 million noncash charge associated with the redemption.
During Q1, the Company transferred $722.5 million amortized cost of held-to-maturity securities to available-for-sale, citing possible changes in corporate tax rates and flexibility to sell. It recorded a $40.5 million net unrealized gain in other comprehensive income at transfer. Available-for-sale securities were $1.74 billion at September 30, with $53.5 million gross unrealized losses; accumulated other comprehensive loss was $21.2 million after tax.
Net gains on securities sales and calls were $27.2 million for the first nine months, versus $13.2 million in 2012. The Company prepaid $450 million of repurchase agreements during the first nine months and incurred $22.6 million in penalties.

Credit quality, liquidity, outlook, and risks

Non-performing assets were $150.1 million, or 1.4% of total assets, compared with $150.9 million at year-end 2012. Non-accrual loans were $99.9 million; OREO was $49.8 million. Impaired loans totaled $215.8 million, including $115.9 million of accruing troubled debt restructurings (TDRs). Accruing TDRs declined from $144.7 million at year-end; non-accrual TDRs were $43.6 million.
The allowance for loan losses was $181.5 million, or 2.32% of gross loans; the reserve for off-balance-sheet commitments was $2.1 million. Q3 net recoveries were $3.6 million, compared with $7.7 million of net charge-offs in Q3 2012. Management cautioned that economic weakness, interest rates, collateral values, and regulatory loan classifications could increase future credit costs.
The liquidity ratio was 16.5%, up from 15.3% at year-end. The Bank reported a $1.28 billion approved FHLB credit line, $94.2 million borrowing capacity under the Federal Reserve discount-window program, and $806.4 million of investment and trading securities available as additional liquidity or collateral. About 85% of time deposits were due within one year or less; management expected some competitive runoff at maturity but anticipated it would be minimal.
Management stated it expected to meet Basel III capital requirements on a fully phased-in basis using September 30, 2013 information. The rules were scheduled to take effect in 2015, with phased implementation thereafter.
The Company notified the Federal Reserve that the Board expected to increase the common dividend to $0.05 per share in Q4; regulatory objection remained possible. The filing does not provide earnings or revenue guidance.
Interest-rate simulations estimated that a 200-basis-point rise would increase 12-month net interest income 3.1% and net portfolio value 2.1%; a 200-basis-point fall was estimated to change them by 0.2% and 3.1%, respectively. Management warned that model assumptions may not predict actual results.
Risks include credit and real-estate collateral exposure, interest-rate and liquidity risk, deposit competition, securities valuation changes, regulatory and capital requirements, system-conversion execution, and economic conditions in the U.S. and Asia. The Company reported routine litigation; management did not expect a material adverse effect, but noted that ultimate losses could differ from accrued amounts. It reported no material change in previously disclosed risk factors.
Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter. The memorandum of understanding with the Federal Reserve Bank of San Francisco was terminated effective April 5, 2013; advance consultation on planned capital actions remained applicable.

Key facts for investors to verify

Whether loan growth, especially commercial real estate lending, is accompanied by stable underwriting and credit quality; review non-accrual loans, TDR performance, OREO, and collateral values.
Whether the $181.5 million loan-loss allowance remains adequate as loan balances grow, and how recoveries and credit provisions evolve.
The sustainability of margin and earnings gains given falling asset yields, lower funding costs, securities gains, and debt-redemption penalties.
The source and durability of deposit growth, including increased brokered time deposits, and the effect of near-term maturities and competition on liquidity and funding costs.
How securities unrealized losses, interest-rate movements, and the securities portfolio reclassification affect equity, liquidity, and future realized gains or losses.
The effect of the completed TARP redemption, Basel III implementation, regulatory oversight, and any proposed Q4 dividend increase on capital flexibility.