Cathay General Bancorp — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The filing was signed August 7, 2014. Cathay General Bancorp is the holding company for Cathay Bank, which operates across several U.S. states and in Hong Kong, with representative offices in Shanghai and Taipei.
Financial performance and condition
Amounts below are in millions, except per-share data and ratios. Quarterly results are compared with Q2 2013; balance-sheet figures are compared with December 31, 2013.
| Metric | Q2 / June 30, 2014 | Comparison |
|---|---|---|
| Net interest income before provision | $85.6 | $80.0 in Q2 2013 |
| Net interest margin, fully taxable-equivalent | 3.37% | 3.30% in Q2 2013; 3.38% in Q1 2014 |
| Non-interest income | $9.0 | $20.4 in Q2 2013 |
| Non-interest expense | $42.5 | $53.7 in Q2 2013 |
| Net income attributable to common stockholders | $35.1; diluted EPS $0.44 | $27.8; diluted EPS $0.35 in Q2 2013 |
| Efficiency ratio | 44.92% | 53.53% in Q2 2013 |
| Return on average assets / equity | 1.29% / 9.25% | 1.15% / 7.74% in Q2 2013 |
| Total assets | $11,556.8 | $10,989.3 |
| Gross loans / deposits | $8,565.3 / $8,580.6 | $8,084.6 / $7,981.3 |
| Stockholders’ equity | $1,538.4 | $1,459.0 |
For the six months ended June 30, net income attributable to common stockholders was $66.3 million, up from $51.5 million; diluted EPS was $0.83 versus $0.65. Net interest income before provision was $168.3 million versus $160.1 million, and the six-month net interest margin was 3.37% versus 3.33%. The six-month efficiency ratio improved to 47.21% from 52.64%.
Cash flow: For the first six months, operating cash flow was $66.7 million (prior-year period: $73.8 million), investing cash flow was negative $461.6 million (positive $42.4 million), and financing cash flow was positive $487.0 million (negative $128.1 million). Cash and due from banks ended June at $245.9 million, up from $153.7 million at year-end. The investing outflow chiefly reflected increased short-term investments and net loan growth; financing inflows included deposit growth.
Funding, liquidity and capital: Deposits rose 7.5% from year-end, while gross loans increased 5.9%. The reported liquidity ratio was 16.5%, compared with 15.3% at year-end. The Bank had a $3.5 billion approved FHLB credit line, of which $521.2 million was drawn, and $76.2 million of borrowing capacity under the Federal Reserve Borrower-in-Custody program. Of $1.34 billion in investment securities, $490.9 million was unpledged. Repurchase-agreement borrowings were $700.0 million; FHLB advances were $521.2 million; long-term debt was $119.1 million.
At June 30, Bancorp’s Tier 1 risk-based, total risk-based and leverage ratios were 15.13%, 16.43% and 12.65%; the Bank’s were 14.73%, 15.99% and 12.31%. The Bank was classified as well capitalized. Management stated that both Bancorp and the Bank would meet Basel III capital requirements on a fully phased-in basis as if then effective.
Material changes and asset quality
- Loans grew by $480.7 million from year-end, led by commercial mortgage loans (+$285.1 million), residential mortgages (+$113.5 million) and construction loans (+$63.6 million). Commercial mortgage loans were 50.3% of gross loans.
- Non-performing assets declined 17.0% to $113.8 million, or 1.0% of total assets, from $137.2 million at year-end. Other real estate owned fell 34.3% to $34.8 million; non-accrual loans fell 6.7% to $77.6 million.
- The allowance for loan losses was $169.1 million, 1.97% of gross loans, versus $173.9 million and 2.15% at year-end. First-half net charge-offs were $0.7 million; Q2 had net recoveries of $3.6 million. The company recorded a $3.7 million provision credit in Q2, benefiting earnings.
- Impaired loans totaled $188.7 million, including $111.1 million of accruing troubled debt restructurings (TDRs). Non-accrual TDRs increased to $43.6 million from $38.8 million at year-end; one previously modified commercial mortgage loan of $62,000 subsequently defaulted. Management said accruing TDRs were performing under their modified terms.
- Available-for-sale securities fell to $1.34 billion from $1.59 billion. Net unrealized loss in accumulated other comprehensive income improved to $8.9 million from $29.7 million. Gross unrealized losses were $26.6 million, primarily attributed to interest-rate increases and wider credit/liquidity spreads; management considered the impairments temporary and recorded no impairment charge.
Management commentary, outlook and risks
Q2 earnings increased despite much lower securities gains: $0.5 million versus $12.2 million in Q2 2013. Higher loan interest income and lower repurchase-agreement interest expense supported net interest income. Lower expenses also reflected reduced debt-redemption costs, completion of the 2013 core-system conversion, full amortization of the General Bank core deposit premium, and lower affordable-housing investment expense. These benefits were partly offset by higher salaries and incentive compensation. First-half net securities gains were $6.5 million versus $18.5 million a year earlier. The company prepaid $100 million of repurchase agreements in the first half and incurred $3.4 million in penalties; the Q2 income statement reported a $0.6 million net gain in the debt-redemption line.
The filing provides no numerical earnings or growth guidance. Management expected deposit maturities to produce some runoff, but anticipated it would be minimal and replenishable through normal deposit growth; it believed available funding sources would meet operating needs. The company increased its common dividend to $0.07 per share in June. Future dividends remain subject to board decisions, regulatory consultation and restrictions in the junior subordinated notes.
Key risks include credit quality and collateral values, economic conditions, interest-rate and liquidity risk, regulatory and Basel III changes, foreign-country exposure, and model uncertainty. Commercial real estate loans were 255% of Bank risk-based capital, below the Bank’s 300% internal limit. Foreign-country risk net exposure was $870.8 million, mainly Hong Kong ($408.4 million) and China ($158.4 million). The interest-rate simulation estimated that a +200-basis-point shock would increase net interest income 15.7%, slightly beyond the stated ±15% policy tolerance; estimated market-value-of-equity change was +3.6%. A −200-basis-point shock produced estimated changes of −1.8% in net interest income and −12.1% in market value of equity. Management cautioned that simulation assumptions and actual outcomes can differ.
Management reported routine litigation and did not expect it to materially affect the company overall, while noting that ultimate losses may differ from accrued amounts. No material change to the 2013 Form 10-K risk factors was reported. Disclosure controls were judged effective, with no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth, especially in commercial real estate and construction, is accompanied by sustained credit quality and adequate allowance coverage.
- How the $3.7 million Q2 provision credit and net recoveries affect the underlying earnings trend, apart from ongoing net interest income and operating costs.
- Whether the securities portfolio’s unrealized losses remain temporary and how changes in rates affect securities values, funding costs and net interest margin.
- Deposit retention and funding costs as substantial time deposits mature, and availability of pledged collateral and contingent borrowing capacity.
- Capital ratios under phased-in Basel III rules, including changes to capital treatment and the conservation buffer.
- Interest-rate model assumptions and the reported +200-basis-point net-interest-income sensitivity relative to the company’s stated policy tolerance.
- Developments in TDRs, non-accrual loans, OREO, foreign-country exposures and any litigation or regulatory matters.