Cathay General Bancorp — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The filing covers Cathay General Bancorp and its banking subsidiary, Cathay Bank. Unless otherwise noted, balance-sheet comparisons are with December 31, 2018; income-statement comparisons are year over year.
Business context and key financial results
The company operates a U.S.-focused commercial bank with branches in several states and Hong Kong. Lending is concentrated in commercial real estate, residential mortgages, and commercial loans. Amounts below are in U.S. dollars.
| Metric | Q3 2019 / September 30, 2019 | Comparable period / change |
|---|---|---|
| Net interest income before credit-loss reversal | $147.0 million | Up 1.3% from $145.1 million in Q3 2018 |
| Net interest margin | 3.56% | 3.83% in Q3 2018; 3.58% in Q2 2019 |
| Non-interest income | $10.4 million | Up 33.3% from $7.8 million in Q3 2018 |
| Non-interest expense | $65.6 million | Down 0.6% from $66.0 million in Q3 2018 |
| Net income / diluted EPS | $72.8 million / $0.91 | Net income up 4.3%; diluted EPS was $0.85 in Q3 2018 |
| Assets / total equity | $18.0 billion / $2.25 billion | Assets up 7.1%; equity up $124.0 million from year-end 2018 |
| Loans, including held-for-sale / deposits | $14.8 billion / $14.7 billion | Loans up $769.5 million and deposits up $955.9 million from year-end 2018 |
| Cash, cash equivalents and restricted cash | $825.1 million at period-end | Up from $600.3 million at the start of the nine-month period |
Cash flow, margins, debt and liquidity
- For the first nine months, operating cash flow was $323.7 million, investing cash flow was negative $999.7 million, and financing cash flow was $900.8 million. Loan growth was a major investing cash use; deposit growth and FHLB funding were important financing sources.
- Q3 return on average assets was 1.65% (1.72% a year earlier); return on average equity was 12.98% (13.19%). The efficiency ratio improved to 41.67% from 43.14%. For the first nine months, net income was $211.8 million, diluted EPS was $2.64, and net interest margin was 3.61%, versus $207.2 million, $2.53, and 3.80%, respectively, in 2018.
- Interest expense rose substantially year over year, particularly on time deposits. Q3 average cost of interest-bearing deposits increased to 1.60% from 1.05%; the filing attributes margin pressure in part to deposit-cost increases.
- At September 30, borrowings included $600 million of FHLB advances, $160.4 million of long-term debt, and $30.8 million of other affordable-housing investment borrowings. The company also reported $330 million in overnight FHLB borrowings. FHLB funding is secured by loans.
- The average monthly liquidity ratio was 12.7%, versus 12.0% at year-end 2018. The company reported a $4.4 billion approved FHLB credit line and $24.3 million of Federal Reserve Discount Window borrowing capacity. Management said it expects liquidity sources to be adequate for the next 12 months, while noting that deposit competition may cause some time-deposit runoff; about 90% of time deposits mature within one year.
- Capital ratios remained above regulatory minimums and “well capitalized” thresholds. At September 30, Bancorp’s common equity Tier 1 ratio was 12.41% and total capital ratio was 14.06%; Cathay Bank’s corresponding ratios were 13.13% and 14.00%.
Material changes and notable items
- Loan growth was led by commercial mortgages and residential mortgages; commercial loans declined. Total deposits rose, with time deposits increasing to 52.0% of deposits from 49.0% at year-end 2018.
- Q3 non-interest income benefited from a $1.5 million year-over-year increase in interest-rate-swap valuation and a $0.8 million gain from residential mortgage sales. For the first nine months, equity-security gains were $7.8 million, compared with a $4.6 million loss in 2018.
- The company recorded a $2.0 million Q3 reversal for credit losses, compared with a $1.5 million reversal in Q3 2018. Nine-month net recoveries were $5.5 million; commercial-loan charge-offs increased to $6.3 million from $0.6 million in the prior-year period.
- Non-performing assets were $59.2 million, or 0.3% of assets, compared with $58.3 million at year-end 2018. Non-accrual loans increased to $47.2 million from $41.8 million, while accruing troubled debt restructurings declined to $41.6 million from $65.1 million.
- The allowance for loan losses was $125.9 million, or 0.85% of gross loans excluding loans held for sale; the reserve for off-balance-sheet credit commitments was $4.6 million. Management cited additional tariffs on imports from China as a factor in the increased allowance for commercial loans.
- The company adopted lease accounting on January 1, 2019, recognizing an operating lease liability of $41.2 million and right-of-use asset of $40.6 million at adoption. At quarter-end, the right-of-use asset was $34.5 million and lease liability was $36.1 million.
- During the first nine months, the company paid $74.4 million in common dividends and repurchased $36.3 million of shares. A May 2019 repurchase program authorized up to $50 million; $23.6 million remained available at September 30.
Outlook, risks and contingencies
- The filing provides no specific earnings, loan-growth, or margin guidance. Management’s stated liquidity outlook is that available sources should meet operating needs for the next 12 months.
- Management was implementing the CECL expected-credit-loss standard for adoption on January 1, 2020. It had completed a preliminary calculation but stated that the quantitative impact was not yet determinable.
- Interest-rate modeling estimated that a parallel 200-basis-point increase would raise net interest income by 7.2%, while a 200-basis-point decrease would reduce it by 17.0%. Management cautioned that model assumptions and actual outcomes may differ.
- Key disclosed risks include credit deterioration and additional loss provisions, deposit funding and liquidity, interest-rate changes, economic and market conditions, trade-related effects on borrowers, regulation, technology and cybersecurity, and legal proceedings. The company reported no material change to the risk factors in its 2018 Form 10-K.
- Management said ordinary-course litigation was not expected to have a material adverse effect. The company also disclosed an IRS audit of its 2017 tax year; it did not expect possible changes in unrecognized tax benefits to materially affect the annual effective tax rate.
- Q3 income tax expense included a $1.4 million adjustment related to delayed solar-system installation and a $0.8 million adjustment for lower-than-expected low-income housing tax credits. Management cited these as contributors to the quarter’s 22.4% effective tax rate.
Important facts for investors to verify
- Whether loan growth and asset quality remain sound, especially given higher non-accrual commercial loans, increased commercial-loan charge-offs, and trade-tariff exposure.
- Whether deposit growth can continue at acceptable funding costs, and how much of the large time-deposit balance renews as it matures.
- How net interest margin responds to changing rates and deposit repricing; review the assumptions behind the disclosed interest-rate sensitivity scenarios.
- The eventual CECL adoption effect on the allowance, earnings, and capital; the filing does not provide a clear quantitative estimate.
- Whether planned solar projects and affordable-housing tax credits perform as expected, given the quarter’s tax adjustments and the company’s partnership investments.
- Capital, liquidity, dividend, and repurchase capacity, including the effect of FHLB funding and the remaining authorization under the share repurchase program.