Cathay General Bancorp — Q3 2011 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2011; filed November 4, 2011. Cathay General Bancorp is the holding company for Cathay Bank, a U.S. commercial bank with branches across several states and operations in Hong Kong, plus representative offices in Shanghai and Taipei. Unless stated otherwise, balance-sheet comparisons are with December 31, 2010; operating results are compared with the three or nine months ended September 30, 2010.
Financial performance and position
| Metric | Q3 2011 | Prior-year comparison |
|---|---|---|
| Net interest income before provision | $81.0 million | $73.3 million, up 10.4% |
| Provision for credit losses | $9.0 million | $17.9 million |
| Non-interest income | $16.8 million | $3.9 million |
| Non-interest expense | $48.4 million | $34.9 million |
| Net income attributable to Bancorp | $26.1 million | $17.3 million |
| Net income available to common shareholders; diluted EPS | $22.0 million; $0.28 | $13.2 million; $0.17 |
| Net interest margin, fully taxable-equivalent | 3.32% | 2.74% |
| Return on average assets; return on average equity | 0.98%; 6.91% | 0.61%; 4.76% |
| Efficiency ratio | 49.48% | 45.17% |
For the first nine months of 2011, net income attributable to Bancorp was $72.4 million and income available to common shareholders was $60.1 million, or $0.76 per diluted share, versus a common-shareholder loss of $18.8 million, or $0.25 per share, in 2010. Net interest income before provision was $234.4 million versus $222.7 million; provision was $25.0 million versus $146.9 million. The nine-month net interest margin was 3.19% versus 2.73%.
- Balance sheet: Total assets were $10.50 billion, down 2.8% from year-end 2010. Gross loans were $7.02 billion, up 2.2%; deposits were $7.13 billion, up 1.9%; total equity was $1.49 billion, up 4.1%.
- Funding and debt: Repurchase-agreement borrowings were $1.41 billion, down from $1.56 billion; FHLB advances were $205 million, down from $550 million. Long-term debt was $171.1 million. Deposits included $4.30 billion of time deposits, of which approximately 91% mature within one year or less.
- Liquidity: Cash and cash equivalents were $208.9 million at quarter-end. The reported liquidity ratio was 14.5%, versus 20.3% at year-end 2010. The Bank reported $1.4 billion of unused capacity on its $1.6 billion FHLB line and $241 million of borrowing capacity under the Federal Reserve collateral program; $747.7 million of investment and trading securities was available for liquidity or additional collateral.
- Cash flows: For the first nine months, operating activities used $31.6 million, compared with providing $154.6 million in 2010; investing activities provided $534.4 million and financing activities used $381.3 million. Cash and cash equivalents increased $121.5 million during the period.
- Credit quality: Non-accrual portfolio loans declined to $192.7 million from $242.3 million at year-end, while total non-performing assets were $300.1 million, including $94.3 million of other real estate owned (OREO). The allowance for loan losses was $209.1 million; net charge-offs were $61.6 million for the first nine months, versus $103.6 million in 2010. Accruing and non-accrual troubled debt restructurings (TDRs) were $126.3 million and $44.1 million, respectively.
- Capital: At September 30, Bancorp’s Tier 1 risk-based, total risk-based, and leverage ratios were 15.83%, 17.72%, and 12.60%; the Bank’s were 15.44%, 17.32%, and 12.29%. The Bank was categorized as well capitalized and both entities exceeded stated regulatory-plan targets.
Material changes versus prior periods
- Q3 earnings improved as lower credit-loss provision and funding costs, higher securities gains, and lower FDIC assessments more than offset higher expenses. Securities gains were $8.8 million for the quarter and $20.2 million year to date.
- Expense growth was substantial: Q3 non-interest expense rose 38.7% year over year. Salaries and benefits increased to $17.5 million, and OREO expense rose to $6.1 million from $0.5 million.
- Loan mix shifted: commercial loans increased $379.9 million year to date, while construction loans declined $161.0 million and commercial mortgage loans declined $191.5 million. Non-accrual loans fell, but OREO increased $16.6 million to $94.3 million.
- Investment securities declined by approximately $550.6 million from year-end; available-for-sale securities fell while held-to-maturity securities and trading securities increased. Available-for-sale securities had a net unrealized loss of $9.5 million versus $1.8 million at year-end.
- FHLB advances were prepaid by $400 million during the first nine months. Associated prepayment penalties were $16.8 million, including $4.5 million in Q3; the company also incurred a $1.7 million penalty on a repurchase-agreement prepayment. The income statement reported $18.5 million of debt-redemption costs year to date.
Outlook, commentary, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management said it expected available funding sources to meet the Bank’s operating needs and expected time-deposit runoff at maturity to be minimal based on historical experience.
- The Bank was not expected to pay dividends to Bancorp in 2011. Bancorp dividends and other capital distributions require prior written Federal Reserve approval under a 2009 memorandum of understanding (MOU). The Bank is also subject to an MOU with California regulators and the FDIC, including requirements concerning CRE concentrations, asset quality, capital, liquidity and wholesale funding. The company reported compliance with its capital-plan targets and the MOUs; noncompliance could lead to additional regulatory action.
- Management identified credit losses and asset quality, California and other regional economic and real-estate conditions, liquidity, interest-rate movements, regulatory changes and goodwill impairment among key risks. The allowance for loan losses, goodwill and investment impairment involve significant estimates.
- Management reported no other-than-temporary impairment on securities despite $27.2 million of gross unrealized losses at quarter-end, citing intent and ability to hold for recovery. This judgment includes non-agency mortgage-backed securities and a below-investment-grade regional-bank bond position.
- Goodwill remained $316.3 million. Retail Banking and East Coast reporting units had estimated fair value above carrying value, while Commercial Lending had no allocated goodwill and was not subjected to goodwill impairment testing. The filing cautioned that weaker economic conditions or lower peer valuation multiples could reduce reporting-unit fair values.
- Off-balance-sheet commitments totaled $1.67 billion, including $1.53 billion of commitments to extend credit. Routine litigation was described as not expected to have a material adverse effect. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether declining non-accrual loans and charge-offs persist, and whether rising OREO and TDR balances lead to further losses or expenses.
- Whether the $209.1 million loan-loss allowance remains adequate as loan growth, collateral values and economic conditions evolve.
- The sustainability of earnings excluding securities gains and after the elevated OREO costs and debt-prepayment penalties.
- Liquidity and funding sensitivity, including near-term time-deposit maturities, repurchase-agreement terms and the effect of regulatory limits on dividends or funding actions.
- The basis for no impairment recognition on securities with unrealized losses and the assumptions supporting goodwill valuations.