Cathay General Bancorp (NASDAQ:CATY) Q3 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to the Cathay General Bancorp third quarter 2020 earnings conference call. My name is Val and I'll be your coordinator for today. At this time, all participants are listening on remote. Following the prepared remarks, there will be a question and answer session. If you would like to participate in this portion of the call, please press star followed by one at any time during the conference. If assistance is needed at any time during the call, please press star followed by zero and a coordinator will be happy to assist you. Today's call is being recorded and will be available for replay at www.cafegeneralbancorp.com. Now I'd like to turn the call over to Megan Chung, Investor Relations of Cafe General Bancorp.

0:39 Thank you, Valerie, and good afternoon. Here to discuss the financial results today are Mr. Chang Lui, our President and Chief Executive Officer, and Mr. Hang Chan, our Executive Vice President and Chief Financial Officer. Before we begin, We wish to remind you that the speakers on this call may make forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 concerning future results and events, and that these statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are further described in the company's annual report on Form 10-K for the year ended December 31, 2019, at item 1A in particular, and in other reports and filings with the Securities and Exchange Commission from time to time.

1:36 As such, we caution you not to place undue reliance on such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and except as required by law, we undertake no obligation to update or review any forward-looking statements to reflect future circumstances, developments or events or the occurrence of an anticipated event. This afternoon, Cafe General Bancorp issued an earnings release outlining its third quarter 2020 results. To obtain a copy of our earnings release as well as our third quarter earnings presentation, please visit our website at www.cafegeneralbancorp.com. After comments by management today, We will open up this call for questions.

2:27 I will now turn the call over to our President and Chief Executive Officer, Mr. Chang Lui.

2:33 Thank you, Megan, and good afternoon, everyone. Welcome to our 2020 Third Quarter Earnings Conference Call. While we acknowledge our third quarter operating results, our commitment and focus today is on continuing to support our clients, team members, and communities during the COVID-19 pandemic. This afternoon, we reported net income of $56.8 million for the third quarter of 2020, a 22% decrease when compared to a net income of $72.8 million for the third quarter of 2019. The Luda earnings per share decreased 22% to $0.71 per share for the third quarter of 2020, compared to $0.91 per share for the same quarter a year ago. In the third quarter of 2020, our gross loans decreased by $42.5 million to $15.6 billion, The decrease in loans for the third quarter of 2020 was primarily driven by a decrease of $164 million, or 6%, in commercial loans due to unusually high paydowns from our commercial borrowers resulting from their strong cash flows.

3:35 Commercial real estate loans increased by $67.8 million, or 0.9%, as a result of the origination of new loans, and construction loans increased by $50.9 million, or 8.2%, as a result of construction drawdowns. During the third quarter, we again conducted credit reviews of our borrowers in industries particularly impacted by the economic impact of the pandemic. We are encouraged because 68.6% of our commercial real estate and single-family mortgages that were on payment deferral have returned to full scheduled payment status as of September 30, 2020. Also, many of our borrowers are reporting improved cash flows, and many of our hotel borrowers are reporting higher occupancy levels during the third quarter.

4:20 We are also encouraged by the low loan-to-value for these review loans and of the outside liquidity that is held by the guarantors of these loans, which we expect could be used to support these loans. As of September 30, 2020, our COVID-19 loan modifications were as follows. 48 CNI loans with an aggregate balance of $45.3 million as of September 30, 2020, or approximately 1.8% of our commercial loan portfolio, are still modified to provide relief on repayment terms. Turning to slide seven of our earnings presentation, as of September 30, 2020, 95 CRE loans with an aggregate balance of $428 million, or approximately 5.7% of our CRE loan portfolio, are still on loan modifications to provide relief on repayment terms.

5:14 The average loan-to-value ratio at origination for these loans was 52%. By October 20, 2020, the balance of CRE loans still under loan modifications have further decreased to only $146 million, or approximately 2% of our CRE loan portfolio. We will provide some specifics about Cathay's hotel and retail loan portfolios of the two segments more impacted by the downturn. As of September 30, 2020, Cathay has 64 hotel loans that total $351.6 million, including 49.2 million of SBA loans. As of September 30th, 2020, the remaining loans with loan mods were at 129 million or 37% of the total hotel portfolio.

6:02 Among the 64 hotel loans, 59 are limited service and five are full service, three in Southern California and two in Texas. Turning to slide eight, we note that we review 81% of the loans in our retail loan portfolio which comprises 19% of our total commercial real estate loan portfolio and 9% of our total loan portfolio as of September 30, 2020. The majority, 62% of the $1.42 billion in retail loans reviewed is secured by neighborhood, community or strip centers and only 12% is secured by regional malls, power or lifestyle or factory outlet properties. among the 161 million of CRE retail loans still under loan modifications as of September 30th, 2020, approximately 38% are paying interest only.

6:53 Turning to slide nine, as of September 30th, 2020,367 payment deferment requests with an aggregate balance of 180.6 million or approximately 4.3% of our residential mortgage loan portfolio remain on payment deferral status. As of October 20th, 2020, The balance of our residential mortgage loans still under loan modifications had decreased to $139 million, or approximately 3.3% of our residential mortgage loan portfolio. For the third quarter of 2020, we reported net charge-offs of $3.1 million compared to net charge-offs of $3.6 million in the second quarter of 2020. Our non-accrual loans increased by $20.7 million, or $77.2 million.

7:40 or 0.5% of period end loans as compared to the end of the second quarter of 2020. The increase is a result of the placement of our only two movie theater loans acquired through the acquisition of Far East National Bank going to non-accrual status during the third quarter of 2020. We recognized a 12.5 million loan loss provision in the third quarter of 2020 compared to 25 million in the second quarter of 2020. The 12.5 million loan loss provision in the third quarter of 2020 included qualitative adjustments under the incurred loss model due to the impact of the COVID-19 pandemic. We have elected to defer the implementation of the CECL standard for recognizing credit losses as permitted under the recently enacted CARES Act.

8:27 Based on preliminary calculations, the CECL allowance for credit losses for the third quarter of 2020 will be approximately $15 to $25 million less than the $12.5 million incurred loan loss provisions. The lower ACL provision is primarily a result of the improvement in the forecasted economic factors shown in the Moody's September baseline case forecast compared to Moody's June baseline forecast. We also continue to monitor and evaluate the potential impact of the continuing tariffs from the partially resolved trade dispute between the U.S. and China to our loan portfolio. Borrowers that we believe could be adversely impacted by the current tariffs constitute approximately 1.6% of our total loans.

9:12 Turning to slide 12, total average deposits increased by $363 million or 2.3% during the third quarter. Average money market deposits increased by $363 million or 13.2% in part as a result of marketing efforts to large corporate depositors. Average time deposit decreased by $335 million or 4.4% due to the runoff of wholesale deposits. We plan to further address the excess liquidity brought by the growth in core deposits by reducing broker deposits during the fourth quarter of 2020. With that, I'll turn the floor over to our Executive Vice President and Chief Financial Officer, Peng Cheng, to discuss the third quarter 2020 financial results in more detail.

9:56 Thank you, Chang, and good afternoon, everyone. For the third quarter of 2020, net income decreased by 16 million, or 22%, and 56.8 million compared to the third quarter of 2019, which was primarily attributable to 12.5 million loan loss provision due to COVID-19 mentioned earlier. Our net interest margin was 3.02 in the third quarter of 2020 as compared to 3.02 in the second quarter of 2020. There were 2.4 billion of loans at the floor rate as of September 30, 2020.

10:41 In the third quarter of 2020, interest recoveries and prepayment penalties added eight basis points to the net interest margin compared to three basis points for the second quarter of 2020. Approximately $1.5 billion, $2.6 billion, and 0.9 billion of our CDs will mature during the fourth quarter of 2020 and the first and second quarters of 2021 with average rates of 1.51, 1.47% and 0.88% respectively. We are targeting renewing retail CDs in the 50 to 60 basis point range. Non-interest income during the third quarter of 2020 decreased by 0.4 million to 10 million when compared to the third quarter of 2019.

11:42 Non-interest expense increased by 10 million or 15.9% to 76 million in third quarter of 2020 when compared to 65.6 million in the same quarter a year ago. Excluding the amortization of low-income housing and alternative energy partnerships, non-interest expense only increased by $1.2 million or 2% between the third quarter of 2020 and compared to the third quarter of 2019. For the third quarter of 2020, the increase in non-interest expense was primarily due to a $7.5 million increase in amortization of the investments in low-income housing and alternative energy partnerships, a $1.4 million increase in salaries and benefits, and a $1 million increase in the reserve for unfunded loan commitments.

12:44 The effective tax rate for the third quarter of 2020 was 3.7%, compared to 22.4% for the third quarter of 2019. We completed our investment in a solar tax credit fund in the second quarter, which we project will lower our full-year effective tax rate to approximately 8%. Solar tax credit amortization was 10.8 million in the third quarter of 2020, and is expected to be 10 million in the fourth quarter of 2020. As of September 30th, 2020, our Tier 1 leveraged capital ratio decreased to 10.51% as compared to 10.83% as of December 31, 2019. Our Tier 1 risk-based capital ratio increased to 13.22% from 12.51% as of December 31, 2019. And our total risk-based capital ratio increased to 15.23% from 14.11% as of December 31, 2019.

14:01 We expect to resume our stock buyback program during the fourth quarter of 2020.

14:08 Thank you, Hang. We will now proceed to the questions and answer portion of the call. Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your keyboard. on your touchstone telephone. We ask that you please limit yourself to one question and a follow-up. You may then return to the queue. If your question has been answered or you wish to remove yourself from the queue, please contact the counsel. To prevent any background noise, we ask that you please place yourself on mute once your question has been stated. Our first question comes from Michael Yod of Truist Security. Your line is open.

14:52 Hey, thanks for taking the question. Hi, Michael.

14:57 I appreciate the commentary on the share buyback reinstatement. Could you maybe help size it or frame that for us and kind of your expectations given there's not a lot standing on the remaining program and how you guys would think about future programs and how much capital to deploy?

15:17 Yeah, Michael, right now our plan is to hopefully complete the 10.7 million remaining here in the fourth quarter and then we would go to our board for a new authorization in 2021 and hopefully we would announce that in the January call. We hope that, you know, based on our excess capital generation that and the fact that our credit quality seems to stabilize that we could start buying back at a higher pace in 2021 than the 10.7 million that we hope to complete in Q4.

16:14 But we're going to look at it every quarter so that we don't We maintain our strong capital ratios.

16:28 Okay, that makes sense. And I guess the other side of that equation would be, you know, organic growth. Can you maybe provide any outlook on, you know, kind of the organic growth expectation and maybe the contributing factors, whether it be residential or commercial, any outlook on pipelines, et cetera, would be helpful.

16:50 Well, Michael, In light of the current economic uncertainties caused by COVID-19 pandemic, we're no longer able to update our current growth guidance, but we're hopeful that 2021 will have some more recoveries, and we'd love to see more C&I growth in the future in our loan portfolio, and we continue to do fairly well with some CRE loan growth with our existing customer and existing relationships.

17:21 Okay. I mean, I guess just overall, you know, maybe I know this is kind of point in time, maybe not a view for 2021, but are you seeing kind of a return of demand from customers? You know, are you seeing any pipelines building in the construction area? Anything else like that would be helpful if you have any color there.

17:41 Yeah, as far as the construction side of the portfolio, we actually saw a slight decrease in the commitment. The increase in the construction outstanding balance is a result of the actual drawdowns from previously approved commitments. So that's where we saw some of that increase in those numbers.

18:02 Yeah, I can just add, Michael, we have been adding – and a number of mainstream lenders. Chang, do you want to?

18:12 Yeah, we added a team, a commercial banking team in the San Fernando Valley area through an external hire and put a small team together and we're looking and they've got a pretty decent pipeline so we're looking for that pipeline to get to some closings both by fourth quarter and well into 2021.

18:31 Okay, I'll step back. Thank you. Our next question comes from Chris McGrady of KBW. Your line is open.

18:45 Great. Thanks for the question. Hank, can we, excluding the amortization in the quarter, could you talk about how you're thinking about expense growth in the environment that we're in right now relative to that adjusted number that you referenced in the deck?

19:01 Yeah. I mean, the third quarter was a little bit higher because we had higher bonus accruals. Also, because we had some loan pay downs or the loan growth was a little bit weaker, we had lower deferred loan costs capitalized. But, you know, I mean, that's where we are. Could you rephrase the question? Because I think I answered part of it.

19:39 If I'm looking at the trend on slide 15 of your core non-interest expense over the past several quarters, I'm just trying to get a sense of what the right base rate is either into Q4 and into next year. You know, how much growth will we see off of either, you know, the average of the last two quarters or this quarter specifically?

19:59 Yeah, I mean, you know, we had that million-dollar provision for – Long Commitments. You know, when these things are under-receivable, that expense is going to be in the loan loss provision line. But, you know, our goal is, you know, it's Chang's goal. We know it's a tough revenue environment, so we're doing many things such as I think increasing the span of control, having fewer layers of management, you know, trying to avoid replacing staff, you know, certain staff people when they leave if that work could be split up. So we're not in a position to give guidance as to 2021, but, you know, we have a history of working hard on expenses.

21:11 And maybe on the margin, I guess two-part question. Number one, could you repeat the maturity schedule?

21:16 I got the rates, but I missed the maturity of the CDs that occur in the next... Yeah, it's $1.5 billion will mature in the fourth quarter, $2.6 billion of CDs will mature in the first quarter, and 0.9 billion will mature in the second quarter.

21:37 Okay. And as it relates to just the outlook for margin, you know, it seems like you've got additional downward repricing on the liabilities. You know, loan growth's obviously not great at the industry level. How do we think about margin from here, from the 302 level over the next quarter or so?

21:56 Well, I'm optimistic. One, the excess cash we have in the Fed, that added, just in the fourth quarter, it added seven bases to the NIM. We had a flow of deposits. Our average at the Fed was about a billion four. That's excess. And so we have 400 million of broker CDs that are maturing, most of them in October.

22:49 And that is just going to reduce the excess cash at the Fed. So not only will you have the benefit of reducing that CD expense, you'll also shrink the earning, the fluff that's in the earning asset. And then we have some federal home loan bank borrowings, a couple hundred million, which will mature in June of next year. So we may, like many banks, prepay a portion of that. and the cost is relatively low.

23:29 And Chris, if I could speak to the asset side of the equation, we got approximately 2.4 billion or 15% of our total loans of our floating rate loans that are at their floor rates. Our residential mortgages, which is about 27% of our loan portfolio, they're generally fixed rate or hybrid arms that are still in their fixed rate period. And also most of our CRE loans are fixed. So the majority of our loans are either fixed rate loans or at their floor rates.

23:57 Okay, so Margin, the message you're sending is Margin's going to likely expand from here, if I'm hearing you right?

24:03 We hope so.

24:05 Okay, got it. Thanks for all the color. Thank you. Our next question comes from Gary Tenner of Davidson, DA Davidson. Your line is open.

24:16 Thanks. Good afternoon. A couple of questions. I guess first, the $400 million in brokerage CDs that you just mentioned, is that included in that $1.5 billion, or is that over and above the – that's included in the $1.5?

24:30 Yes, yes.

24:32 Okay, thanks. And then, Han, you mentioned, I think, that part of the thought process around reinstating the buyback was kind of stabilization on the credit side. And, you know, NPAs – up a little bit, classified loans, you know, sequentially higher. Just curious kind of what the markers are, what, you know, what you're seeing behind the numbers that gives you increased comfort.

25:02 And, you know, I think we kind of mentioned that for the last couple quarters. You know, we reviewed 81% of our retail loans, and we reviewed all of our hotel loans. and we talked about the burden rate and the personal guarantee.

25:24 Yes, so we looked at, you know, we did deeper dives in both of the last two quarters on our retail and hotel portfolios and kind of really looked at just in addition to beyond the rent roll and what the collectability of the rent rolls are and kind of also looked at the principal guarantors and their liquidities and really try to measure the burn rates and of how long these properties can continue to go and support the pest service. And we came away with some pretty positive feedback. And so that's some color for you in terms of what we've been able to do behind the scenes.

26:01 Okay. And just to get some background numbers in terms of PPP, I didn't see it in your press release, but what the What the actual net fees that were created into NII were on PPP this quarter?

26:17 It's about a million, too. We're amortizing the fees on a two-year, you know, perspective-wise. Chang, you want to talk about submissions?

26:36 In terms of PPP forgiveness submissions, we started that process. and out of the about 1,200 PPP loans we have on our books, by the middle of the week, we probably will be about 12% into the forgiveness of the application process.

26:55 Great. Thank you. Thank you. Our next question comes from Matthew Clark of Piper Sandler. Your line is open.

27:09 Just on the other income line, it looked like a decent uptick from 2Q to 3Q. Can you just quantify what that was driven by?

27:23 Well, in the one, we have to exclude the mark-to-market for the equity security. But in terms of In the third quarter, we booked a million for a gain from a low-income housing partnership that the investment was made back in 2004. And so that's one time, and that's the primary reason why it was a little bit stronger.

28:08 September, and we don't expect that to be recurring. Most low-income housing partnerships, particularly the New York Vintage, are designed that they're closed out at no gain to the tax equity investor at the liquidation of the partnership.

28:33 Okay, yeah, I'm sorry. I see it on slide 14 now. And then just on the amortization for 4Q. I think you mentioned $10 million. Was that just the energy piece? Yes.

28:48 So what do you expect from low-income housing? It should be the same. I think we're about $6 million and a quarter.

28:56 Okay. Okay. And then just the increase in classified, I think there was some mention of a couple of commercial real estate properties. Can you give us some more color on the types of projects those are?

29:13 Yeah, so on those, they were two theater loans that was acquired as part of the Far East National Bank acquisition. We believe, our latest update is that the majority of the theaters have now reopened during secondary markets, but they're limited to a certain 25% capacity. They also have recently, I believe, liquidated an asset that gave them more cash and liquidity as well. So I believe they have more carrying power in terms of being able to continue to support their business.

29:46 And then the other, we had a $14 million downgrade for a C&I loan that was made by a Hong Kong branch. Okay. Got it.

30:02 Thank you. Sure. Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch-tone telephone. One moment, please. Our next question comes from David Chiani of Web Bush Securities. Your line is open.

30:22 Hi, thanks. The first question is on the residential mortgage portfolio. In terms of loan growth, you know, the mortgage market has been booming. Low rates clearly are leading to paydowns given refi. Just curious as to what you're seeing in resi mortgage and if you guys are experiencing a heavy level of paydowns and what the outlook is for resi mortgage growth.

30:53 We're definitely seeing a higher level of paydown compared to prior year at the same time period. We're seeing, however, an uptick in the demands as well. The question is really a bit more about resource and applying sort of the right resource to the team so that they can be able to turn around and fund the loans quicker at a quicker pace. We're hopeful that the residential mortgage group will be able to continue to contribute slightly to the loan growth for the fourth quarter and going forward.

31:28 Okay, thanks for that. And in terms of your markets, Is there anything that you're seeing that could lead to an increase in demand? Clearly we're in the midst of a recession or coming out of a recession or going into a double dip depending on who you talk to. Would a stimulus package help or is it really ultimately seeing the case numbers come down and the vaccine being distributed and that's when we would see In your view, an increase in loan demand on the commercial side?

32:05 I think it's a little bit of both. I think it's really, you know, if you look at even the markets today, the market is down substantially, over 600 points. The last time I checked, it's because the vaccine cases are up. There's really no certainty about, excuse me, the COVID cases are up and there's no certainty about vaccine yet. So I think it's a combination of both that people got to have more confidence in the economy to continue to get back to executing their business plan. We've had, as you noticed, substantial pay downs in our CNI book because they've had some of them included some furniture, some medical supplies, and other parts of our industry that has been able to do quite well during this downturn, but I think that's sort of segment-specific. So in terms of an overall recovery, I think it depends on both.

32:58 And the last one for me is on the provision. So clearly it came down nicely this quarter. When we look out to 4Q and 1Q, and clearly a lot of uncertainty out there, but given the really positive trend on the deferral rates, Is your expectation that we would kind of be in the same neighborhood of this low teens, or is it too tough to forecast? Just curious your views there on the provision.

33:25 Well, I think it's hard to predict two or three months ahead. But in terms of, one, our incurred loss, loan loss provision, is essentially the same as our ACL after he had the $17 million transition adjustment in January. So we're roughly at $200 million for the ACL as of 9-30. I mean, hopefully we should be booking just the net charge-offs in the next few quarters.

34:21 Anyway, that's our hope. Particularly, even if we have, even if we have more downgrade into non-accrual, I mean, the fact that the LTDs are 50% and those personal guarantees, I think we're seeing in many cases our guarantors carrying their properties out of pocket. So when they do go on that, there's not gonna be any charge off because the LTDs are so low. So those are some of the macro factors that will impact our Q4 provision.

35:09 Got it. And actually, that just reminded me about how you guys previously said about when CECL does get implemented to assume a $20 million bump to the reserve. But I think I heard you say $15 to $25 million less. Were you referring to when CECL is implemented that, you know, your allowance could come down by $15 to $25 million? Or did I get that wrong?

35:35 Yeah. That was for the third quarter. So had we been on CECL, instead of booking $12.5 million expense, we would have been booking a negative provision of $5 to $15 million.

35:56 I see. So is there an update for January 1st, 2021, how much of a bump in allowance? or decrease in allowance.

36:08 There should be none. At 930, our incurred loss reserve after we add in the 17 million day one adjustment for CECL, the January 1 day one adjustment that goes through January, they should be the same, almost the same.

36:30 Got it. Got it. Okay. Thanks very much.

36:33 Sure. Thank you. Thank you. Our next question comes from Michael Young of Truist Securities. Your line is open.

36:43 Hey, thanks for the follow-up. I'm glad I could come in already. But I was just curious, given that you guys have a pretty broad geographic overlay on the market in some of the major cities across the country, I was just curious if there's anything you could speak to in terms of geographic performance of your clients. I know that may not affect your actual loss content given the learned values, but Have you noticed a wide dispersion in let's say California versus New York or Chicago, et cetera?

37:13 Yeah, the bulk of our kind of business in terms of CNI are mostly in California throughout south and north. The bulk of our commercial real estate is both California and New York. In New York, however, the bulk of that business is a lot of mixed use, mixed use meaning residential over small retail in kind of the Queens and Flushing area mostly. We don't have a lot of exposure in the main part of the city in Manhattan. primarily we just try to stay out of what we think is a high rent and high cost per square foot kind of a segment of the market. In California, I think it's a mix of mostly apartments, retail, and some industrial. We have very limited in terms of any of the exposure to the office segment.

38:07 Historically, our New York group has had A lot of our CRE growth was in Southern California.

38:25 Most of that growth in SoCal was more multifamily and some owner-occupied commercial real estate.

38:34 Okay, but no broad, I don't know, takeaways in terms of where you're seeing more rent collections or Yeah, just better performance generally between New York versus California at this point.

38:46 They're about the same, I think, from a collection standpoint. I think they both coasted you fairly well.

38:54 Okay. Thanks for the call. Thank you. I'm showing no further questions at this time. I'll just turn the call back over to the management for any closing remarks.

39:09 I want to thank everyone for joining us on the call. It has been a challenging time for our country due to the pandemic. We look forward to speaking with you at our next quarterly earnings release call. Ladies and gentlemen, thank you for participating in today's conference. This concludes the presentation. You may now disconnect. Have a good day.