Jul 17, 2013
Executives
Monica Chen - Investor Relations Dunson Cheng - Chairman of the Board, President and Chief Executive Officer Heng Chen - Executive Vice President, Chief Financial Officer and Treasurer
Analysts
Aaron Deer - Sandler O’Neill & Partners Joe Morford - RBC Capital Markets Brett Rabatin - Sterne Agee Herman Chan - Wells Fargo Julianna Balicka - KBW Gary Tenner - D.A. Davidson Don Destino - Harvest
Operator
Good afternoon, ladies and gentlemen, and welcome to the Cathay General Bancorp’s Second Quarter 2013 Earnings Conference Call. My name is Philip and I will be your coordinator for today.
At this time, all participants are in listen-only mode. Following the prepared remarks, there will be a question-and-answer session.
(Operator Instructions) Today’s call is being recorded and will be available for replay at www.cathaygeneralbancorp.com. Now, I would like to turn the call over to Monica Chen, Investor Relations for Cathay General Bancorp.
Monica Chen
Thank you, Philip, and good afternoon. Here to discuss the financial results today are Mr.
Dunson Cheng, our Chairman of the Board, President and Chief Executive Officer; and Mr. Heng Chen, 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 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, 2012, at Item 1A in particular, and in other reports and filings with the Securities and Exchange Commission from time-to-time.
As such, we caution you not to place undue reliance on such forward-looking statements, which speak only as of the date of this presentation. We undertake no obligation to update any forward-looking statements or to publicly announce any revision of any forward-looking statements to reflect future developments or events, except as required by law.
This afternoon, Cathay General Bancorp issued an earning release outlining its second quarter 2013 results. To obtain the copy, please visit our website at www.cathaygeneralbancorp.com.
After comments by management today, we will open up this call for questions. I will now turn the call over to our Chairman of the Board, President and CEO, Mr.
Dunson Cheng.
Dunson Cheng
Thank you, Monica, and good afternoon. Welcome to our 2013 second quarter earnings conference call.
This afternoon, Cathay General Bancorp reported net income of $29.9 million for the second quarter of 2013 or $0.35 per common share. That compared to a net income of $29.9 million or $0.33 per common share for the second quarter of 2012 and $28.8 million or $0.30 per common share for the first quarter of 2013.
In the second quarter, we see a much stronger loan growth. Gross loans increased $330 million in the quarter or 4.5% increase from the first quarter of 2013.
For the first half of 2013, loans increased by $265 million or 3.6%. Commercial loans increased by $179 million, commercial mortgages, CRE loans, increased by $150 million and residential mortgage loans increased by $41 million.
The increase in commercial loans was due to new borrowing, higher usage of existing credit line, increased activities in our trade finance business and growth in our Hong Kong branch. New CRE origination was strong but construction balances dropped because one large construction loan mature and was turned into CRE.
While our residential mortgage increased in the quarter, we expect it will slowdown in the coming months. Our current expectation for loan growth for the entire year is 7% a slight upward revision from the previous 6%.
For the second quarter 2013, our total deposits increased $285 million or 3.8% from $7.4 billion at March 31, 2013. During the second quarter, we completed the acquisition of new Las Vegas branch on June 17.
In July, we signed an agreement to open an additional branch in Brooklyn. Both this branch and the previously announced new one in West Covina are expected to open in the fourth quarter.
Net recovery for the second quarter of 2013 was $0.9 million compared to net recoveries of $2.6 million in the same quarter a year ago. Our loan loss provision was zero for the second quarter of 2013 compared to a credit of $5 million in the same quarter a year ago.
Our non-accrual loans decreased 4.5% or $4.7 million during the second quarter to $95.6 million or 1.24% of period-end loans. This past weekend, we successfully completed a 24-month effort to upgrade our computer system to a new core.
We expect the new system will provide good functionality and allow us to streamline our internal processes in all of our operating areas and therefore to improve our efficiency ratio. With that I’ll turn the floor over to our Executive Vice President and CFO, Heng Chen to discuss the second quarter 2013 financials in more detail.
Heng Chen
Thank you, Dunson and good afternoon everyone. For the second quarter, we announced net income of $29.9 million or $0.35 per share.
Included in second quarter results were $10.1 million in prepayment penalties as well as $12.2 million in securities gains. Our net interest margin was 3.3% in the second quarter of 2013 compared to 3.35% in the first quarter of 2013 and compared to 3.24% for the second quarter of 2012.
During the first quarter of 2013, recognition of interest income on loans previously on non-accrual status added 8 basis points to the net interest margin or as during the second quarter recognition of interest income on non-accrual loans only added 3 basis points to the margin. In the second quarter of 2013, we prepaid $200 million of structural repos with average rate of 3.65% with a prepayment cost of $10.1 million.
We expect an improvement in the net interest margin during the third quarter of 2013 as a result of the full quarter impact of the second quarter actions, the repayment during July of $100 million of structural repos with an average rate of 3.39% and continued strong loan growth. Non-interest income during the second quarter of 2013 was $20.4 million including $12.2 million of security gains, which offset the $10.1 million prepayment penalties incurred during the second quarter, higher legal fees and higher incremental costs related to the core system conversion.
Non-interest expense excluding cost associated with redemption of debt decreased $3.6 million to $43.7 million in the second quarter of 2013 compared to $47.3 million in the second quarter a year ago. The decrease was due to a $7.3 million decrease in OREO expense which more than offset a $1.5 million increase in salary and employee benefit expense.
During the second quarter expenses related for the core conversion were approximately $2.6 million compared to $1.8 million for the first quarter and approximately $1 million expected for the third quarter. At June 30, 2013, our Tier 1 leverage capital ratio increased to 13.4% and our Tier 1 risk-based capital ratio decreased slightly to 16.15%.
And total risk-based capital ratio decreased to 17.92% as a result of the strong loan growth during the second quarter. Our ratios significantly exceeded well capitalized minimum ratios under all the regulatory guidelines.
At June 30, 2013, our Tier 1 common risk-based capital ratio was 13.11%. We continue to have discussions with our regulators concerning the repayment of the remainder of TARP during the third quarter of 2013 using dividends from Cathay Bank.
Our classified asset ratio for Cathay Bank increased to 31% at June 30, 2013 compared to 30.8% at March 31, 2013. Loans rated substandard or worse increased from $408 million at March 31, 2013 to $411 million at June 30, 2013.
Net recoveries for the second quarter 2013 totaled $0.9 million or 0.05% of average loans compared to net charge-offs of 0.15% of loans during the first quarter of 2013. The provision for credit losses was zero compared to zero for the first quarter of 2013 and a negative provision of $5 million in the same quarter a year ago.
We anticipate that a continuation of current trends will allow for a zero or low quarterly loan loss provision in 2013. Total non-accrual portfolio loans decreased by 4.7% or $4.7 million to $95.6 million at June 30, 2013 compared to $100.3 million at March 31, 2013.
During the second quarter, total inflows to non-accrual loans were $12.8 million, transfers to OREO were $7.0 million, charge-offs were $3.9 million and cures and repayments were $6.6 million.
Dunson Cheng
Thank you, Heng. We will now proceed to the question-and-answer portion of this call.
Operator
Ladies and gentlemen, we are ready to open the lines up for your questions. (Operator Instructions) Your first question comes from the line of Aaron Deer from Sandler O’Neill & Partners.
Please proceed.
Aaron Deer - Sandler O’Neill & Partners
Hi. Good afternoon guys.
Dunson Cheng
Hi, Aaron.
Aaron Deer - Sandler O’Neill & Partners
First question is about the loan growth in the quarter is very strong and it looks like just kind of judging on the average versus the end of period it looks like it came in fairly late in the quarter. First, what kind of trends you saw in terms of pricing particularly on the commercial real estate as the quarter went on and now here in the third quarter.
Have you seen much benefit in pricing now that rates have come up some?
Dunson Cheng
With regard to CRE origination there is, yes, it’s very important to pick up quite well and at this point in time we still believe that the trend of stronger growth in CRE is going to continue.
Heng Chen
We have Aaron, we generally before the jump in interest rates we kind of targeted a minimum of 4% for 5 year fixed rate loan on some limited cases for very good quality borrowers, we will be lower than 4%. During late in the second quarter our targeted threshold rate was 4.5%.
I guess today with Chairman Bernanke’s comments and the rally in the five-year, we might be a little bit lower. But, because of this increase in interest rates, we have a -- we instituted a rate lock policy where borrowers have to rate lock by paying a 1% fee.
And then there it’s generally a 45-day rate lock with a 15 day extension. So we have about $150 million of loans that were rate locked starting in early June.
So they will fund in late July and middle of August. So we feel pretty good about that in terms of the -- both the pricing as well as the certainty of the closing because that 1% fee is non-refundable.
And then lastly, we booked about $125 million of fixed rate broker CDs mainly at 5 years about 1.1% in the second quarter so that’s a funding for these loans are coming at.
Aaron Deer - Sandler O’Neill & Partners
I’m sure that’s 5 years, at what rate?
Heng Chen
1.1%.
Aaron Deer - Sandler O’Neill & Partners
Okay. And then it was interesting to see, it did look like you have stepped up your deposit gathering during the quarter yet your CD costs were flat I think sequentially at about 80 basis points.
I was just wondering with the -- your more general sub-jumbo CDs, have you -- had to step up the pricing there, are you able to still get really attractive rates on those?
Heng Chen
We haven’t had change in the pricing to our relationship customers, what we are doing here in the third quarter, we started the second quarter with basically zero broker CDs we had small amount of broker money market accounts. But, what we are doing now that -- now that the five-year broker CD rate is roughly 1.9%, we shortened that so our new funding is three-year broker CDs at roughly 1%.
So we are -- at the margin we still think or on average we still think that 80 basis points should drift down by 1 or 2 basis points in the third quarter.
Aaron Deer - Sandler O’Neill & Partners
Okay. Very good.
Thanks for the color. I will step back.
Heng Chen
Okay. Thank you.
Operator
Your next question comes from the line of Joe Morford from RBC Capital Markets. Please proceed.
Joe Morford - RBC Capital Markets
Thanks. Good afternoon guys.
Dunson Cheng
Hi, Joe.
Heng Chen
Hi, Joe.
Joe Morford - RBC Capital Markets
I guess to follow up a little more about your expectations for the margin going forward probably related to Aaron’s comments but also did you do anything in terms of securities investments at the quarter with the back up and rates, are you looking to do that at all with the steepening of the curve we have seen. And in the past you talked about maybe getting to 3.40ish kind of margin and is that still doable?
Heng Chen
I will try to answer it in the order of the question. We bought about $200 million of 30-year MBS in the second quarter.
We were a little bit early, we did most of the buying in the middle of May, early June. And then in terms of what we were doing here in July, in terms of our mortgage portfolio, we have about $450 million that’s -- still has decent profits in it.
And so, to manage we are trying to keep our market value equity positive in up 200 basis point rate shock, Joe. So, what we are doing in the second quarter, we used up the funding side to sort of hedge our fixed rate exposure.
In the third quarter, we are selling the 30-year MBS. We through today we sold probably about $225 million and we have about $7 million or $8 million in gains.
And we prepaid $100 million of these structural repos as we mentioned in the script. So, with the loan growth and the TARP repayment hopefully later on in the quarter, I’m optimistic that we will get as well as a more normal level of interest recoveries.
I’m optimistic that we can get to 3.4 but we -- I’m always a little bit off on this. So, I’m going to -- I’m not going to predict that we will hit that, Joe.
Joe Morford - RBC Capital Markets
Okay. We won’t hold you to the hank.
Heng Chen
All right. Thank you.
Joe Morford - RBC Capital Markets
One other question on the expenses, what would you, if you can quantify at all, the kind of duplicate costs in the current quarter related to the systems conversion or alternative, what might we expect going forward in terms of savings now that this is behind you?
Heng Chen
Yes, Joe. It was $2.5 million in incremental costs.
So and we are thinking there is -- now that we converted last weekend, we can let many of -- almost all of the consultants go to other assignments. So, the third quarter should be about $1 million.
Meanwhile, the data processing fee for the new core system is going to be more expensive than our very thrifty former system because the capabilities are more. But, we think that what Dunson alluded to , there is like on the new account opening there is a lot of -- there should be a lot of streamlining and what we -- there is one module we didn’t put in which is the loan origination and that’s going to save work on the loan -- on the [reporting] (ph) side.
So we should see personnel savings that more than offset the higher cost of the operating expenses for the data processing system. And then more importantly, we had kind of the legal fees have a late or even though our problem assets continue to drop, we had a bump up in legal fees, we had a mechanic’s lien action that was resolved in the second quarter and we spend a lot of legal fees on that.
And as well as some other cases that were resolved in the second quarter. So, hopefully we will -- the legal fees will drop down to a lower level in the third and future quarters.
Joe Morford - RBC Capital Markets
Okay. That’s really helpful.
Thanks Heng.
Heng Chen
Sure. Thank you, Joe.
Operator
Your next question comes from the line of Brett Rabatin from Sterne Agee. Please Proceed.
Brett Rabatin - Sterne Agee
Hi, guys, good afternoon. I was just hoping to get some color maybe around capital thoughts going forward kind of post the CPP final repayment.
And just kind of how you think about what’s the right level of capital and what you do with the excess if you’re thinking more about that post repayment and maybe just around that also any update on acquisition thought as well.
Heng Chen
Let me cover the capital part first. Well, we turned in at the end of June a new capital plan that’s -- that one includes the repayment of TARP hopefully in the third quarter and then a few other minor capital actions and then it’s our next capital, the next capital submission would be March of 2014 for bank holding companies over $10 billion.
So in our capital plan we budgeted a small buyback in the first quarter and roughly 30% of net income and then we also project the increase in dividends once we finish repaying TARP. And then, so I mean the stock buyback is something we could do after we increase the common dividend but our first preference will be to use that on acquisitions like some of the Korean banks here in Southern California.
So, Dunson you want to add any more there?
Dunson Cheng
Well, Brett, as we have announced that this year we hope to open five new branches and we have done one already with the acquisition of a branch in Las Vegas two other should be finished by the end of this year. So, I think the first preference for us is to use some of the excess capital to fuel expansion and then to increase of dividends and stock buyback as Heng just mentioned to you.
Brett Rabatin - Sterne Agee
Okay. And then just around the whole return of capital, what kind of ratios are you guys thinking about in terms of returning that in kind of a payback to shareholders in terms of percentage maybe?
Heng Chen
Well, it’s going to be less than a 100%.
Brett Rabatin - Sterne Agee
Right.
Heng Chen
First we want to repay TARP because that continues to be our first priority and then I think will give more input from both the bank regulators as well as the federal reserve as to what banks of our size can expect in terms of buybacks as a percentage of earnings. But in terms of our loan stress tests, we updated those to the second quarter and we think that we’ve improved them and we have a better understanding of it so that’s we feel relatively good about credit exposure in the future anyway.
Brett Rabatin - Sterne Agee
Okay. And then just one last follow up around loan growth towards the end of the quarter, was just curious if you’re talking about rate locks, did the movement higher and rates during the quarter impact commercial real estate growth towards the end of the quarter due to investors looking to lock in rates or can you comment maybe a little more around just the end of quarter loan growth phenomenon?
Heng Chen
Well, I think on the rate lock it’s we will loans takes a while because there is the credit approval, and before that you need to get a fresh appraisal. But in terms of the jump in interest rates, I think a large number of our borrowers were sitting on the fence and when they saw that how fast the five-year was moving they want to lock in a rate before it went way above them.
And then in terms of the pattern or the funding of loans we historically we tend to fund loans near the end of the quarter so it shows up in the average. We have some trade finance business that bridge the end of a quarter that were well off in the third quarter but I think except for that we should expect a good growth in the average balance.
Brett Rabatin - Sterne Agee
Okay, great. Thanks for the color.
Operator
Your next question comes from the line of Herman Chan from General Earnings. Please proceed.
Herman Chan - Wells Fargo
Hi, that’s right, Herman Chan, Wells Fargo. Dunson, you mentioned higher utilization in your commercial balances in the quarter.
Can you talk about utilization rates in Q2 in relative to where they stood at Q1? Thanks.
Heng Chen
Well, Herman I am going to jump in. In our new core system that’s going to be in the GL.
So we don’t have this statistics we have to manually produce that and so we don’t have it yet for the June 30th, but once again in our new system it’s in the GL everyday and so.
Herman Chan - Wells Fargo
Understood. And you also mentioned strength in the Hong Kong geography, I wonder if you can give some color there and what you’re seeing in that particular location?
Heng Chen
Yes. So the Hong Kong branch last year, we acquired a new team of lenders for the Hong Kong office and that team is finally producing better loan growth for the office.
So for example, in our Hong Kong branch is relatively a small operation and the total loans outstanding is around $160 million or so and in the last quarter they were able to increase by about some $52 million so that is a meaningful addition to the total loan outstanding for us.
Dunson Cheng
And then we expect them to grow some more in the third quarter.
Heng Chen
Yes.
Herman Chan - Wells Fargo
Great, thanks for the color. Much appreciated.
Dunson Cheng
Thank you, Herman.
Operator
(Operator Instructions). And your next question comes from line of Julianna Balicka from KBW.
Please proceed.
Julianna Balicka - KBW
Hi, good afternoon.
Dunson Cheng
Hi, Julianna.
Heng Chen
Hi, Julianna.
Julianna Balicka - KBW
Hello. I was wondering if you could talk a little bit about your tax rate strategies I mean sold some munis and stuff so what are your tax planning strategies going forward or your tax rate was the effective tax rate was very similar this quarter, and how you’re thinking about that into second half of the year and 2014?
Dunson Cheng
Julianna, it’s we just have a small adjustment in the second quarter, it has to do with the capital loss carry forwards in California. So I believe the full year -- the expected full year effective tax rate is 36.5 but let me, I don’t have my notes here but I’ll call you back to confirm that.
Julianna Balicka - KBW
Great. And then in terms of the new branches, the West Covina, Vegas and some of the other ones you’re planning, as you think about opening your branches, what kind of contribution are you looking from anyone branch in terms of loans or deposits, in terms of balance sheet growth, or anyway, any more color on what you’re expecting from them?
Dunson Cheng
I sort of missed your second part of the question with regard to West Covina?
Heng Chen
No, no. It’s any new branch, Dunson.
Julianna Balicka - KBW
And West Covina specifically and Vegas that you mentioned in your press release but in general like what kind of loan or deposit growth contribution and how quickly are you looking for from your new branch opening?
Dunson Cheng
Julianna, before we open a branch we also -- we always have a -- come up with a projection for three years. And our hope is that for the first year, we should attain roughly above $15 million in deposits, second year $13 million.
And we aim to breakeven in the second year, I would say a brand new branch but for the Las Vegas branch we were able to acquire with relatively small investment and that branch should make money in the first year.
Julianna Balicka - KBW
Okay. Very good.
Thank you.
Operator
And your next question comes from the line of Aaron Deer from Sandler O’Neill & Partners. Please proceed.
Aaron Deer - Sandler O’Neill & Partners
I just had a quick follow-up. One of the things you noted Dunson in your opening remarks was that there was a loan, I’m sorry a construction loan that or the project was completed for a commercial real estate, we have seen construction balances continue to trend down.
I’m just worrying it seems as though there is some good opportunities now in some of the more urban markets that you operate in, is that a construction or is construction a loan type that you might be looking to grow at this point?
Dunson Cheng
Yes, Aaron. As a matter of fact in our second quarter we -- construction loan picked up quite a bit and because construction takes time to disperse.
And so we expect that the balances in the succeeding quarters should reflect that fact. So we are doing quite a few new construction loan and in a (draw) period of a typical construction loan is roughly 15 months.
So we are at few other loan losses at the inception and so we expect to grow -- the balance should grow as we go along.
Aaron Deer - Sandler O’Neill & Partners
Okay, that’s great. Thanks for taking my follow-up.
Dunson Cheng
Thanks Aaron. Thank you.
Operator
And your next question comes from the line of Gary Tenner from D.A. Davidson.
Please proceed.
Gary Tenner - D.A. Davidson
Thanks, good afternoon.
Dunson Cheng
Hi, Gary.
Gary Tenner - D.A. Davidson
So a quick bookkeeping question, in terms of the repos, the prepaid in the second quarter what was the timing in those?
Heng Chen
Yes, it was a $100 million in April, $50 million in May and then $50 million in June. They’re all -- towards the end of each of those months.
Gary Tenner - D.A. Davidson
Okay. And then the $100 million that you spent for July what is the expected prepayment cost on that?
Heng Chen
It’s about $4.3 million and we have as I mentioned we have security gains to offset that.
Gary Tenner - D.A. Davidson
Okay, perfect. All right.
Thank you very much.
Heng Chen
Sure. Thank you.
Operator
Your next question comes from the line of Brett Rabatin from Sterne Agee. Please proceed.
Brett Rabatin - Sterne Agee
Yes, hi. I just had a quick follow-up on security portfolio, I’m just thinking in terms of what you’re reinvesting you mentioned the $200 million of 30-year MBS earlier but I didn’t catch the rate, I was just trying to think about maybe you are reinvesting in that portfolio and kind of what the securities portfolio yields kind of do from this point going forward?
Heng Chen
Yes, Brett. The loans that we bought I guess the rate would be about 3%.
We bought close to par and just slightly over par. But in terms of reinvesting we’re not with the loan growth we’re -- we said before we rather run-off securities or sell securities to fund our loan growth.
So we don’t see much in a way of new investments in securities at least in the third quarter.
Brett Rabatin - Sterne Agee
Okay, great. Thanks for the color.
Heng Chen
Thanks.
Operator
Your next question comes from the line of Don Destino. Please proceed.
Don Destino - Harvest
Hi. I’m Don Destino.
Just a quick question on the security as well. I mean obviously for all banks we have seen the ASBI line is some way down and then turn negative.
Can you just talk a little bit about what’s your inventory is as per the security gains how many -- how much more you can kind of use the actual in the toolbox to offset your prepayments?
Heng Chen
Yes, Don. This is a little bit rough, I think our net unrealized losses at the end of June were $26 million and in terms of growth and like gains we had about $28 million.
We are not going to trigger all $28 million. We are going to do enough to shrink our balance sheet a little bit more and then –
Don Destino - Harvest
I’m just trying to think of the economic behind that. So, I want a portfolio on selling my -- basically selling your winners, keeping the losers and then sell the winners, you can call back revenue, is that exactly what happened?
Heng Chen
Well, it’s, I mean two things. One, we had $140 million of munis that we sold in late March and early April and we booked $10 million in gains.
And that was fairly long duration and have we not sold them, I think we would have a $5 million loss today.
Don Destino - Harvest
You had a good sale.
Heng Chen
Well, so and that’s the same. And then something similar in that with MBS, I mean, we try to be quick-witted about that.
But because like here in July, we sold some on July 1, we sold some today and in between there was a two point difference. So, we are not trading this, we are just trying to manage our balance sheet to minimize our exposure to higher interest rates for that part of our portfolio.
Don Destino - Harvest
Got it. Heng, thank you very much.
Heng Chen
Okay.
Operator
Thank you for your participation. I will now turn the call back over to Cathay General Bancorp’s management for closing remarks.
Dunson Cheng
Well, thank you. And thank you for joining us on this call.
And we look forward to talking with you all at our next quarter earnings release date. Thank you.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation.
And you may now disconnect. Good day.