Cathay General Bancorp (NASDAQ:CATY) Q2 2020 Earnings Call

0:00 Hello. Good afternoon, ladies and gentlemen, and welcome to the CAFE General Bancorp Second Quarter 2020 Earnings Conference Call. My name is Val, and I'll be your coordinator for today. At this time, all participants are on listen-only mode. 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 1 at any time during the conference. If assistance is needed any time during the call, please press star followed by 0, 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 let's turn the call over to Georgia Lo, Investor Relations of Cafe General Bancorp. You may begin.

0:43 Thank you, Valerie, and good afternoon. Here to discuss the financial results today are Mr. Pin Tai, our Chief Executive Officer, Mr. Chang Liu, Cafe Bank's President and Chief Operating Officer, and Mr. Hang 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 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 1-A 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. 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 unanticipated events.

1:55 This afternoon, Cafe General Bancorp issue an earnings release outlining its second quarter 2020 results. To obtain a copy of our earnings release as well as our second quarter earnings presentation, please visit our website at CafeGeneralBancorp.com. After comments from management today, we will open this call up for questions. I will now turn the call over to our Chief Executive Officer, Mr. Pintai.

2:20 Thank you, Georgia, and good afternoon. Welcome to our 2020 Second Quarter Earnings Conference Call. While we acknowledge our second 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 $64.3 million for the second quarter of 2020. 24.8% decrease when compared to a net income of $72.2 million for the second quarter of 2019. Valued earnings per share decreased 24.4% to $0.68 per share for the second quarter of 2020 compared to $0.90 per share for the same quarter a year ago.

3:15 In the second quarter of 2020, our growth loan grew by $74.1 million to $15.6 billion or an increase of 1.9% on an annualized basis. The increase in loans for the second quarter of 2020 was primarily driven by the origination of $261.7 million of Paycheck Protection Program loans and $47 million or 32.5% annualized of construction loans as a result of drawdowns. Next changes in the remaining loan portfolios was relatively muted. As of June 30th, 2020, we have originated 1,381 PPP loans with an aggregate balance of approximately 261.7 million.

4:09 We will continue to monitor the impact of the COVID-19 pandemic on our financial results as well as demand for our loans, deposits, services, and products. during the third quarter of 2020 and beyond. During the second quarter, we conducted credit review of our borrowers in industries particularly impacted by the economic impact of the pandemic. We are encouraged by the generally low loan-to-values for these review loans and a review of the outside liquidity that is held by the guarantors of these loans, which we expect could be used to support these loans. With that, I'll turn the floor over to the bank's president and chief operating officer, Cheng Liu, to discuss our second quarter asset quality in more detail and our COVID-19 initiatives for our borrowers.

5:04 Thank you, Pen, and good afternoon, everyone. With respect to the COVID-19 pandemic, we have implemented several lending initiatives to assist borrowers that are impacted by the pandemic. 41 CNI loans with an aggregate balance of $43.2 million as of June 30th, 2020, or approximately 1.6% of our commercial loan portfolio have been modified to provide relief on repayment terms based on requests from borrowers. Turning to slide 7 of our earnings presentation, at June 30th, 2020,431 CRE loans with an aggregate balance of $1.269 billion, or approximately 17.2% of our CRE loan portfolio and 8.1% of our total loan portfolio, have been modified to provide relief on repayment terms.

5:53 The average loan-to-value ratio at origination for these loans was 52%. For the loan mods that matured during the month of June 2020, 81% went back to regular payment terms. At June 30, 2020, Cafe has 64 hotel loans that total $296 million. We have processed loan mods on 51% or $151 million. of the 64 hotel loans, 60 are limited service and four are full service, three in Southern California and one in Texas. Turning to slide eight, we note that we review 83% of the loans in our retail loan portfolio, which comprises 24% of our total commercial real estate loan portfolio and 11% of our total loan portfolio as of June 30th, 2020.

6:43 The majority 62% of the $1.46 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. Of the $676 million of CRE retail loans with loan modifications, approximately 37% are paying interest only. Turning to slide 9, as of June 30, 2020, We have approved 1,198 payment deferment requests for 90 days with an aggregate balance of $518.1 million or approximately 12.4% of our residential mortgage loan portfolio. Through July 24, 2020, 37% of the $140.4 million of July maturing loan deferments have requested an additional deferment.

7:34 We also launched a microloan program, the Smart Relief Loan Program. which is independent and separate from any SBA or government-backed loan relief programs. The purpose of the program is to help small business owners affected by the COVID-19 pandemic in our nine-state footprint with loans between 5,000 to 10,000. As of June 30, 2020, we are processing over 250 applications with an aggregate balance of nearly 2.5 million. For the second quarter of 2020, we reported net charge-offs of 3.6 million compared to net recoveries of $49,000 in the first quarter of 2020 and net recoveries of $96,000 in the second quarter of 2019. Our non-accrual loans increased by $2.7 million to $56.5 million or 0.36% of period end loans as compared to the end of the first quarter of 2020.

8:28 Accruing loans past due 90 days or more at June 30, 2020 have been reduced from $21.4 million to $3.1 million as of July 24th, 2020, as renewals for these past few loans were completed. We recognized a $25 million loan loss provision in the second quarter of 2020, the same amount as in the first quarter of 2020. The $25 million loan loss provision in the second 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. We continue to work on the loan loss reserve under CECL and will disclose the estimated range in our second quarter Form 10-Q.

9:19 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 portfolios. Followers that we believe could be adversely impacted by the current tariffs hold approximately 2.5% of our total loans. Turning to slide 12, total deposits increased by $1.2 billion or 32% annualized during the second quarter. DDA balances increased by $438 million or 61% annualized due primarily to unspent PPP funds on deposit with CAFE and customers increasing liquidity during these uncertain times. Money Market Deposits increased by $499 million, 80% annualized in part as a result of marketing efforts to large corporate depositors.

10:10 We plan to address the excess liquidity brought by the growth in core deposits by reducing brokered and wholesale deposits during the second half of 2020. With that, I'll turn the floor over to our Executive Vice President and Chief Financial Officer, Heng Cheng, to discuss the second quarter 2020 financial results in more detail.

10:28 Thank you, Chang, and good afternoon, everyone. For the second quarter of 2020, net income decreased by $17.9 million, or 24.8%, to $54.3 million compared to the second quarter of 2019, which was primarily attributable to the $25 million loan loss provision due to COVID-19 as mentioned earlier. Our net interest margin was 3.02% in the second quarter of 2020 as compared to 3.34% for the first quarter of 2020. There were $2.4 billion of loans at their floor rates as of June 30, 2020, compared to $2.1 billion of loans at their floor rates as of March 31, 2020.

11:30 In the second quarter of 2020, interest recoveries and prepayment penalties added three basis points to the net interest margin compared to one basis point for the first quarter of 2020. Approximately $1.8 billion, $1.5 billion, and $2.5 billion of our CDs mature during the third and fourth quarters of 2020 and the first quarter of 2021 with average rates of 1.7%, 1.47%, and 1.55% respectively. We are targeting renewing retail CDs in the 50 to 60 basis point range.

12:18 Non-interest income during the second quarter of 2020 increased by 2.8 million to 15.6 million when compared to the second quarter of 2019. The increase was primarily attributable to a $2.5 million increase in the valuation of equity securities. Non-interest expense decreased by $2.2 million or 3.2% to $67.3 million in the second quarter of 2020 when compared to $69.5 million in the same quarter a year ago. For the second quarter of 2020, the decrease in non-interest expense was primarily due to a $5 million decrease in salaries and employee benefits expense resulting from lower bonus accruals and the increase in salaries capitalized for loan originations.

13:22 The effective tax rate for the second quarter of 2020 was 6%. compared to 16.6% for the second quarter of 2019. We completed an investment in a solar tax credit fund in the second quarter of 2020, which we project would lower our full-year effective tax rate to approximately 11%. Solo Tax Credit Amortization was $6.6 million in the second quarter of 2020, and it's expected to be $8.5 million a quarter in each of the last two quarters of 2020. At June 30, 2020, our Tier 1 leverage capital ratio decreased to 10.46% as compared to 10.83% at December 31, 2019. Our Tier 1 risk-based capital ratio increased to 12.88% from 12.51% at December 31, 2019. And our total risk-based capital ratio increased to 14.81% from 14.11% at December 31, 2019.

14:41 Thank you, Hank. We'll now proceed to the question and answer portion of the call. Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then 1 on your telephone. One moment. Our first question comes from Michael Young of SunTrust. Your line is open.

15:06 Hey, good evening. Thanks for the question. I wanted to just start with outside of the classified assets, could you provide the levels of criticized and or special mention assets at this time?

15:19 Yeah, it actually went down at March 31st, 2020. It was $505 million, and it went down to $414 million. So there was a migration from special mention to substandard during the second quarter.

15:42 Okay, that's helpful. And then I was just kind of a bigger picture question, I guess, Hank. on the loan loss reserve. It just seems like maybe the level of reserve on the CRE book is low relative to peers. I understand you guys have a low loan-to-value, but it looks like it's about sub-60 basis points of reserve on the $7.4 billion book. So just was trying to help parse that out a little bit better, if you could help me with that.

16:10 Yeah, let me make a stab at that, and maybe Chang or Flynn can add in. You know, we... We did a very deep dive, as we tried to mention, in all our loan portfolios, starting with our hotel loan portfolio and Most of our real estate loans, almost all of them have full personal guarantees. So our review involves looking at the outside liquidity of the borrowers as well as the operating statistics of the hotel portfolio.

16:55 So on that one, we didn't mention it much in our procurement remarks, We calculated burn rates as well as the outside liquidity. And I think on the whole, most of them can last a year or more based on the current occupancy levels. Then we go to the retail. We did a similar analysis looking at outside liquidity as well as the current pay rates. and I think we had it in our comments. Many of our retail loans are secured by a neighborhood center with a supermarket or a drugstore as an anchor.

17:53 That's 20%. Or there are neighborhood centers without that type of anchor, but they are neighborhood centers. So we think they will hold up pretty well. So I think all in all, our historical loss for our CRE is generally 15 basis points a year. And that's when our loan-to-values were typically in the 70% range. So, Chang, would you, or anything else? I think you covered it. Okay. Yeah, so that's kind of how we look at it. I think time will tell. I think one of the things is that Chang mentioned that 80% of the CIEs that had loan mods, they went back to full interest and principal repayments.

18:56 This is for June. So these borrowers are capable of supporting the properties.

19:06 Okay, that's helpful, and I did appreciate all the breakout in the slide deck, very helpful. Last one for me was just on PPP, just trying to understand how much of the fee amortization and total impact there was in the margin and that interest income this quarter, and if there was any offsetting expense piece.

19:28 Yeah. The origination fees were 8.8 million dollars. which is 3.37%. We are amortizing the straight line over the 24-month term. I know some other banks are doing it quicker. And then we capitalize about almost $2 million of salary expense related to the elicitation of PPP loans.

20:08 Okay, perfect. Thank you, Hank. Sure. Thank you. Our next question comes from Chris McGrady of KBW. Your line is open.

20:18 Great. Thanks. Hank, how should we think about near-term loan growth absent the impact of the PPP program? A lot of banks start growth in the first quarter and then some moderation given line utilization rates in the second quarter. How do we think about core loan demand into the back half of the year? Thanks.

20:39 I think we're not given formal guidance given the uncertainties, but our pipelines are lighter than normal. And I think given the fact that we're in the recession, we're very cautious about underwriting new loans, residential mortgage, That's continuing. We are originating about $80 million a month of new residential mortgage, and that so far has offset the prepayments. And then I think the others, once again, were pretty cautious.

21:30 CRE, certainly on new loans, we want to make sure that the occupancy rates are firm before we make a new loan, before we make a loan to a new borrower.

21:48 Okay, so it sounds like the Resi book might stay stable and you could add a little bit of rundown in the commercial book based on the conservatism?

21:58 Yes.

21:59 Okay. Okay. Thank you for that. In terms of the expenses, could you help us with the run rate going into the back half of the year? We talked about $8.5 million on the solar. Do you have the low income as well that we should be adding to that? Also, the salary line, you talked about the movement there. How do we think about just overall expenses in the back half of the year?

22:26 We try to break it out on slide 15 So the long-term housing was $6.3 million in Q2, and we think you'll be about that rate. Solar, as I mentioned, $8.5 million per quarter. And then the non-interest expense, that was all other non-interest expense, that was $53.7 million. We think... In the second half of the year, it might drift up a little bit to just under $55 million. But we're working real hard on controlling the costs that we can.

23:19 Okay, great. And then last kind of a housekeeping question. The total modifications, I think you provided... I just want to make sure I have the total number of loan mods as of June 30th, please.

23:35 I think it's in our comments, but hold on. So for CNI, it's $43 million. CRE is $1,269,000. And then for a residential mortgage, it's $518 million.

24:09 Great. Thank you very much.

24:10 Sure. Thank you. Our next question comes from Lana Chan of BMO Capital Markets. Your line is open.

24:20 Thank you. Just a question on the margin. Given the continued repricing of the CDs downward, do you think that that's going to be able to help offset or stabilize the margin in the second half of the year?

24:37 Yes. Yes. As I mentioned in my comments, we have a a billion eight of CDs that's maturing in the third quarter, and that rate is at 1.7, and for retail CDs, we're renewing them to the 50 to 60 basis point range. For wholesale CDs, which we have, that's probably 200 million or so, for the ones that we're keeping, those are repricing down to to around 20 basis points. And then on the loan side, we're tracking our yields by month. The loans have been pretty stable for each of the three months in Q2.

25:28 With the loans on the floors, active floors, we're primarily a fixed rate portfolio. that should continue into Q3. And then lastly, residential mortgage, surprisingly, there was an article in today's Wall Street Journal about jumbo rates now not decreasing. And so that's the case for us. We're renewing or we're originating new loans at about a 4.3% rate, average rate.

26:15 And that's very close to the current portfolio.

26:23 Great. Thanks. And then my follow-up question is on the CNI side, The loans that have been modified in commercial, are there any specific industries where you're seeing more stress?

26:39 Not particularly. I think we have one loan in that population that accounted for about half of that. That was really to do with actually the loan terms. It wasn't a payment mod in particular. It was just sort of the receivables being delayed as a result of the COVID-19 situation. So then the rest of it is mostly small business. And so because then the rest of it is, you know, on average, probably about $500,000 to $600,000. Okay, thank you. Thank you. Our next question comes from Matthew Clark of Piper Stanley. Your line is open.

27:20 Hey, good afternoon. On the renewals, I think you had mentioned one portion where 81% of them went back to normal payments. Do you have an overall number as it relates to the deferrals that have expired so far for the overall deferral bucket so we can get a bigger picture? Sure.

27:49 That's a small population, so we looked at, we tracked the deferments for really April, May, and June that kind of expired in June, and that number was less than 200 million, between 160 to 200 million or so. The bigger population comes when it expires in July, and we'll track that number at that point in time sometime in the month of August. But that certainly, for us, is an indication of hopefully an indication of what the rest of the deferment population will look like as they roll off of the deferment period.

28:28 And how much of that is expiring here in July? Just trying to get a sense for how large that slug is and what might be beyond that in August, September.

28:39 The July number...

28:52 Matthew, I think we'll call you on that rather than give you the wrong number.

28:58 Yeah.

28:59 No worries. Okay. And then on the high-risk exposures and retail series, obviously your largest bucket of concern, but it drops off after that, but what about the office piece? Are you seeing any I'm sure it's much longer term in terms of the changes that will occur there, but how's that portfolio looking of late?

29:32 Our office portfolio is holding up pretty strong, I think. We did have a small number of modifications there as a total percentage. The total percentage is probably... about a little over 10% of the office portfolio that has Aspen Mods.

30:00 Okay, great. And then just on the CECL timing, any desire to adopt it early in 3Q? And I think you had mentioned we'll see the estimated impact in a Q, but if you happen to have that number or range, we'll take it now, I'm sure.

30:18 Well... We're still working on it, Matthew, so we'll put it in the queue. But yeah, I mean, hopefully, you know, if Moody's doesn't, if their September forecast isn't worse than what they had in June, then under CECL, if our charge-offs remain muted, then the loan loss provision should be very low in the third and fourth quarters. That's the whole thing. Got it. Thank you. Thank you. Our next question comes from David Piaverni of Webless Securities. The line is open.

31:02 Hi, thanks. I wanted to ask about credit quality. Could you talk about the increase in the net charge-offs in the quarter, what the driver was there, And then the same question you mentioned about the migration from special mention to substandard. Could you talk about the credits there?

31:19 Yeah. That was – the charge off was one credit for $4.9 million. This was a credit – that originated in our Hong Kong branch. It had been on non-recall for a few quarters. It's really unrelated to COVID. So because it was unsecured, we had to charge that off in the second quarter. Then on the, what was the second part of your question, Dan?

31:59 The migration from special mention to substandard, the drivers there.

32:04 Yeah, there's one loan that's over $10 million. That's a metal wholesaler. So that went on non-accrual in the second quarter. It also went to substandard. We had... We had a mailing company that we made a PPP loan to. That was substandard. We had a chain of juice bars that we also made a PPP loan to. So I think those are really the three largest ones.

32:52 Got it. And then I had a follow-up question on the net interest margin. You mentioned about how The rates that you're originating, at least on the resume mortgage side, are close to the current portfolio, and then you have so many loans that are at their floors, so it's behaving like a fixed-rate portfolio as we move into the third quarter, but yet you mentioned about the repricing opportunity on the CDs. So would that translate into actual margin expansion, or are you thinking more of stability rather than expansion from here?

33:26 We hope the margin will trend higher, mainly from the CDs repricing. And we also have several hundred million of excess liquidity, which we're going to use to pay off local CDs. So those will also help the margin. And then lastly, probably in the fourth quarter will have, you know, will start to see the forgiveness on the PPP loans, which will help.

34:01 Got it. Got it. That makes sense. And then the last one for me is on the construction portfolio. You know, increased slightly in the quarter, and you mentioned about how there was some drawdown activity. Are there any new commitments that you guys are putting out in construction, given that a lot of banks are pulling back and you see some opportunities? Or was this solely due to drawdowns that we saw the increase there?

34:29 Yeah, David, this is Chang. That's primarily due to drawdowns of our existing commitments. While we do see a lot of opportunities for construction that's coming in the door, but were being very, very careful and very selective. As a matter of fact, I can't remember the last construction loan that actually went through committee and got approval. We certainly recognize that there's opportunities for relationships out there, but we're looking to continue to expand and serve our current client base with the right credit quality and the sponsorship and the history that we have with them. But as far as any new potential relationships, we're being very selective.

35:09 Great. Thanks very much. Thank you. Our next question comes from Gary Penner of D.A. Davidson. Your line is open.

35:19 Thanks. Just a couple of questions on PPP. I don't think you disclosed it, but can you give us the average PPP loans outstanding for the quarter?

35:30 We just have the period end. I think the average property would be two-thirds of that.

35:43 Okay. And then relative to the net fees recognized in the quarter, I know you said you were going to recognize the fees and net of the comp expense over 24 months. Was it two months' worth of that recognition in the quarter? Yes. All right. Great. Thank you. Yes. Thank you. Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then 1 when you touch the phone telephone. I'm showing no further questions at this time. I'm trying to call back over to Pim and manager for any closing remarks.

36:24 I want to thank everyone for joining us on our call. It has been a challenging time for our country due to the pandemic. As previously announced, after over 20 years as of today, I'll be retiring as CEO as of September 30th, 2020. And Mr. Cheng Liu will become the next CEO. I wish Chang all the best in his new role and am confident that today's unwavering legacy of strong commitment to customer satisfaction and increasing stockholders' value will continue to flourish under his leadership. It has been an honor and a privilege to have served and led the company. Chang and Heng both look forward to speaking with you at our next quarterly earnings release call.

37:17 Ladies and gentlemen, thank you for participating in today's conference. This concludes the presentation. You may now disconnect. Have a good day.