Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp’s Second Quarter of 2023 Earnings Conference Call. My name is Vaishnavi and I will be your coordinator for today. [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 Georgia Lo, Investor Relations of Cathay General Bancorp. Please go ahead..

Thank you, Vaishnavi and good afternoon. Here to discuss the financial results today are Mr. Chang Liu, our 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 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, 2022 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.

Any forward-looking statements 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.

This afternoon, Cathay General Bancorp issued an earnings release outlining its second quarter 2023 results. To obtain a copy of our earnings release as well as earnings presentation, 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 President and Chief Executive Officer, Mr. Chang Liu..

Thank you, Georgia and good afternoon everyone. Welcome to our 2023 second quarter earnings conference call. This afternoon, we reported net income of $93.2 million for the second quarter of 2023, a 2.9% decrease as compared to a net income of $96 million for the first quarter of 2023.

Diluted earnings per share decreased 2.3% to $1.28 per share for the second quarter of 2023 compared to $1.32 per share for the first quarter of 2023. In the second quarter of 2023, our gross loans increased $635.5 million or 13.9% annualized.

The increase in loans for the second quarter of 2023 was primarily driven by increases of $377 million or 17.1% annualized in commercial real estate loans. $158 million or 12.1% annualized in residential mortgage loans and $165 million or 19.9% annualized in commercial loans offset by a decrease of $38 million in construction loans.

With the strong loan growth in the second quarter, we have revised our guidance for overall loan growth for 2023 to between 5% to 7% from our previous guidance of 1% to 3%. Our strong loan growth during the second quarter included advances from a handful of commercial loan borrowers.

In addition, we have increased our loan spreads for fixed rate commercial real estate loans to help improve the returns. We continue to monitor our commercial real estate loans. Turning to Slide 7 of our earnings presentation. As of June 30, 2022, the average loan-to-value of our CRE loans was 50%.

As of June 30, 2023, our retail property loan portfolio at Slide 8 comprises 22% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. 88% of the $2.1 billion in retail loans is secured by retail store, building, neighborhood, mixed use or strip centers, and only 11% is secured by shopping centers.

At Slide 9, office property loans represent 17% of our total commercial real estate loan portfolio and 8% of the total loan portfolio. Only 34% of the $1.6 billion in office property loans are collateralized by pure office buildings and only 3% of the office property loans are in central business districts.

Another 38% of office property loans are collateralized by office, retail stores, office mixed use and medical offices. The remaining 28% of office property loans are collateralized by office condos. For the second quarter of 2023, we reported net charge-offs of $2 million compared to net charge-offs of $4.9 million in the first quarter of 2023.

Our non-accrual loans were 0.36% of total loans as of June 30, 2023, which decreased by $4.6 million to $69 million as compared to the end of the first quarter of 2023. Turning to Slide 12.

As of June 30, 2023, classified loans decreased to $193 million from $240 million as of March 31, 2023 and our special mention loans increased slightly to $260 million from $251 million as of March 31, 2023.

We recorded a provision for credit loss of $9.2 million in the second quarter of 2023 as compared to an $8.1 million in provision for credit losses for the first quarter of 2023. We are pleased that total deposits increased by $448.1 million or 9.7% annualized during the second quarter of 2023.

Total uninsured deposits were $8.4 billion as of June 30, 2023. Excluding $0.9 billion in collateralized deposits, the uninsured and uncollateralized deposits of $7.5 billion was 39.2% of total deposits as of June 30, 2023.

Our unused borrowing capacity from the Federal Home Loan Bank as of June 30, 2023, was $6.1 billion and unplaced securities at June 30, 2023, was $1.3 billion. These and other sources of available liquidity were more than 100% of uninsured and uncollateralized deposits as of June 30, 2023.

Total time deposits increased $325 million or 18.6% annualized during the second quarter of 2023 compared to the first quarter of 2023. Total saving deposits increased by $241 million or 196.2% annualized, primarily due to a promotional campaign. For 2023, the overall deposit growth is expected to range between 5% and 7%.

I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the second quarter 2023 financial results in more detail..

Thank you, Chang and good afternoon everyone. For the second quarter of 2023, net income decreased by $2.8 million or 2.9% to $93.2 million compared to $96 million for the first quarter of 2023.

The decrease was primarily attributable to net interest margin compression due to the increase in the cost of deposits and because most of the loan growth during the second quarter was from fixed rate loans. Our net interest margin was 3.44% in the second quarter of 2023 as compared to 3.74% for the first quarter of 2023.

In the second quarter of 2023, interest recoveries and prepayment penalties added 2 basis points to the net interest margin as compared to 8 basis points for the first quarter of 2023.

With an anticipated Fed rate hike in July 2023 and no rate cuts after that during 2023, we have revised our net interest margin expectations for 2023 to be between 3.5% to 3.6%.

Non-interest income during the second quarter of 2023 increased by $8.9 million to $23.1 million when compared to the first quarter of 2023 due to an increase of $5.8 million in gain on equity securities and from a $3 million write-off of a corporate bond security in the first quarter.

Non-interest expense increased by $9.6 million or 11.6% to $92.8 million in the second quarter of 2023 when compared to $83.2 million in the first quarter of 2023.

The increase was primarily due to $6.5 million in higher amortization solar tax credit investments, $1.6 million of seasonally higher marketing expenses, $1.5 million in higher professional expenses offset by $1.2 million in lower salaries and bonuses due mainly to higher FICA taxes paid in the first quarter.

We expect or non-interest expense excluding tax credit and core deposit intangible amortization and HSBC innovation expenses to increase 3.5% from 2022 to 2023.

The effective tax rate for the second quarter of 2023 was 9.2% as compared to 21.4% for the first quarter of 2023, due mainly from additional investments and solar tax credits – and solar tax credit funds. For 2023, we expect the effective tax rate of between 13% and 14%.

We expect 2023 solar tax credit investment amortization of $42 million, including $16 million for Q3 and $11 million in Q4 of 2023. As of June 30, 2023, our Tier 1 leverage capital ratio increased to 10.45% as compared to 10.27% as of March 31, 2023.

Our Tier 1 risk-based capital ratio decreased to 12.38% compared to 12.42% as of March 31, 2023, and our total risk-based capital ratio decreased to 13.88% from 13.94% as of March 31, 2023..

Thank you, Heng. We will now proceed to the question-and-answer portion of the call..

[Operator Instructions] The first question comes from Matthew Clark with Piper Sandler. Please go ahead..

Hi, good afternoon..

Hi..

First one for me on the margin, if you can give us the spot rate on interest-bearing deposits at the end of June and the average margin in the month of June?.

Yes. The average margin for the month of June was 3.41%. So it was up slightly from the March for the month of May. And then the spot rate of total interest-bearing deposits at June 30 was 3%..

Okay. Great.

And then getting from the 3.41% back up to that 3.50% to – well, you have the benefit, I guess, year-to-date of 3.59% in terms of the first half margin?.

Right..

So it seems like you expect that 3.41% June margin to hang in there.

Can you just speak to what you’re assuming on deposit costs and any kind of pay down borrowings?.

Yes. We think the loan growth in Q3 and Q4 will be quite a bit lower than in Q2. So that will make it easier for us to fund the loans. So I think between that and the additional Fed rate hikes that we assume will happen in Wednesday, will help improve the margin.

And we do expect interest recovery between now and the end of the year slightly over $1 million. So that’s kind of added to that..

Okay. Great. And then just around expenses, the core or adjusted expense outlook at 3.5%, which is unchanged off the $255 million last year. That implies some relief here in the second half.

Can you just speak to what you expect to come out of the expense run rate?.

Well, Matthew, in Q2, we had – as we mentioned in our comments, we make most of our contributions in the second quarter. And then we have probably about $1 million plus of one-time items. That’s in the second quarter. And then last, the – well, we think we might accrue lower bonus expenses in the second half.

But if it’s slightly higher than 3.5%, I don’t think it’ll be much higher than that..

Okay.

And then the low-income housing tax credit amortization for the third and fourth quarter? Do you have those numbers?.

It should be about $10 million per quarter..

Okay, thank you..

Yes, thank you..

The next question comes from Andrew Terrell with Stephens. Please go ahead..

Hi, good afternoon..

Hi..

Just a follow-up on Matt’s question there. On the expenses, I guess, to get to 3.5% core expense growth for 2023, it implies the core expense run rate steps down to about just a little over $63 million per quarter in the back half of the year.

Does that sound right to you?.

No, we kind of think it – it should be close to the $67 million, I guess..

Okay. Got it.

So similar to the first quarter run rate?.

Yes..

Okay. Understood. And then on the loan growth front, it sounded like last quarter on the conference call when the loan growth guidance was lowered, it was mostly predicated on uncertainty within the economy. I guess I am surprised that after the revision last quarter, just surprised to see such strong loan growth here in the second quarter.

I guess of your views around certainty in the economy improved and where do you see growth opportunities in the second quarter? And just what gives you confidence in the growth put on in the second quarter?.

So Andrew, during our second quarter, the C&I loan growth was really from just a handful of large clients on the tech side and the pharmaceutical side that drew down on their advances of the line. That was not the case in the first quarter.

In addition, we had some pull-through on the commercial real estate side that really kind of started the process in the latter part of the first quarter, but it didn’t close until sometime in the second quarter. But we don’t expect, and particularly with the increase in the margins on the CRE side.

We are not expecting to see continued demand at that pace in the second quarter. We think there is going to be more of a muted sort of pickup on any loan growth in the second half of the year..

Yes. Understood. Okay. And then in terms of….

Of that, Chang mentioned, we had infrequent tech borrower that drew down on their line, they have since paid that off in the third quarter. So, that will help, it will make the third quarter loan growth lower just from the payoff..

Understood. Okay. I appreciate it. And then if I am reading it right, it seems like that the guidance would be for the deposit growth to maybe slightly outpace loan growth in the back half of the year.

I guess is the plan going to be to pay down the FHLBs in 3Q or 4Q or at least a portion of them?.

Yes. I mean we are going to try to target a 90% loan-to-deposit ratio. One reason it crept up is we had very strong loan growth in the month of June. So, it was hard for us to match that loan growth in the short time, where it had happened. And then similarly, the Federal Home Loan Bank borrowings, they also jumped up in the second half of June.

We since paid down about $250 million of Federal Home Loan Bank borrowings to where it’s now at a more stable level for the second half..

Okay. Got it. Thank you for taking the questions..

Thank you..

[Operator Instructions] Our next question comes from Christopher McGratty with KBW. Please go ahead..

Hey. How it’s going? This is Andrew Lisher [ph] on for Chris McGratty. I was just wondering, have you started to see any stabilization in your non-interest bearing deposit outflows? And I guess should we continue to expect a further mix shift from here? Thank you..

Yes. We think it’s stabilized just giving you the month end balances. It was $3.7 billion at the end of April, $3.7 billion rounded at the end of May and then $3.6 billion at the end of June. So, yes it – Chang, do you….

Yes. We are not seeing any additional sort of outflows. I think at this point, given the rate hikes and some of the sensitive clients with the cash and liquidity that had them in checking to money market. They to the extent they wanted to move them into higher yielding accounts, they have already done so at this point.

So, we believe that the non-interest bearing core should remain relatively stable..

Okay. Great. Thank you. That’s really helpful.

And then on credit, have you started to see any credit migration within the office portfolio? And can you also just remind us what reserve you have on that portfolio?.

Sure. Just kind of on the credit portfolio a little bit, we kind of – there is a page on Page 9 of the deck. It’s all encompassing. It’s about $1.5 billion in total and the average loan size of these is about $2.1 million. Average property size is only about – a little over 12,000 square feet.

Only 3% of it is in the commercial business district, so truly downtown core. The rest of it is 66% in urban, 31% in the suburban space. And if you exclude some of the portion of that, 20% [ph] of that was in office condos, which might have – might skew the balance towards lower balance and lesser square footage.

But even if we exclude office condos, the average loan size is still just about a little over $3 million with an average property size just a little over 21,000 square feet. So, we are not in the big Class A 300,000 downtown core. That’s not what we are.

And some of these – a lot of these are sort of office over retail and some of the medical office space as well. As far as you add the average occupancy, we are about 84% across the board, and the average debt cover on this is about 1.8% or higher..

And then we don’t have any special reserves on office. So, it’s the same as our CRE reserves, which is the CRE reserves are about the same, it’s up 0.8% of loans. We did build up our reserves this quarter by about $7 million. So – but that wasn’t for office. It was for general reserving..

Okay. Great. Thank you for the questions..

Yes. Thank you..

[Operator Instructions] The next question comes from Gary Tenner with D.A. Davidson. Please go ahead..

Thanks. Good afternoon.

Most of my questions were asked, but just on the capital front, just wondering, given strong capital ratios and you have beefed up a little bit this quarter or the ACL this quarter, any thoughts on resuming buyback at this point?.

Not for a while, Gary. We want to see how our economy shakes out, hopefully, very late in the year or early next year..

Thank you..

Yes..

At this time, there are no questions in the queue. [Operator Instructions] As we see no questions, this ends the Q&A session. I will now turn the call back over to Cathay General Bancorp’s management for closing remarks..

I want to thank everyone for joining us on our call and we look forward to speaking with you at our next quarterly earnings release call..

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may all now disconnect. Thank you. Good day..