Cathay General Bancorp - 10-Q quarterly report FY

Washington, D.C. 20549

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

 

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OFTHE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

 

 

 

 

 

 

 

In this quarterly Report on Form 10-Q, the term “Bancorp” refers to Cathay General Bancorp and the term “Bank” refers to Cathay Bank. The terms “Company,” “we,” “us,” and “our” refer to Bancorp and the Bank collectively. The statements in this report include forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 regarding management’s beliefs, projections, and assumptions concerning future results and events. These forward-looking statements may include, but are not limited to, such words as "believes," "expects," "anticipates," "intends," "plans," "estimates," "may," "will," "should," "could," "predicts," "potential," "continue," or the negative of such terms and other comparable terminology or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such risks and uncertainties and other factors include, but are not limited to adverse developments or conditions related to or arising from: 

 

 

 

 

 

 

 

 

 

Cathay General Bancorp (the “Bancorp”) is the holding company for Cathay Bank (the “Bank”), six limited partnerships investing in affordable housing investments in which the Bank is the sole limited partner, and GBC Venture Capital, Inc., (together the “Company” or “we”, “us,” or “our”). The Bancorp also owns 100% of the common stock of five statutory business trusts created for the purpose of issuing capital securities. The Bank was founded in 1962 and offers a wide range of financial services. As of October 31, 2007, the Bank operates twenty one branches in Southern California, ten branches in Northern California, three branches in Washington State, nine branches in New York State, one branch in Massachusetts, two branches in Texas, three branches in Illinois, one branch in New Jersey, one branch in Hong Kong, and representative offices in Taipei and Shanghai.

 

 

The acquisition was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” The assets acquired and liabilities assumed were recorded by the Company at their fair values as of March 31, 2007:

 

 

No loans acquired as part of the acquisition of UHB were determined to be impaired and therefore no loans were within the scope of Statement of Position (SOP) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”. In addition, the estimated other costs related to the acquisition were recorded as a liability at closing when allocating the related purchase price. The purchase price allocation is still subject to final determination and valuation of the fair value of assets acquired and liabilities assumed.

 

 

 

The following table presents the activity in the merger-related liability account that was allocated to the purchase price as of September 30, 2007:

 

 

 

The preparation of the consolidated financial statements in accordance with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The most significant estimate subject to change relates to the allowance for loan losses.

 

 

 

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, together with a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and requires a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. Market participant assumptions include assumptions about the risk, the effect of a restriction on the sale or use of an asset, and the effect of a nonperformance risk for a liability. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not completed its analysis to determine the impact on the Company’s consolidated financial statements from adoption of SFAS 157.

 

 

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits a business entity to choose to measure financial instruments and certain other items at fair value to mitigate volatility in reported earnings caused by measuring financial instruments differently without having to apply complex hedge accounting provisions. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments. Following the initial fair value measurement date, a business entity shall report unrealized gains and losses on financial instruments for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not completed its analysis to elect the fair value option on the Company’s consolidated financial statements at the date of adoption of SFAS 159.

 

Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock that then shared in earnings.

 

Outstanding stock options with anti-dilutive effect were not included in the computation of diluted earnings per share. The following table sets forth the basic and diluted earnings per share calculations and the average shares of stock options with anti-dilutive effect:

 

 

 

 

 

 

 

 

 

During the nine months period, exercised option shares were 84,236 shares in 2007 and 89,776 shares in 2006. Exercised options shares were 6,000 shares for the third quarter of 2007 and 18,694 shares for the third quarter of 2006. The table below summarizes cash received and aggregate intrinsic value from options exercised:

 

 

The following table presents the fair value of stock options vested for the period indicated:

 

 

The table below summarizes stock option activity for the periods indicated:

 

At September 30, 2007, 2,247,433 shares were available under the Company’s 2005 Incentive Plan for future grants.

 

 

The Company has granted non-vested stock to its Chairman of the Board, President, and Chief Executive Officer. The shares vest ratably over certain years if certain annual performance criteria are met. The following table presents information relating to the non-vested stock grants as of September 30, 2007:

 

 

 

Prior to 2006, the Company presented the entire amount of the tax benefit on options exercised as operating activities in the consolidated statements of cash flows. After adoption of SFAS No. 123R in January 2006, the Company reports only the benefits of tax deductions in excess of grant-date fair value as cash flows from financing activity. The following table summarizes the tax benefit from options exercised:

 

 

 

For the first nine months in 2007, the Company entered into seven long-term resale agreements totaling $350.0 million. The agreements have terms of ten years with interest rates ranging from 8.10%, to 9.12%. The counterparty has the right to a quarterly call. Among these agreements, $150.0 million are callable after the first year and $200.0 million are callable after the first three months anniversary. When the callable term starts if certain conditions are met, there may be no interest earned for those days when the certain conditions are met. The collateral for these resale agreements consists of U.S. Government agency securities. In addition to long-term agreements, in July 2007, the Company entered into a $10 million 180-day short term resale agreement at a rate of 5.20%.

 

 

 

In the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans, or through commercial or standby letters of credit, and financial guarantees. Those instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying condensed consolidated balance sheets. The contractual or notional amount of these instruments indicates a level of activity associated with a particular class of financial instrument and is not a reflection of the level of expected losses, if any.

 

The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The following table summarizes the outstanding commitments as of the dates indicated:

 

 

As of September 30, 2007, $23.7 million unfunded commitments for affordable housing limited partnerships were recorded under other liabilities.

 

 

 

 

 

At September 30, 2007, seven repurchase agreements totaling $350.0 million were callable but had not been called. Two repurchase agreements for $50.0 million each bear fixed interest rates of 4.75% and 4.79%, respectively, until their final maturities in March 2011. Five repurchase agreements of $50.0 million each bear fixed interest rates ranging from 4.29% to 4.61%, until their final maturities in the first half of 2014.

 

 

On May 31, 2005, the Bancorp entered into a $30.0 million 364-day unsecured revolving loan agreement with a commercial bank bearing an interest rate of LIBOR plus 90 basis points and a commitment fee of 12.5 basis points on unused commitments. This loan was paid off in April 2007.

 

On September 29, 2006, the Bank issued $50.0 million in subordinated debt in a private placement transaction. This instrument matures on September 29, 2016 and bears interest at a per annum rate based on the three month LIBOR plus 110 basis points, payable on a quarterly basis. At September 30, 2007, the per annum interest rate on the subordinated debt was 6.30%. The subordinated debt was issued through the Bank and qualifies as Tier 2 capital for regulatory reporting purposes and is included in long-term debt in the accompanying condensed consolidated statement of financial condition.

 

 

The Bancorp issued junior subordinated debt securities of $46.4 million on March 30, 2007, and $20.6 million on May 31, 2007, in connection with pooled offerings of trust preferred securities by two newly formed and wholly-owned subsidiaries, Cathay Capital Trust III and Cathay Capital Trust IV, both of which are Delaware statutory business trusts.

 

 

On March 30, 2007, Cathay Capital Trust III issued and sold $45.0 million of trust preferred securities in a private placement to institutional investors and $1.4 million of common securities to the Bancorp. Similarly, on May 31, 2007, Cathay Capital Trust IV issued and sold $20.0 million of trust preferred securities in a private placement to institutional investors and $619,000 of common securities to the Bancorp.

 

The trust preferred securities issued by Cathay Capital Trust III have a scheduled maturity of June 15, 2037, and bear interest at a per annum rate based on the three-month LIBOR plus 148 basis points, payable on a quarterly basis. The trust preferred securities issued by Cathay Capital Trust IV have a scheduled maturity of September 6, 2037, and bear interest at a per annum rate based on the three-month LIBOR plus 140 basis points, payable on a quarterly basis. The Bancorp acts as a guarantor on the payment of certain obligations associated with these trust preferred securities.

 

Cathay Capital Trust III and Cathay Capital Trust IV used the proceeds from the sale of these trust preferred and common securities to purchase junior subordinated debt securities of the Bancorp that have identical maturity and payment terms as the respective trust preferred securities issued by these trusts.

 

Interest on the Bancorp's junior subordinated debt securities may be deferred at any time or from time-to-time for a period not exceeding 20 consecutive quarterly payments, provided there is no event of default and the deferral does not extend beyond maturity. If the Bancorp elects to defer interest on the junior subordinated debt securities, or if a default occurs, the Bancorp will generally not be able to declare or pay any dividends or distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to, any of the Bancorp's common stock. The entire principal of the junior subordinated debt securities may become due and payable immediately if an event of default occurs.

 

At September 30, 2007, junior subordinated debt securities totaled $121.1 million with a weighted average interest rate of 7.73%. The junior subordinated debt issued qualifies as Tier 1 capital for regulatory reporting purposes.

 

 

As previously disclosed, on December 31, 2003, the California Franchise Tax Board (FTB) announced its intent to list certain transactions that in its view constitute potentially abusive tax shelters. Included in the transactions subject to this listing were transactions utilizing regulated investment companies (RICs) and real estate investment trusts (REITs). While the Company continues to believe that the tax benefits recorded in 2000, 2001, and 2002 with respect to its regulated investment company were appropriate and fully defensible under California law, the Company participated in Option 2 of the Voluntary Compliance Initiative of the Franchise Tax Board, and paid all California taxes and interest on these disputed 2000 through 2002 tax benefits, and at the same time filed a claim for refund for these years while avoiding certain potential penalties. The Company retains potential exposure for assertion of an accuracy-related penalty should the FTB prevail in its position in addition to the risk of not being successful in its refund claims.

 

The FASB issued Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”) which requires that the amount of recognized tax benefit should be the maximum amount which is more-likely-than-not to be realized and that amounts previously recorded that do not meet the requirements of FIN 48 be charged as a cumulative effect adjustment to retained earnings. As of December 31, 2006, the Company reflected a $12.1 million net state tax receivable related to payments it made in April 2004 under the Voluntary Compliance Initiative program for the years 2000, 2001, and 2002, after giving effect to reserves for loss contingencies on the refund claims. The Company has determined that its refund claim related to its regulated investment company is not more-likely-than-not to be realized and consequently, charged a total of $8.5 million, comprised of the $7.9 million after tax amount related to its refund claims as well as a $0.6 million after tax amount related to California Net Operating Losses generated in 2001 as a result of its regulated investment company, to the balance of retained earnings as of the January 1, 2007, effective date of FIN 48.

 

 

At the January 1, 2007 adoption date of FIN 48, the total amount of the Company’s unrecognized tax benefits was $5.5 million, of which $1.7 million, if recognized, would affect the effective tax rate. The Company recognized interest and penalties accrued related to unrecognized tax benefits in income tax expense. At January 1, 2007, the adoption date of FIN 48, the total amount of accrued interest and penalties was $1.7 million.

 

 

During the third quarter of 2007, the Company repurchased 175,500 shares of its common stock for $5.4 million, or $30.77 average cost per share. For the nine months ended September 30, 2007, the Company repurchased 2,279,553 shares of its common stock for $76.9 million, or $33.74 average cost per share. At September 30, 2007, 172,150 shares remain under the Company’s May 8, 2007, repurchase program.

 

From October 30, 2007 to November 2, 2007, the Company repurchased 172,150 shares of its common stock for $5.1 million, or $29.66 average cost per share and thereby completed its May 2007 repurchase program. From January 1, 2007 to November 2, 2007, the Company repurchased 2,451,703 shares of its common stock for $82.0 million, or $33.45 average cost per share.

 

On September 27, 2007, the Company sold the $3.6 million bank owned property that formerly housed a Bank branch and recognized a gain on sale of $2.7 million. This property was transferred from premises and equipment when management decided to sell this property.

 

 

The following discussion is given based on the assumption that the reader has access to and has read the Annual Report on Form 10-K for the year ended December 31, 2006, of Cathay General Bancorp (“Bancorp”) and its wholly-owned subsidiary Cathay Bank (the “Bank” and, together, the “Company” or “we”, “us,” or “our”).

 

 

The discussion and analysis of the Company’s unaudited condensed consolidated balance sheets and results of operations are based upon its unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Accounting for the allowance for loan losses involves significant judgments and assumptions by management, which have a material impact on the carrying value of net loans; management considers this accounting policy to be a critical accounting policy. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances as described under the heading “Accounting for the allowance for loan losses” under Item 7 to Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Accounting for investment securities involves significant judgments and assumptions by management, which have a material impact on the carrying value of securities and the recognition of any “other-than-temporary” impairment to our investment securities. The judgments and assumptions used by management are described under the heading “Investment Securities” under Item 7 to Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Accounting for income taxes involves significant judgments and assumptions by management, which have a material impact on the amount of taxes currently payable and the income tax expense recorded in the financial statements. The judgments and assumptions used by management are described under the heading “Income Taxes” under Item 7 to Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

 

 

Net income was $34.0 million, or $0.67, per diluted share for the third quarter of 2007, a $3.3 million, or 10.9%, increase compared with net income of $30.7 million, or $0.59, per diluted share for the same quarter a year ago. Return on average assets was 1.46% and return on average stockholders’ equity was 14.45% for the third quarter of 2007 compared with a return on average assets of 1.60% and a return on average stockholders’ equity of 13.76% for the three months ended September 30, 2006.

 

 

The comparability of financial information is affected by our acquisitions. Operating results included the operations of acquired entities from the date of acquisition.

 

Net interest income before provision for loan losses increased $9.1 million, or 12.9%, to $79.8 million during the third quarter of 2007 from $70.7 million during the same quarter a year ago. The increase was due primarily to the strong growth in loans and securities.

 

The net interest margin, on a fully taxable-equivalent basis, was 3.69% for the third quarter of 2007. The net interest margin decreased 9 basis points from 3.78% in the second quarter of 2007 and decreased 37 basis points from 4.06% in the third quarter of 2006. The decrease in the net interest margin from the same quarter a year ago was primarily a result of the repricing of time deposits to reflect higher market interest rates, and increased reliance on more expensive wholesale deposits and borrowings.

 

For the third quarter of 2007, the yield on average interest-earning assets was 7.34% on a fully taxable-equivalent basis, and the cost of funds on average interest-bearing liabilities equaled 4.24%. In comparison, for the third quarter of 2006, the yield on average interest-earning assets was 7.42% and cost of funds on average interest-bearing liabilities equaled 4.01%. The interest spread, defined as the difference between the yield on average interest-earning assets and the cost of funds on average interest-bearing liabilities, decreased to 3.10% for the quarter ended September 30, 2007 from 3.41% for the same quarter a year ago primarily due to the reasons discussed above.

 

 

Average daily balances, together with the total dollar amounts, on a taxable-equivalent basis, of interest income and interest expense, and the weighted-average interest rate and net interest margin for the periods indicated are as follows:

 

 

 

 

The following table summarizes the changes in interest income and interest expense attributable to changes in volume and changes in interest rates for the periods indicated:

 

The provision for loan losses was $2.2 million for the third quarter of 2007 compared to negative $1.0 million provision for loan losses for the third quarter of 2006 and a $2.1 million provision for loan losses for the second quarter of 2007. The provision for loan losses was $5.3 million for the first nine months of 2007 and $2.0 million for same period of 2006. The provision for loan losses was based on the review of the adequacy of the allowance for loan losses at September 30, 2007. The provision for loan losses represents the charge or credit against current earnings that is determined by management, through a credit review process, as the amount needed to establish an allowance that management believes to be sufficient to absorb loan losses inherent in the Company’s loan portfolio. The following table summarizes the charge-offs and recoveries for the periods as indicated: