UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 30, 2001
OR
For the transition period from __________________to______________
Commission file number 0-18630
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common stock, $.01 par value, 9,068,506 shares outstanding as of August 3, 2001
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CATHAY BANCORP, INC. AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION(Unaudited)
See accompanying Notes to Unaudited Condensed Consolidated Financial StatementsCATHAY BANCORP, INC. AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME(Unaudited)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements
CATHAY BANCORP, INC. AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)
See accompanying Notes to Unaudited Condensed Consolidated Financial StatementsCATHAY BANCORP, INC. AND SUBSIDIARYNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
BUSINESS
Cathay Bancorp Inc. is the one-bank holding company for Cathay Bank (the “Bank” and together the “Company”). Cathay Bank was founded in 1962 and offers a full-range of financial services. Cathay Bank now operates 12 branches in Southern California, six branches in Northern California, two branches in New York State, one branch in Houston, Texas and two overseas offices (one in Taiwan and one in Hong Kong). The Bank is a commercial bank, servicing primarily the individuals, professionals and small to medium-sized businesses in the local markets in which it branches are located. The Bank has obtained regulatory approval to open a new branch in Union City, Northern California.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. Certain reclassifications have been made to the prior year’s financial statements to conform to the June 30, 2001 presentation. For further information, refer to the consolidated financial statements and footnotes included in Cathay Bancorp’s annual report on Form 10-K for the year ended December 31, 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No.141, “Business Combinations” (“SFAS 141”) and Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS 141 will require upon adoption of SFAS 142, that the Company evaluate its existing goodwill that was acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform to the new criteria in SFAS 141 for recognition apart from goodwill.
SFAS 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of SFAS 142, which for the Company, will be January 1, 2002. Upon adoption of SFAS 142, the Company will be required to reassess the useful lifes and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of SFAS 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. Management does not expect that the adoption of SFAS 142 will have a material impact on the Company’s results of operations or financial position, however management expects to complete its analysis of the impact of adopting SFAS 142 by the 4th quarter 2001.
In September 2000, the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), which the Company fully adopted by April 1, 2001. Adoption of SFAS 140 did not have a material impact to the Company’s consolidated financial statements.
FINANCIAL DERIVATIVES
The Company enters into financial derivatives in order to seek to mitigate the risk of interest rate exposures related to its interest-earning assets and interest-bearing liabilities. For periods prior to January 1, 2001, for those qualifying financial derivatives that altered the interest rate characteristics of assets or liabilities, the net differential to be paid or received on the financial derivative was treated as an adjustment to the yield on the underlying assets or liabilities. Interest rate financial derivatives that did not qualify for the accrual method, were recorded at fair value, with gains and losses recorded in earnings.
Effective January 1, 2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended by SFAS No. 137 and No. 138. SFAS 133 establishes accounting and reporting standards for financial derivatives, including certain financial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all financial derivatives as assets or liabilities in the Company’s statement of financial condition and measurement of those financial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a financial derivative is designated as a hedge and if so, the type of hedge.
Upon adoption of SFAS 133, the Company recognizes all derivatives on the balance sheet at fair value. Fair value is based on dealer quotes, or quoted prices from instruments with similar characteristics. The Company uses financial derivatives designated for hedging activities as cash flow hedges. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings.
As of January 1, 2001 and March 31, 2000, the Company hedged a portion of its variable interest rate loans through an interest rate swap agreement with a $20.0 million notional amount. The purpose of the hedge is to provide a measure of stability in the future cash receipts from such loans over the term of the swap agreement, which at June 30, 2001 was approximately less than four years. Adoption of SFAS 133, resulted in recording a $977,333 ($566,403, net of tax) increase in fair value to accumulated other comprehensive income and other assets. Amounts to be paid or received on the interest rate swap will be reclassified into earnings upon the receipt of interest payments on the underlying hedged loans including amounts totaling $130,692 that were reclassified into earnings at period end. The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to reclassified into earnings within the next 12 months is approximately $678,000.
The Company entered into a forward rate agreement with a notional amount of $100 million that was recorded at fair value, with the gain recorded as securities gains in the accompanying condensed consolidated statement of income and comprehensive income.
EARNINGS PER SHARE
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 or resulted in the issuance of common stock that then shared in earnings.
The following table sets forth basic and diluted earnings per share calculations:
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is given based on the assumption that the reader has access to and read the Annual Report on Form 10-K for the year ended December 31, 2000 of Cathay Bancorp, Inc. (“Bancorp”) and its subsidiary Cathay Bank (the "Bank"). When referring collectively to the Bancorp and the Bank we will use the term “Company” or “we”, “us” or “our”).
The following discussion, and other sections of this report, includes forward-looking statements regarding management’s beliefs, projections and assumptions concerning future results and events. These forward-looking statements may, but do not necessarily, also include words such as “believes”, “expects”, “anticipates”, “intends”, “plans”, “estimates” or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, adverse developments or conditions related to or arising from:
Actual results in any future period may also vary from the past results discussed in this report. Given these risks and uncertainties, we caution readers not to place undue reliance on any forward-looking statements, which speak as of the date of this report. We have no intention and undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision of any forward-looking statement to reflect future developments or events.CONSOLIDATED INCOME STATEMENT REVIEW
Net IncomeConsolidated net income for the three months ended June 30, 2001 was up 12% to $10.2 million or $1.12 per diluted share compared to $9.1 million or $1.00 per diluted share for the comparable period. The $1.1 million or 12% increase in 2001 second quarter net income was attributable to the following:
• a $630,000 or 3% increase in net interest income before provision for loan losses• a $150,000 or 14% increase in provision for loan losses• a $257,000 or 9% increase in non-interest income• a $1.0 million or 11% increase in non-interest expense• a $1.4 million or 25% decrease in income tax expense
Return on average stockholders’ equity was 17.85% and return on average assets was 1.77% for the second quarter of 2001 compared with a return on average stockholders’ equity of 19.60% and a return on average assets of 1.74%, for the second quarter of 2000.
Interest IncomeInterest income was up $429,000 to $40.7 million for the second quarter of 2001 compared to $40.3 million in the like quarter of 2000. Quarter-to-quarter average interest-earning assets increased by $175 million. The increase in average interest-earning assets was the result of increases in average gross loans1 of $150 million, or 86% of the total increase in average interest-earning assets, increases in average short-term investments2of $16 million and increases in average investment securities of $8 million. The increase in average interest-earning assets contributed $3.7 million to interest income, which was partially offset by relative decreases in the weighted-interest rate of interest-earning assets, resulting in a $3.3 million reduction to interest income during the second quarter 2001. The average interest rate on interest-earning assets decreased 62 basis points to 7.71% in the second quarter of 2001 compared with 8.33% in the same quarter of 2000.
Interest ExpenseInterest expense decreased $201,000 to $17.7 million for the three months ended June 30, 2001 compared to $17.9 million for the same period a year ago. During the second quarter 2001, average time deposits grew $160 million or 14% to $1.3 billion, average interest-bearing checking grew $27 million or 12% to $257 million and other borrowed funds decreased by $60 million or 61% to $39 million. In the comparable quarter a year ago, average time deposits were $1.1 billion and average interest-bearing checking accounts were $230 million. The average interest rate on interest-bearing liabilities decreased 33 basis points to 3.49% in the second quarter of 2001 compared with 3.82% in the same quarter of 2000. This was the result of a lower interest rate environment during the second quarter of 2001, and accounted for $2.0 million of the decrease in interest expense, partially offset by increases in average time deposits and interest-bearing checking accounts, which added $1.8 million to interest expense.
Net Interest Income – Taxable-Equivalent BasisAverage daily balances, together with the total dollar amounts of interest income (tax-equivalent basis) and interest expense and the weighted-average interest rate and net interest margin were as follows:
Changes in net interest income and margin result from the interaction between the volume and composition of earning assets, related yields, and associated funding costs. Accordingly, portfolio size, composition, and yields earned and funding costs can have a significant impact on net interest income and margin.
Taxable-equivalent net interest income before provision for loan losses of $23.6 million for the three months ended June 30, 2001, increased $732,000 compared to $22.9 million for the same quarter of 2000. Quarter-to-quarter, the $732,000 increase in taxable-equivalent net interest income before provision for loan losses was primarily the result of a net increase of $24.7 million in average interest-earning assets over average interest-bearing liabilities and a favorable change in the mix of interest-earning assets.
This increase in average interest-earning assets over interest-bearing liabilities was partially offset by relative decreases in the weighted-interest rate of interest-earning assets and interest-bearing liabilities, as a result of actions taken by the Federal Reserve Bank during the first half of 2001. Since January 2001, the Federal Reserve Bank has lowered rates by 275 basis points, with 125 basis points of the reduction occurring during the second quarter 2001, in contrast to the 50 basis point rate increase during the same quarter last year. For the quarter ended June 30, 2001, the impact of lower interest rates on net interest income before provision for loan losses was a negative $1.2 million, offset by a $1.9 million increase in net interest income, as a result of the increase of average interest-earning assets over interest-bearing liabilities and a favorable change in the mix of interest-earning assets.
The Company’s taxable-equivalent net interest margin was 4.46% at June 30, 2001 compared with 4.57% in the first quarter of 2001 and 4.73% in last year’s second quarter. The decrease of 27 basis points from last year’s second quarter is primarily due to a lower interest rate environment during this year’s second quarter. The Company is asset sensitive in the short-term scenario, which resulted in lower yielding assets and lagging time deposits. Of the Company’s $1.3 billion in time certificates of deposit, $701 million, or 54% will re-price during the third quarter of 2001.
Provision for Loan LossesThe provision for loan losses was $1.2 million in the second quarter of 2001 and $1.1 million for the second quarter of 2000. Management believes the increase is prudent to cover additional inherent risk resulting from the overall increase of our loan portfolio. Net charge-offs were $46,000 for the second quarter of 2001 and $476,000 for the second quarter of 2000.
Non-Interest IncomeNon-interest income was $3.1 million for the second quarter of 2001, up 9%, compared to $2.8 million during the second quarter of 2000. Letters of credit commission income for the second quarter of 2001 decreased $66,000 compared to the second quarter of 2000. This decrease was primarily the result of a slowing economy. Service charges increased to $1.2 million for the three months ended June 30, 2001 compared to $1.1 million during the like quarter a year ago. The increase in service charges was primarily due to increases in depository fee income during the 2001 quarter. Other operating income, which includes primarily loan fees, wire transfer fees, safe deposit fees and foreign exchange fees increased $265,000 to $1.3 million for the quarter ended June 30, 2001 compared to $1.0 million in the prior-year quarter.
Non-Interest ExpenseNon-interest expense increased $1.0 million or 11% to $10.3 million in the second quarter of 2001. Salaries and employee benefits grew by $143,000 primarily due to annual salary adjustments for officers in the second quarter of 2001. Professional services expense increased by $630,000. The increases in professional services were partially related to professional fees for the registered investment company as well as legal fees in connection with loans and other corporate matters. Operations in investments in real estate were $326,000 in 2001 versus $248,000 in 2000, primarily due to losses from low income housing investments that qualify for tax credits.
Other operating expense increased by $476,000, primarily as a result of one lawsuit. On June 29, 2001, at the Los Angeles County Superior Court, a jury awarded $300,000 to the plaintiff in a lawsuit filed against the Bank. As a result of the jury verdict, the Company accrued $300,000 to other operating expense. The Bank is evaluating an appeal of the verdict.
As a result of the above, the efficiency ratio increased to 39.60% in the second quarter of 2001, compared to 36.85% in the same quarter of 2000.
Income TaxesThe effective tax rate for the second quarter of 2001 was 30.0% compared to 38.9% for the second quarter of 2000. The lower tax rate for 2001 was due primarily to the impact of the formation of a registered investment company subsidiary that provides flexibility to raise additional capital in a tax efficient manner. The long-term plan for the registered investment company is currently under review. Depending on the results of the review and other factors, the effective tax rate may change. Currently, management believes the effective tax rate will be approximately 31.5% for the remainder of 2001. There can be no assurance that the subsidiary will continue as a registered investment company, or that any tax benefits will continue, or as to our ability to raise capital through this subsidiary.
YEAR-TO-DATE REVIEW – STATEMENT OF OPERATIONS
Net income was $19.6 million or $2.15 per diluted share for the six months ended June 30, 2001, an increase of 12% over the $17.4 million or $1.93 per diluted share for the same period a year ago. The taxable-equivalent net interest margin for the six months ended June 30, 2001 decreased 19 basis points to 4.52% compared to 4.71% during the like period a year ago.
Return on average stockholders’ equity was 17.66% and return on average assets was 1.75% for the six months of 2001 compared to a return on average stockholders’ equity of 19.14% and a return on average assets of 1.70%, for the six months of 2000.
BALANCE SHEET REVIEW
AssetsThe Company’s total assets increased by $97 million or 4.4% to $2.3 billion at June 30, 2001 compared to $2.2 billion at December 31, 2000. The increase in total assets was primarily the result of increases of $64 million each in total loans (gross of unearned deferred fees and the allowance for loan losses) and in securities.
SecuritiesThe fair value of securities available-for-sale at June 30, 2001 was $225.8 million compared to $177.8 million at December 31, 2000. Securities available-for-sale represented 9.8% of total assets compared to 8.1% at December 31, 2000. Securities held-to-maturity at June 30, 2001 increased $15.8 million to $403.0 million compared to $387.2 million at December 31, 2000. As a percentage of total assets, securities held-to-maturity remained unchanged at 17.5% of total assets.
At June 30, 2001, the securities available-for-sale balance included a net unrealized gain of $5.4 million, which represented the difference between fair value and amortized cost. The comparable amount at December 31, 2000, was a net unrealized gain of $4.0 million. The increase in unrealized holding gains in 2001 resulted from the decreasing interest rate environment in the first six months of 2001. Net unrealized gains and losses in the securities available-for-sale are included in accumulated other comprehensive income or loss, net of tax.
The average taxable equivalent yield on investment securities was up 17 basis points to 6.58% in the second quarter of 2001, compared with 6.41% for the same quarter in 2000.
The following tables summarize the composition, amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale, as of June 30, 2001 and December 31, 2000:
The following tables summarize the composition, carrying value, gross unrealized gains, gross unrealized losses and estimated fair values of securities held-to-maturity, as of June 30, 2001 and December 31, 2000:
LoansThe $64 million or 4% increase in total loans was primarily the result of increases of $47 million in real estate construction loans, $13 million in residential mortgage loans, and $8 million in commercial mortgage loans. The increase in real estate construction loans in the second quarter of 2001 was attributable to both new projects and disbursements on old projects. As of June 30, 2001, we had approximately $79 million in undisbursed construction loan commitments. The increase in residential and commercial mortgage loans was primarily due to new business. This increase in total loans was partially offset by a decrease of $3 million in installment loans.
The following table sets forth the classification of loans by type, mix, and percentage change as of the dates indicated:
Other Real Estate OwnedOther Real Estate Owned (“OREO”), net of a valuation allowance of $131,000, remained relatively unchanged at $5.4 million at June 30, 2001, compared to $5.2 million at year-end 2000.
As of June 30, 2001, there were five outstanding OREO properties, which included one parcel of land, two commercial buildings, and two single-family residences (“SFR”). All properties are located in California. During the second quarter of 2001, we acquired one additional SFR property totaling $442,000 and disposed of one parcel of land with a carrying value of $223,000.
To reduce the carrying value of OREO to the estimated fair value of the properties, we maintain a valuation allowance for OREO properties. We perform periodic evaluations on each property and make corresponding adjustments to the valuation allowance, if necessary. Any decline in value is recognized by a corresponding increase to the valuation allowance in the current period. Management did not make any provision for OREO losses in the second quarter of 2001.
Investments in Real EstateOur investments in real estate, at June 30, 2001, comprised of four limited partnerships formed for the purpose of investing in low income housing projects, which qualify for federal low income housing tax credits and/or California tax credit.
As of June 30, 2001, investments in real estate increased $869,000 to $18.2 million from $17.3 million at year-end 2000. During 2001, we recognized $1.2 million in net losses from the four limited partnerships. In addition, we contributed $2.1 million to the Wilshire Courtyard investment.
The following table summarizes the composition of our investments in real estate as of the dates indicated:
DepositsThe increases in total assets were funded primarily by increases in time deposit accounts totaling $114 million, savings accounts totaling $12 million, and money market accounts totaling $6 million. As a result of these deposit increases, the Bank crossed the $2 billion mark in total deposits for the first time in the Bank’s history.
The following table presents the deposit mix as of the dates and for the periods indicated:
As interest rate spreads widened between Jumbo CD’s and other types of interest-bearing deposits under the prevailing interest rate environment, our Jumbo CD portfolio continues to grow faster than other types of deposits. Management believes our Jumbo CD’s are generally less volatile primarily due to the following reasons:
Management continues to monitor the Jumbo CD portfolio to identify any changes in the deposit behavior in the market and of the patrons the Bank is servicing. To discourage the concentration in Jumbo CD’s, management has continued to make efforts in the following areas:
Capital ResourcesStockholders’ equity of $232.4 million was up $17.6 million or 8.2% from December 31, 2000. At June 30, 2001, Stockholders’ equity was 10.1% of total assets, compared with $214.8 million or 9.7% of total assets at year-end 2000. The increase of $17.6 million or 8.2% in stockholders’ equity was due to the following:
We declared cash dividends of $0.25 per common share in January 2001 on 9,074,365 shares outstanding, in April 2001 on 9,086,323 shares outstanding and in July 2001 on 9,097,576 shares outstanding. Total cash dividends paid in 2001 amounted to $6.8 million.
ASSET QUALITY REVIEW
Nonperforming AssetsNonperformingassets include loans past due 90 days or more and still accruing interest, nonaccrual loans, and other real estate owned.
Nonperforming assets decreased $756,000 or 4% to $19.7 million at June 30, 2001, compared with $20.5 million at year-end 2000. As a percentage of loans3and OREO, nonperforming assets decreased to 1.29% at June 30, 2001 from 1.39% at year-end 2000. The nonperforming loan coverage ratio, defined as the allowance for loan losses to nonperforming loans, increased to 165.91% at June 30, 2001, compared with 143.72% at year-end 2000. The increase in the nonperforming loan coverage ratio at June 30, 2001, was primarily the result of lowering nonperforming loans by $756,000, and a net increase in the allowance for loan losses by $1.8 million.
The following table sets forth the breakdown of nonperforming assets by categories as of the dates indicated:
Nonaccrual LoansNonaccrual loans of $13.2 million at June 30, 2001 consisted mainly of $8.9 million in commercial loans and $4.1 million in commercial mortgage loans.
The following table presents the type of collateral securing the loans, as of the dates indicated:
The following table presents nonaccrual loans by type of businesses the borrowers engaged in, as of the dates indicated:
Troubled Debt RestructuringsA troubled debt restructuring is a formal restructure of a loan when the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower. The concessions may be granted in various forms, including reduction in the stated interest rate, reduction in the loan balance or accrued interest, and extension of the maturity date.
Troubled debt restructurings remained at $4.8 million at June 30, 2001 and at December 31, 2000. All of the troubled debt restructurings at June 30, 2001 were commercial mortgage loans. With the exception of one borrower with loans totaling $2.4 million, which were 46 days past due, all other troubled debt restructurings were performing under their revised terms as of June 30, 2001.
Impaired LoansA loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement based on current circumstances and events.
We consider all loans classified and restructured in our evaluation of loan impairment. The classified loans are stratified by size, and loans less than our defined selection criteria are treated as a homogenous portfolio. If loans meeting the defined criteria are not collateral dependent, we measure the impairment based on the present value of the expected future cash flows discounted at the loan’s effective interest rate. If loans meeting the defined criteria are collateral dependent, we measure the impairment by using the loan’s observable market price or the fair value of the collateral. If the measurement of the impaired loan is less than the recorded amount of the loan, we then recognize an impairment by creating or adjusting an existing valuation allowance with a corresponding charge to the provision for loan losses.
We identified impaired loans with a recorded investment of $25.2 million at June 30, 2001, which approximated those at year-end 2000.
The following tables present a breakdown of impaired loans and the related allowances as of the dates indicated:
Loan ConcentrationThere were no loan concentrations to multiple borrowers in similar activities, which exceeded 10% of total loans as of June 30, 2001.
Allowance for Loan LossesThe following table sets forth information relating to the allowance for loan losses for the periods indicated:
Charge-offs on commercial loans accounted for 89% of the total charged-off loans during the six months of 2001. The remaining 11% were primarily installment loans and open-end credit loans.
In determining the allowance for loan losses, management continues to assess the risks inherent in the loan portfolio, the possible impact of known and potential problem loans, and other factors such as collateral value, portfolio composition, loan concentration, financial strength of borrower, and trends in local economic conditions.
Our allowance for loan losses consists of the following:
Based on our evaluation process and the methodology to determine the level of the allowance for loan losses mentioned previously, management believes the allowance level at June 30, 2001 to be adequate to absorb estimated probable losses identified through its analysis.
CAPITAL ADEQUACY REVIEW
Management seeks to retain the Company’s capital at a level sufficient to support future growth, protect depositors and stockholders, and comply with various regulatory requirements.
Both Bancorp’s and the Bank’s regulatory capital continued to well exceed the regulatory minimum requirements as of June 30, 2001. In addition, the capital ratios of the Bank place it in the “well capitalized” category which is defined as institutions with total risk-based ratio equal to or greater than 10.0%, Tier 1 risk-based capital ratio equal to or greater than 6.0% and Tier 1 leverage capital ratio equal to or greater than 5.0%.
The following table presents the Company’s capital and leverage ratios as of June 30, 2001 and December 31, 2000:
The following table presents the Bank’s capital and leverage ratios as of June 30, 2001 and December 31, 2000:
LIQUIDITY AND MARKET RISK
LiquidityOur principal sources of liquidity are growth in deposits, proceeds from the maturity or sale of securities and other financial instruments, repayments from securities and loans, federal funds purchased and securities sold under agreements to repurchase, and advances from the Federal Home Loan Bank (“FHLB”).
To supplement its liquidity needs, the Bank maintains a total credit line of $53 million for federal funds with three correspondent banks, and $100 million with two brokerage firms. The Bank is also a shareholder of the FHLB, which enables the Bank to have access to lower cost FHLB financing when necessary. At June 30, 2001, the Bank had $61.1 million in borrowing capacity under a collaterized line of credit with the FHLB of San Francisco, of which $10.0 million had been utilized.
As of June 30, 2001, our liquidity ratio (defined as net cash, short-term and marketable securities to net deposits and short-term liabilities) increased to 33.12% from 30.76% at year-end 2000. A significant portion of our time deposits will mature within one year or less. Management anticipates that there may be some outflow of these deposits upon maturity due to the keen competition in our marketplaces. However, based on our historical runoff experience, we expect the outflow will be minimal and can be replenished through our normal growth in deposits. Management believes all the above-mentioned sources will provide adequate liquidity to the Bank to meet its daily operating needs.
Bancorp, on the other hand, obtains funding for its activities primarily through dividend income contributed by the Bank and proceeds from investments in the Dividend Reinvestment Plan. Dividends paid to Bancorp by the Bank are subject to regulatory limitations. The business activities of Bancorp consist primarily of the operation of the Bank with limited activities in other investments. Management believes Bancorp’s liquidity generated from its prevailing sources are sufficient to meet its operational needs.
Market RiskMarket risk is the risk of loss from adverse changes in market prices and rates. Our principal market risk is the interest rate risk inherent in our lending, investing, and deposit taking activities, due to the fact that interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same extent, or on the same basis.
We actively monitor and manage our interest rate risk through analyzing the repricing characteristics of our loans, securities, and deposits on an on-going basis. The primary objective is to minimize the adverse effects of changes in interest rates on our earnings, and ultimately the underlying market value of equity, while structuring our asset-liability composition to obtain the maximum spread. Management uses certain basic measurement tools in conjunction with established risk limits to regulate our interest rate exposure. Due to the limitations inherent in any individual risk management tool, we use both an interest rate sensitivity analysis and a simulation model to measure and quantify the impact to our profitability or the market value of our assets and liabilities.
The interest rate sensitivity analysis details the expected maturity and repricing opportunities mismatch or sensitivity gap between interest-earning assets and interest-bearing liabilities over a specified timeframe. A positive gap exists when rate sensitive assets which reprice over a given time period exceed rate sensitive liabilities. During periods of increasing interest rates, net interest margin may be enhanced with a positive gap. A negative gap exists when rate sensitive liabilities which reprice over a given time period exceed rate sensitive assets. During periods of increasing interest rates, net interest margin may be impaired with a negative gap.
The following table indicates the expected maturity or repricing and rate sensitivity of our interest-earning assets and interest-bearing liabilities as of June 30, 2001:
As of June 30, 2001, the Company was asset sensitive with a gap ratio of a positive 17.37% within three months, and liability sensitive with a cumulative gap ratio of a negative 9.23% within one year. This compared with a positive 18.13% gap within three months, and a negative 9.78% cumulative gap within one year at year-end 2000.
Since interest rate sensitivity analysis does not measure the timing differences in the repricing of asset and liabilities, we use a simulation model to quantify the extent of the differences in the behavior of the lending and funding rates, so as to project future earnings or market values under alternative interest scenarios.
The simulation measures the volatility of net interest income and net portfolio value, defined as net present value of assets and liabilities, under immediate rising or falling interest rate scenarios in 100 basis point increments. We establish a tolerance level in our policy to define and limit interest income volatility to a change of plus or minus 30% when the hypothetical rate change is plus or minus 200 basis points. When the tolerance level is met or exceeded, we then seek corrective action after considering, among other things, market conditions, customer reaction and the estimated impact on profitability.
The following table presents the estimated impacts of immediate changes in interest rates at the specified levels at June 30, 2001. The results presented may vary if different assumptions are used or if actual experience differs from the assumptions used.
The Bank utilizes financial derivative instruments in order to mitigate the risk of interest rate exposures related to our interest-earning assets and interest-bearing liabilities. We believe that these transactions, when properly structured and managed, may provide a hedge against inherent interest rate risk in the balance and against risk in specific transactions. In such instances, the Bank may protect its position through the purchase or sale of interest rate futures contracts for a specific cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, floors, financial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, we seek to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bank’s Investment Committee.
On March 21, 2000, we entered into an interest rate swap agreement with a major financial institution in the notional amount of $20.0 million for a period of five years. The interest rate swap was for the purpose of hedging the cash flows from a portion of our floating rate loans against declining interest rates. The purpose of the hedge is to provide a measure of stability in the future cash receipts from such loans over the term of the swap agreement, which at June 30, 2001, was approximately less than four years. At June 30, 2001, the fair value of the interest rate swap was approximately $1.2 million ($674,000, net of tax) compared to $977,000 ($566,000, net of tax) at December 31, 2000. Amounts to be paid or received on the interest rate swap will be reclassified into earnings upon the receipt of interest payments on the underlying hedged loans including amounts totaling $130,700 that were reclassified into earnings at period end.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information concerning market risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk.”
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Management is not currently aware of any litigation that is expected to have material adverse impact on the Company’s consolidated financial condition or the results of operations.
With regard to the previously disclosed lawsuit regarding the spouse of director Anthony M. Tang, the court denied the Bank’s motion for summary judgment and scheduled a trial to commence on September 24, 2001. Based on consultation with the attorneys representing the Bank in this lawsuit, the Company continues to believe that, under the California Uniform Commercial Code, among other reasons, it has a strong defense to the claims made in the lawsuit.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of stockholders of Cathay Bancorp, Inc. was held on April 17, 2001 for the purpose of considering and acting upon the following:
Election of Directors: Four directors were elected as Class II directors to serve until the 2004 Annual Meeting and the votes cast for or withheld or against were as follows:
Other Directors whose terms of office continued after the meeting:
Item 5. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit:
None
Reports on Form 8-K:
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.