Cathay General Bancorp - 10-Q quarterly report FY

 

 

 

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

 

 

 

 

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 Bancorp 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 four 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 March 31, 2007, the Bank operates twenty branches in Southern California, ten branches in Northern California, three branches in Illinois, two branches in Washington State, nine branches in New York State, one branch in Massachusetts, one branch in Houston, Texas, one branch in New Jersey and one loan production office in Dallas, Texas, plus representative offices in Taipei, Hong Kong, 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 preliminary and 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 for the three months ended March 31, 2007:

 

On March 31, 2006, the Bank announced an agreement to buy a 20% stake in First Sino Bank, a Shanghai-based joint venture bank, for an estimated purchase price of $52.2 million. This investment was subject to regulatory approval from the China Bank Regulatory Commission in China and Cathay Bank's regulators in the United States and other customary closing conditions. The agreement provided that it could be terminated by either party if all conditions to closing were not fulfilled or waived prior to September 30, 2006. By mutual agreement of the parties, this closing date was extended to November 15, 2006. The parties have not further extended this closing date and the agreement can therefore be terminated by either party upon written notice.

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.

 

 

As of March 31, 2007, the Company had no interest rate swaps.

 

The Company has received rights to acquire stock in the form of warrants as an adjunct to its high technology lending relationships. All warrants with cashless exercise provision qualify as derivatives under SFAS No. 133. Those warrants that qualify as derivatives are carried at fair value and are included in other assets on the consolidated balance sheets with the change in fair value included in current earnings.

 

 

 

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 basic and diluted earnings per share calculations and the average shares of stock options with anti-dilutive effect:

 

 

 

 

 

 

 

 

The Company grants 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 March 31, 2007:

 

 

The stock compensation expense recorded related to non-vested stock above was $60,000 for the three months ended March 31, 2006 and $148,000 for the three months ended March 31, 2007. Unrecognized stock-based compensation expense related to non-vested stock awards was $1.3 million at March 31, 2007, and is expected to be recognized over the next 1.8 years.

 

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:

 

 

 

 

 

 

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. These 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 March 31, 2007, $17.7 million unfunded commitments for affordable housing limited partnerships were recorded under other liabilities compared to $21.3 million at December 31, 2006.

 

 

 

 

 

 

On May 31, 2005, Cathay General 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. On September 29, 2006, in conjunction with the issuance of subordinated debt discussed below, this loan was further amended to reduce the commitment to $35.0 million until October 31, 2006 and to $10.0 million thereafter. At March 31, 2007, $10.0 million was outstanding with a rate of 6.22% under this loan. The Company paid off the $10.0 million borrowing on April 13, 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 March 31, 2007, the per annum interest rate on the subordinated debt was 6.45%. 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.

 

 

On March 30, 2007, Bancorp issued $46.4 million of junior subordinated debt securities through a pooled trust preferred offering. Similar to previous offerings, these securities were issued through a newly formed statutory business trust, Cathay Capital Trust III, a wholly-owned subsidiary of Bancorp. The proceeds from the debt securities are loaned by Cathay Capital Trust III to Bancorp and are included in long-term debt in the accompanying Condensed Consolidated Balance Sheet. The 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. At March 31, 2007, the interest rate on the junior subordinated debt was 6.83%. 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 amounts of accrued interest and penalties was $1.7 million.

 

 

 

During the first quarter of 2007, the Company repurchased 877,903 shares of its common stock for $29.9 million, or $34.11 average cost per share. On March 6, 2007, the Company announced that its Board of Directors had approved a new stock repurchase program to buy back up to an aggregate of one million shares of the Company’s common stock following the completion of March 2005’s stock repurchase program. At March 31, 2007, 573,800 shares remain under the Company’s March 2007 repurchase program.

 

On May 8, 2007, the Company completed its March 2007 repurchase program by purchasing 573,800 shares in May 2007 for $19.4 million or $33.90 average cost per share. Also on May 8, 2007, the Company’s Board of Directors approved a new program to repurchase up to an aggregate of one million shares of the Company’s common stock following the completion of March 2007 repurchase program.

 

In 2005, $3.6 million was transferred from premises and equipment to other assets when management decided to sell a bank owned building, land, and related improvements. The $3.6 million is the lower of the carrying amount or fair value less estimated selling costs and is recorded as other assets as of March 31, 2007 and December 31, 2006.

 

 

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” in 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” in 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” in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

 

 

Net income for the first quarter of 2007 was $30.0 million, or $0.57 per diluted share, a $2.7 million, or 9.6%, increase compared with net income of $27.3 million, or $0.54 per diluted share for the same quarter a year ago. Return on average assets was 1.45% and return on average stockholders’ equity was 12.87% for the first quarter of 2007 compared with a return on average assets of 1.67% and a return on average stockholders’ equity of 14.06% for the first quarter of 2006.

 

 

 

 

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

 

Net interest income before provision for loan losses increased $7.7 million to $72.8 million during the first quarter of 2007, or 11.7% higher than the $65.1 million during the same quarter a year ago. The increase was due primarily to the increases in loans and securities and higher loan prepayment fees of $0.9 million.

 

The net interest margin, on a fully taxable-equivalent basis, was 3.83% for the first quarter of 2007. The net interest margin decreased 18-basis points from 4.01% in the fourth quarter of 2006 and decreased 50-basis points from 4.33% in the first quarter of 2006. The decrease in the net interest margin was primarily the result of increases in investment securities that had lower yields than loans, repricing of time deposits to reflect higher market interest rates, and increased reliance on more expensive wholesale borrowings.

 

For the first quarter of 2007, the yield on average interest-earning assets was 7.44% on a fully taxable-equivalent basis, and the cost of funds on average interest-bearing liabilities equaled 4.27%. In comparison, for the first quarter of 2006, the yield on average interest-earning assets was 6.94% and cost of funds on average interest-bearing liabilities equaled 3.18%. 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 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 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:

 

 

 

 

Non-interest income, which includes revenues from depository service fees, letters of credit commissions, securities gains (losses), gains (losses) on loan sales, wire transfer fees, and other sources of fee income, was $5.9 million for the first quarter of 2007, an increase of $809,000, or 15.9%, compared to the non-interest income of $5.1 million for the first quarter of 2006.

 

For the first quarter of 2007, the Company recorded net securities gains of $191,000 compared to net securities gains of $27,000 for the same quarter in 2006.

 

 

Depository service fees increased $91,000, or 7.3%, from $1.26 million in the first quarter of 2006 to $1.35 million in the first quarter of 2007 due primarily to the increases in overdraft and non-sufficient fund charges.

 

In addition, other operating income increased $331,000, or 12.2%, to $3.1 million in the first quarter of 2007 from $2.7 million in the same quarter a year ago primarily due to increases in loan referral fees of $356,000, commissions on safe deposit box rentals of $156,000, wealth management commissions of $138,000, wire transfer fees of $121,000, and other miscellaneous income of $181,000 offset by a decrease in warrant income of $883,000.

 

 

Non-interest expense increased $4.9 million, or 19.4%, to $30.2 million in the first quarter of 2007 compared to $25.3 million during the same quarter a year ago primarily due to increases in salaries and employee benefits expenses, occupancy expenses and computer and equipment expenses. The efficiency ratio was 38.44% for the first quarter of 2007 compared to 36.07% in the year ago quarter and 38.82% for the fourth quarter of 2006.

 

The increase of non-interest expense from the first quarter a year ago to the first quarter of 2007 was primarily due to the acquisitions of Great Eastern Bank and New Asia Bancorp in 2006, and a combination of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Offsetting the above increases was a $355,000, or 27.3%, decrease in operations of affordable housing investments primarily due to a $500,000 cash distribution from a low income housing partnership which had been fully amortized in previous years.

 

 

The effective tax rate was 36.8% for the first quarter of 2007, compared to 37.0% for the same quarter a year ago and 36.4% for the full year 2006.

 

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 opening balance of retained earnings as of the January 1, 2007, effective date of FIN 48.

 

 

Total assets increased by $662.3 million, or 8.3%, to $8.7 billion at March 31, 2007, from year-end 2006 of $8.0 billion. The increase in total assets was represented primarily by increases in investment securities, securities purchased under agreements to resell and loans funded by increases in securities sold under agreement to repurchase agreements and FHLB borrowings. Securities purchased under agreements to resell increased $150.0 million and long-term certificates of deposit increased $50.0 million during the first quarter due to attractive rates available on these investments

 

 

 

 

Total securities were $1.9 billion, or 21.4%, of total assets at March 31, 2007, compared with $1.5 billion, or 19.0%, of total assets at December 31, 2006. The increase of $338.0 million, or 22.2%, was primarily due to purchases of callable agency securities which provided collateral for repurchase agreements.

 

The net unrealized loss on securities available-for-sale, which represented the difference between fair value and amortized cost, totaled $13.4 million at March 31, 2007, compared to a net unrealized loss of $21.4 million at year-end 2006. The decrease in unrealized loss on securities available-for-sale was caused by the decrease in market interest rates during the first quarter of 2007. Net unrealized gains/losses in the securities available-for-sale are included in accumulated other comprehensive income or loss, net of tax, as part of total stockholders’ equity.

 

The average taxable-equivalent yield on securities available-for-sale increased 101 basis points to 5.60% for the three months ended March 31, 2007, compared with 4.59% for the same period a year ago, as securities matured, prepaid, or were called and proceeds were reinvested at higher interest rates.

 

The following tables summarize the composition, amortized cost, gross unrealized gains, gross unrealized losses, and fair value of securities available-for-sale, as of March 31, 2007, and December 31, 2006:

 

 

 

 

The following table summarizes the scheduled maturities by security type of securities available-for-sale, as of March 31, 2007: