Cathay General Bancorp (NASDAQ:CATY) Q4 2022 Earnings Conference Call January 25, 2023 6:00 PM ET
Company Participants
Georgia Lo – Investor Relations
Chang Liu – President and Chief Executive Officer
Heng Chen – Executive Vice President and Chief Financial Officer
Conference Call Participants
Chris McGratty – KBW
Matthew Clark – Piper Sandler
Gary Tenner – D.A. Davidson
Andrew Terrell – Stephens
Operator
Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp’s Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Sarah and I will be your coordinator for today. [Operator Instructions] Today’s call is being recorded and will be available for replay at www.cathaygeneralbancorp.com. Now, I would like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp.
Georgia Lo
Thank you, Sarah and good afternoon. Here to discuss the financial results today are Mr. Chang Liu, our President and Chief Executive Officer and Mr. Heng Chen, our Executive Vice President and Chief Financial Officer.
Before we begin, we wish to remind you that the speakers on this call may make forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 concerning future results and events and that these statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are further described in the company’s annual report on Form 10-K for the year ended December 31, 2021, at Item 1A in particular and in other reports and filings with the Securities and Exchange Commission from time to time.
As such, we caution you not to place undue reliance on forward-looking statements. Any forward-looking statement speaks only as of the date of which it is made and except as required by law, we undertake no obligation to update or review any forward-looking statements to reflect future circumstances, developments or events or the occurrence of unanticipated events.
This afternoon, Cathay General Bancorp issued an earnings release outlining its fourth quarter and full year 2022 results. To obtain a copy of our earnings release as well as our earnings presentation, please visit our website at www.cathaygeneralbancorp.com. After comments from management today, we will open this call up for questions.
I will now turn the call over to our President and Chief Executive Officer, Mr. Chang Liu.
Chang Liu
Thank you, Georgia and good afternoon everyone. Welcome to our 2022 fourth quarter earnings conference call. This afternoon, we reported net income of $97.6 million for the fourth quarter of 2022, a 29.6% increase as compared to a net income of $75.3 million for the fourth quarter of 2021. Diluted earnings per share increased 35.7% to $1.33 per share for the fourth quarter of 2022 compared to $0.98 per share for the same quarter a year ago.
In the fourth quarter of 2022, our gross loans increased $147.2 million or 3.6% as annualized. The increase in loans for the fourth quarter of 2022 was primarily driven by increases of $116 million or 5.3% annualized in commercial real estate loans, $122.3 million or 9.5% annualized in residential mortgage loans. The overall loan growth for 2023 is expected to range between 3% to 5%.
We continue to monitor our commercial real estate loans. Turning to Slide 8 of our earnings presentation, as of December 31, 2022, the average loan-to-value of our CRE loans was 51%. As of December 31, 2022, our retail property loan portfolio, at Slide 9, comprises 22% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. The majority, 89% of the $1.96 billion in retail loans, is secured by retail building, neighborhood, mixed use or strip centers and only 10% secured by shopping centers.
For the fourth quarter of 2022, we reported net charge-offs of $2.5 million, which included $2 million that were fully reserved as of September 30, 2022 compared to net charge-offs of $0.6 million in the third quarter of 2022. Our non-accrual loans were 0.38% of total loans as of December 31, 2022 increased by $3 million to $68.9 million as compared to the end of the third quarter of 2022.
Turning to Slide 12, as of December 31, 2022, classified loans increased slightly to $256 million from $240 million as of September 30, 2022 and our special mention loans increased to $321 million from $305 million as of September 30, 2022. We recorded a provision for credit loss of $1.4 million in the fourth quarter of 2022 as compared to a $2 million provision for credit losses in the third quarter of 2022 and $3.5 million provision for credit losses in the fourth quarter of 2021. Total average deposits increased by $387.5 million or 9% annualized during the fourth quarter of 2022.
Average time deposits increased $1.4 billion or 99.2% annualized during the fourth quarter of 2022 compared to the third quarter of 2022. Average money market deposits decreased by $802.8 million or 73.1% annualized due primarily to a migration back to CDs from money market deposits and deposit runoffs. For 2023, the overall deposit growth is expected to range between 3% and 5%.
I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the fourth quarter 2022 financial results in more detail.
Heng Chen
Thank you, Chang and good afternoon everyone. For the fourth quarter of 2022, net income increased by $22.3 million or 29.6% to $97.6 million compared to the fourth quarter of 2021. The increase was primarily attributable to net interest margin expansion in the fourth quarter of 2022 compared to the year ago quarter.
Our net interest margin was 3.87% in the fourth quarter of 2022 as compared to 3.23% for the fourth quarter of 2021. In the fourth quarter of 2022, interest recoveries and prepayment penalties added 1 basis point to the net interest margin as compared to 3 basis points for the third quarter of 2022 and 6 basis points for the same quarter a year ago. Based on Fed Funds target range of between 4.75% and 5%, we have increased our net interest margin expectation for 2023 to be between 3.75% to 3.85%. Our 2023 net interest margin expectations included the impact of the $3.1 million interest recovery from a full repayment of a non-accrual loan last week.
Our non-interest income during the fourth quarter of 2022 decreased by $7.7 million to $12.1 million when compared to the fourth quarter of 2021 due to an increase of $3.2 million in loss on equity securities, a decrease of $3.1 million and the gain on venture capital investment, distributions and a decrease of $1.7 million in derivative fee income. Non-interest expense increased by $8 million or 11% to $81.1 million in the fourth quarter of 2022 when compared to $73.2 million in the fourth quarter of 2021. The increase was primarily due to $1.2 million in higher salaries and bonuses; $3.8 million in higher amortization of low income housing and solar tax credit investments, which included a $1.3 million catch-up adjustment in the first quarter; $1 million in higher amortization of core deposit intangibles, which included approximately $900,000 in accelerated write-downs; and $1.1 million in higher professional and marketing expenses.
Special items in the fourth quarter 2022 once again included a $1.3 million catch-up adjustment for impairment of low income housing investments and $0.9 million of additional CDI amortization. We expect core non-interest expense, excluding tax credit or deposit intangibles and amortization and HSBC integration expenses to increase 3.5% from 2022 to 2023.
The effective tax rate for the fourth quarter of 2022 was 25.7% as compared to 23.6% for the fourth quarter of 2021. For 2023, we expect an effective tax rate of between 17.5% and 18.5%. We expect 2023 sole tax credit investment amortization of $30 million which is $10 million in each of the first three quarters of 2023. As of December 31, 2022, our Tier 1 leverage capital ratio increased to 10.08% as compared to 10.02% as of September 30, 2022. Our Tier 1 risk-based capital ratio increased to 12.19% from 12.06% as of September 30, 2022. And our total risk-based capital ratio increased to 13.71% from 15.59% as of September 30, 2022.
Chang Liu
Thank you, Heng. We will now proceed to the question-and-answer portion of the call.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from Chris McGratty with KBW. Please go ahead.
Chris McGratty
Great. Good evening. Heng, I want to make sure I understand the expenses, just to make sure I’m buttoned up on the expenses. The 3.5% growth, is that off the – it looks like the $255 million, and then I’m adding on top of that $30 million on solar. Is that right?
Heng Chen
Yes, yes. And you’ve got to add $40 million in low-income housing amortization. It’s roughly $10 million a quarter now.
Chris McGratty
Okay. So solar is $30 million, and low income is how much? I missed that.
Heng Chen
$40 million.
Chris McGratty
Okay. So $70 million in total amortization. Okay. Great.
Heng Chen
Yes. And that’s why the tax rate is lower – projected to be lower in 2023.
Chris McGratty
Okay. Great. And then maybe on the margin guide, you had a pretty decent mix shift this quarter. So I’m interested in what – I guess what further remixing you might be forecasting in the CD portfolio. How much more do you have that increasing proportionately to get to that 3.75%, 3.85% margin? Thank you.
Heng Chen
Yes. We – pre-COVID, we used to do Chinese New Year promotions, and so we’re in the third week of our Chinese New Year promotions. So the average rate is – we have two tiers, but the average rate is probably about 4.20%, and we were very pleased with the results of that. We think we will get net new funds into the bank of at least $600 million. And so in terms of context, one, your broker CDs would be at 4.85%. So our rate is 4.20%. And we’re borrowing from a federal home loan bank. We’re borrowing them short-term. So that rate was about 4.8%. It’ll go up to 5% in February when the Fed increase changes. So we think that to help, lack of better word, deliver a good margin in Q1, plus that $3.1 million interest recovery would add 6 basis points to that. But once again, we had one quarter, on our Slide 15, it shows the average Fed funds versus a cost of interest-bearing deposits. So for 2022, our deposit beta was 34%, and it jumped up to 61% in the fourth quarter. But once again, we think the first quarter, the deposit beta will not be 61%, and we have two prime rate increases in Q1. So our loan beta is 44%, and that should continue. So once again, that’s why we think we will be in the range where we’re going to be.
Chris McGratty
Okay. And if I could just make sure I’m totally buttoned up. The interest recovery, is that in the 3.75% full year guide, 3.85%?
Heng Chen
Yes, yes.
Chris McGratty
Okay. And then the mix of deposits, right? CDs are 38%. I think pre-COVID, it was north of 40%. I mean the expectation is that we’re perhaps approaching 50% by the time the Fed’s done. Is that reasonable? Or is that too far?
Heng Chen
I think that’s too far. But if the Fed’s not done, it’s going to help us NIM-wise, net interest income-wise, in 2023. And we’re going to be focusing on 2024 when we had to reprice these CDs downward, which we think we can.
Chris McGratty
Got it. Thanks, Heng. Appreciated all the color.
Heng Chen
Sure.
Operator
The next question comes from Matthew Clark with Piper Sandler. Please go ahead.
Matthew Clark
Hi, good afternoon. I just want to round out the NIM discussion a bit here. Do you have the spot rate on interest-bearing deposits at the end of the year to give us some visibility going into 1Q?
Heng Chen
Yes. Let me find it. Hold on. Yes. It’s – I have it as 1.97%.
Matthew Clark
Okay. Makes sense. Okay. And it sounded like the expectation is the overall NIM kind of hangs in there in the current range. So I don’t need necessarily a monthly NIM, but if you had the December monthly NIM, I’ll take it.
Heng Chen
Yes. Yes. It’s – it was down slightly from the full quarter NIM. It’s – so the December NIM, that’s a 31-day month. So that was 3.81%.
Matthew Clark
Okay, thank you. Got it. And then just on the overall reserve dipping down a little bit here, 80 basis points. Can you give us a sense for what you considered in terms of macro factors? What’s your overall unemployment rate outlook for this year and how you might be weighing kind of the baseline versus adverse scenarios?
Heng Chen
Yes. Matthew, as I might have mentioned in the past, we use a blended rate for – until the fourth quarter, we were at 30%, 40%, 30% Moody’s rating, where the 30% is the S1, the Moody’s S1, which is the most favorable forecast. The base is their base. And Moody’s, in their December base forecast shows no recession in the next eight quarters. And then the S3, the Moody’s S3 has a decline. Well, that has – that’s basically the modest recession forecast. So, that has three quarters of negative GDP. Maximum decline is 3.6% in Q2 this year and unemployment goes up to 7.8% in Q1 2024 and declined to 7.3% in Q4 2024. So, what we did is we were – since we adopted CECL, we were at this 30%, 40%, 40% – sorry, 30%, 40%, 30%. So, this quarter, we changed that to where the moderate recession is now, 55% of our CECL calculation. And the base is 35%, and the optimistic is 10%. So, we think for 2023, we are expecting 3% to 5% loan growth, primarily single-family residential, which requires very little reserving, about 30 basis points for us. That our provision for 2023 would be basically net charge-offs, plus a modest amount for loan growth.
Matthew Clark
Okay, great. That’s good color. Thank you.
Operator
[Operator Instructions] Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead.
Gary Tenner
Thanks. Good afternoon.
Chang Liu
Hi Gary.
Gary Tenner
A couple of follow-up questions. In terms of the CD specialty running for the Chinese New Year, $600 million of new funds, as you mentioned, Heng. Should we assume that, that is – that you largely pay down the FHLB borrowings that you had as of 12/31?
Heng Chen
Yes. Correct.
Gary Tenner
And then in terms of the NIM, again, I think you said it includes 75 basis points of tightening.
Heng Chen
No. We – I think you said, it might have been poorly worded. But we are assuming 25 basis points on February 1, 25 basis points in mid-March. And we are not sure, there might be something in December in terms of a rate cut, but that would have a very minor impact.
Gary Tenner
Okay. No, that’s fine. I thought I heard you say 75 basis points, so I kind of may have misheard. So, if you combine the ability to pay down FHLB, the benefit of the hikes in the first quarter and the interest recovery, it would seem to suggest that the first quarter is kind of peak NIM and then you maybe stay in that range for the full year but trend lower from there. Is that the way that you would expect the year set up?
Heng Chen
Yes, Gary.
Gary Tenner
Okay. And then I saw you took the loss on sale of securities. Did you reinvest that? And if so, what was the yield pickup and – well, the yield pickup of those – that reinvestment?
Heng Chen
Actually, we had no losses. That was a mark-to-market for equity securities. But we – in the fourth quarter, we had pretty light investing. I think we bought $75 million of corporates. They were in the 5.5% range, callable corporates. And then we bought some MDS, they were in the high-4s.
Gary Tenner
Okay. Thanks for that interpretation. I think I must have misread that in your press release. And then last question I had in terms of capital. And you kind of read through the kind of where capital is at year end, you did buy some stock back, but less than you did in the third quarter. Just thoughts about buyback in 2023. Is there any element of kind of economic uncertainty that might keep you on the sidelines, or would you still be a buyer of your stock in ‘23?
Chang Liu
Yes. We still have about $15 million – $16 million left in our buyback – current buyback authorization. So, we would use that up in the first quarter and then our plan is to get Fed approval – apply for approval for another $125 million. And given the relatively weak loan growth, we might – subject to economic conditions, we might try to use up most of that in 2023.
Gary Tenner
Thank you very much.
Chang Liu
Yes. Thank you.
Operator
Our next question comes from Andrew Terrell with Stephens. Please go ahead.
Andrew Terrell
Hi. Good afternoon.
Chang Liu
Hi.
Andrew Terrell
If I could maybe start on just the expenses, the guidance for 3.5% expense growth in 2023. It feels like that might be a bit light versus kind of over hearing across the industry, just given inflationary impacts. So, I was hoping you could speak to maybe just some of the puts and takes as we think about expenses through 2023 and kind of the progression of the quarterly expense base.
Chang Liu
Andrew, we have gone through already half price significantly more than half of our population during the last October’s review process. So, that’s why you saw some of the core non-interest expense increase in the salary section at the Q4 numbers. And then we have a second round of the officers and higher reviews that will come up in March, and our objective is to hold that number to the 3.5% range.
Andrew Terrell
Understand. Okay. And then maybe if I could go back to the margin, just thinking about the – I know you had the spot rate on the deposit cost at the end of the quarter. Do you happen to have the spot yield on the securities portfolio at the end of the quarter?
Heng Chen
Not on the securities. We have it on the loans, if you wanted. Well, on the securities, I have the December securities, it’s 2.72%.
Andrew Terrell
Okay. That works. And then I think I just want to make sure I heard it correctly. The – so like the new kind of offering rate on CDs is around low kind of 4% territory, 4.2% or so. I guess just thinking about the duration of the CD book, should we expect CD costs to, kind of over the next 12 months or throughout 2023, kind of fully re-priced to that low 4% territory?
Heng Chen
Hopefully not. I mean the – this is the promotional rate program. And part of it is you have to bring – if it’s a $100,000 CD, you have to bring half – at least half of it. It has to be non-Cafe funds. So, outside of a normal promotion environment, I think we will be in the mid-3s for CD renewals for retail depositors. So, for large corporate depositors, we are higher than 4.2%, but that’s the market, and we have been doing that in the fourth quarter.
Andrew Terrell
Okay. Got it. Thank you for taking the questions. I appreciate it.
Heng Chen
Thank you.
Operator
There are no further questions at this time. Thank you for your participation. I will now turn the call back over to Cathay General Bancorp’s management for closing remarks.
Chang Liu
I want to thank everyone for joining us on our call and we look forward to speaking with you at our next quarterly earnings release call.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
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