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Cathay General Bancorp  (NASDAQ:CATY)
Q3 2018 Earnings Conference Call
Oct. 17, 2018, 6:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp's Third Quarter 2018 Earnings Conference Call. My name is Sherry and I'll be your coordinator for today. (Operator Instructions) Today's call is being recorded and will be available for replay at cathaygeneralbancorp.com.

Now I would like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp. Ms. Lo, you may begin.

Georgia Lo -- Investor Relations

Thank you, Sherry and good afternoon. Here to discuss the financial results today are Mr. Pin Tai, our Chief Executive Officer and President; 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, 2017, at Item 1A in particular, and in other reports and filings with the Securities and Exchange Commission from time to time. As such, we caution you not to place undue reliance on such forward-looking statements, which speak only as of the date of this presentation. We undertake no obligation to update any forward-looking statements or to publicly announce any revision of any forward-looking statements to reflect future developments or events, except as required by law.

This afternoon, Cathay General Bancorp issued an earnings release outlining its third quarter 2018 results. To obtain a copy, please visit our website at www.cathaygeneralbancorp.com. After comments by management today, we will open up this call up for questions.

I will now turn the call over to our Chief Executive Officer, Mr. Pin Tai.

Pin Tai -- Chief Executive Officer, President, and Director

Thank you, Georgia, and good afternoon. Welcome to our 2018 third quarter earnings conference call. This afternoon, we reported net income of $69.8 million for the third quarter of 2018, a 40.2%(ph)increase when compared to a net income of $49.7 million for the third quarter of 2017. Diluted earnings per share increased 39.3% to $0.85 per share for the third quarter of 2018 compared to $0.61 per share for the same quarter one year ago.

In the third quarter of 2018, our gross loans grew by $298.9 million to $13.6 billion, or an increase of 9.3% on an annualized basis. The increase in loans for the third quarter of 2018 was primarily driven by the continued strong growth in the residential mortgage loans of $190.2 million(ph)or 24.9% annualized, and commercial loans of $97.4 million or 15.6% annualized. We continue to project loan growth in 2018 to be between 7% to 8%.

For the third quarter of 2018, our total deposits increased $476.5 million or 15% annualized to $13.6 billion, mainly as a result of a summer CD promotion. We continue to monitor and evaluate the trade distance(ph)between the U.S. and China and potential impacts to our loan portfolio.

As of September 30th, 2018 those borrowers which we believe will be adversely impacted by the current tariffs will be less than 2.5% of our total loans. We are in frequent contact with these borrowers and many have indicated that they believe that much of the 10% tariffs will be shared between manufacturers, importers, retailers and customers. Many of these borrowers are also evaluating sourcing some of their products from other countries. Through September 30th, 2018 there have been no non-accruals or charge-offs that were linked to the imposition of the tariff.

With that, I will turn the floor over to our Executive Vice President and Chief Financial Officer, Heng Chen, to discuss the third quarter 2018 financials in more detail.

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Thank you, Pin, and good afternoon everyone. For the third quarter, we announced net income of $69.8 million or $0.85 per share. Our net interest margin was 3.83% in the third quarter 2018 as compared to 3.75% in the third quarter of 2017, and 3.83% for the second quarter of 2018. In the third quarter of 2018, interest recoveries and prepayment penalties added 5 basis points to the net interest margin compared to 4 basis points for the second quarter of 2018 and 16 basis points for the third quarter of 2017. Given the third quarter results, we believe that our net interest margin for the fourth quarter of 2018 will be between 3.8% to 3.85%.

Non-interest income during the third quarter of 2018 decreased by $5.2 million to $7.8 million when compared to the third quarter of 2017. The decrease in the third quarter of 2018 compared to 2017 was primarily due to the $5.4 million gain recognized in the third quarter of 2017 from the acquisition of SinoPac Bancorp, the parent company of Far East National Bank.

Non-interest expense increased by $4.7 million(ph)or 7.7%(ph)to $66 million in the third quarter of 2018 when compared to $61.2 million in the same quarter a year ago. For the third quarter of 2018, the increase in non-interest expense was primarily due to a $2.6 million increase in salaries and employee benefits expense and a $5.4 million increase in amortization expense of investments in low income housing and alternative energy partnerships, partially offset by a $3.1 million decrease in acquisition and integration costs, when compared to the same quarter a year ago.

The effective tax rate for the third quarter of 2018 was 21.1%. We anticipate that our effective tax rate for the fourth quarter of 2018 will be approximately 19.3%. The third quarter effective tax rate reflects a year-to-date adjustment to the new full-year effective tax rate. In the third quarter of 2018, we recognized $5.7 million of amortization expense from solar tax credit investment that was made in the second quarter 2018. We expect solar tax credit amortization of approximately $12 million in the fourth quarter of 2018.

At September 30, 2018, our Tier 1 leverage capital ratio increased to 11.03% as compared to 10.35% at December 31, 2017 while Tier 1 risk-based capital ratio increased to 12.81% from 12.19% at December 31, 2017, and our total risk-based capital ratio increased to 14.6% from 14.11% at December 31, 2017.

Net recoveries for the third quarter of 2018 were $3.1 million compared to net charge-offs of $185,000 in the second quarter of 2018 and net recoveries of $5.7 million in the third quarter of 2017. There was a loan loss reversal of $1.5 million for the third quarter of 2018 compared to no loan loss provision in the second quarter of 2018 and third quarter of 2017.

Our non-accrual loans decreased by $23 million to $42.4 million or 0.31% of period-end loans as compared to the third quarter of 2017.

Pin Tai -- Chief Executive Officer, President, and Director

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

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from Aaron Deer with Sandler O'Neill.

Aaron Deer -- Sandler O'Neill -- Analyst

The growth again this quarter was strong and it seems to be still centered in the residential book. Chris,(ph)what kind of rates are you getting on that new production today? And with rates continuing to drift higher, what's your outlook for the growth in that business as we go forward?

Pin Tai -- Chief Executive Officer, President, and Director

Well the current rate that we are underwriting is about 4.5% to 5% (inaudible) residential mortgage loan is 3.1% or 5.1% adjusted for rate of mortgage. And this -- the current underwriting rate is slightly higher than the (inaudible) of 4.57% in the third quarter.

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yeah, and then Aaron, most of our originations are purchases. So we don't think that higher interest rates will slow that down. There is some seasonality during the holiday season and also Chinese New Year. So it may slow down because of that.

Aaron Deer -- Sandler O'Neill -- Analyst

And then I don't know if you guys are prepared to kind of talk about 2019 at this point, but obviously the growth has been pretty good this year. As you look out to next year, do you have a sense of what kind of growth we should expect?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Well, we haven't finished our planning yet. We suspect it will be similar to this year. But in January we'll certainly have a formal guidance.

Aaron Deer -- Sandler O'Neill -- Analyst

Sure. I guess maybe similarly looking out to 2019, Heng you gave an update in terms of what we should expect for the low income housing credits and tax rate related to that. Have you been talking with your partners in that business yet about investments that you might be making in 2019 and what level we might expect going forward?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yes, we need to get regulatory approval and so we -- it takes some time. But assuming we make another investment, our tax rate should be -- for the year should be close to -- for 2019, 19.5% and the amortization expense will be about $20 million, compared to $17 million this year.

Aaron Deer -- Sandler O'Neill -- Analyst

Okay. Perfect, thanks for taking my questions.

Operator

Our next question comes from Michael Young with SunTrust.

Michael Young -- SunTrust Robinson Humphrey, Inc., Research Division -- Analyst

Just wanted to go back on the deposit side and just wondering if you could provide some color on the summer CD special, and anything else you plan to do maybe around the holiday season this year, just to give us a sense of what your expectation is on rate and data(ph)going forward?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yeah, we were targeting our summer CD promotion actually goes into -- it finishes this week. So we are targeting about $600 million of net new funds and it's -- I think we will wind up laying that path(ph)through September 30, we have about $500 million. And then surprisingly there was a -- the pace of that is still pretty constant even though there was a Fed rate increase in the last week of September, and the broker CD rates moved up by about 25 basis points, but we're still getting the same new volume. And then going to next year, we will do another Chinese New Year promotion. The rates, we haven't set up the rate yet, but it probably will be a little bit higher than the 2.25%(ph)rate that we're offering now.

Michael Young -- SunTrust Robinson Humphrey, Inc., Research Division -- Analyst

Okay. So just kind of taking that all together and I guess with the assumption of continued steady growth on the loan side, would you expect your deposit balance to remain relatively similar to where we're at today moving forward?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

I think so. One of the favorable surprises for the third quarter was that our non-interest-bearing demand deposits on average went up $117 million and some of the -- seasonally the second half of the year is a little stronger for core deposits, so that helps us. And then the other thing is we still -- through today, we still haven't updated our poster rate for money market rates. It's still -- we're following the big banks and as long as the larger banks are sitting tight, we sit tight as well.

Michael Young -- SunTrust Robinson Humphrey, Inc., Research Division -- Analyst

And one last one, just on the recovery pipeline that's been benefiting provision for a while. Just what's the current outlook now and into 2019? Do you think you'll be able to continue to harvest those and keep provision at pretty low levels or near zero?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

We still have the same couple of large potential recoveries in the $10 million to $15 million range. But we can't predict what quarter they'll pop up. So we -- it's just a couple of B notes(ph)and we have to depend on the customer to want to sell the properties. But aside from that because so much of our loan growth is coming from residential mortgage, we think our loan loss provision won't be moderate because once again half of the loan growth is residential mortgage which we only need about 50 basis points in reserve for that.

Operator

Our next question comes from Matthew Clark with Piper Jaffray.

Matthew Timothy Clark -- Piper Jaffray Companies, Research Division -- Analyst

Could you just isolate the low income housing tax credit amortization in the third quarter from the solar? And then you gave the $12 million on solar, but could you also give it on the low income housing for the fourth quarter?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yes. So this might be a little rough, but it's -- the total was $11.1 million and we had $5.6 million in solar. So the rest is what $4. --(ph)it's roughly $5 million?

Pin Tai -- Chief Executive Officer, President, and Director

Yeah.

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

And then in the fourth quarter, the solar -- our guidance from last quarter was $15 million, now it's down to $12 million. And then normally, the low income housing amortization is about $6 million a quarter.

Matthew Timothy Clark -- Piper Jaffray Companies, Research Division -- Analyst

Got it. Okay. Great. And then other fee income looked a little light on a sequential basis, flattish year-over-year, but just wondered if there was anything unusual in there within that that might be seasonal?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Well, there was about $900,000 of a mark-to-market on the value of our swaps. And it's unusually high, so we will think -- we think it will turn around in the fourth quarter. These are the swaps that are hedging our fixed rate loans.

Matthew Timothy Clark -- Piper Jaffray Companies, Research Division -- Analyst

Right. Okay. And then any update on your capital management plans in the fourth quarter and into 2019?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Well, I think last quarter I mentioned that we would in the first quarter call up to $50 million of our troughs. And then we also said that we would buy back our stock when that's below $40(ph)and surprisingly it's here. So we will be back -- we will be in the market next week if the stock price is below that.

And in terms of the amount, we had 930,000 shares that we issued at SinoPac and then over the last two years we had all told about 600,000 shares issued from stock options and the vesting of the restricted stock units. So we historically have bought back low(ph)share issuances. So the total is probably(ph)1.5 million shares then.

Matthew Timothy Clark -- Piper Jaffray Companies, Research Division -- Analyst

Got it. And then just last one, any thoughts around potential cost savings -- cost saving initiatives next year? And also, as a partial offset or any related investments or things you're working on projects?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Well, our healthcare premiums are down by almost $1 million in a VP(ph)contract which we renewed in July is also going to save us well. And then we're thinking of some process improvement in the back room which will dribble in in 2019 that will save us. We don't know how much but it's going to be a reasonable amount. So we're really focused on delivering positive offering(ph)leverage and we know that's a constant effort.

Operator

Thank you. (Operator Instructions) Our next question comes from Chris McGratty with KBW.

Chris McGratty -- KBW -- Analyst

Thanks for the question. In terms of the balance sheet growth, I think 7% to 8% loan growth, how should we be thinking about continued(ph)securities purchases and then kind of managing the size of the investment portfolio from here?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yes, we think that the -- we'll start to ramp up the securities portfolio gradually. It could be that interest rates peak late in 2019 and if that happens we would want to have a larger securities portfolio. But we're also pretty mindful of the NIM. But I think we'll be drifting higher in 2019, mainly with the 15-year MBS.

Chris McGratty -- KBW -- Analyst

And if I could follow up on the prior question on capital, aside from the dividend and share repurchases and organic growth, how are you and the Board thinking of external M&A? Is that something that is a priority? Are there a lot of opportunities in your markets? Any comments there would be great.

Pin Tai -- Chief Executive Officer, President, and Director

We are always looking out for prudential target. (inaudible) as price, but we're continuing watching out. There's no (inaudible) right now.

Operator

Our next question comes from Lana Chan with BMO Capital Markets.

Lana Chan -- BMO Capital Markets -- Analyst

Hi. Good afternoon. Just want to ask about the commercial loan growth. You started to get some good C&I growth over the last quarter or two. Which industry segments are those participations?

Pin Tai -- Chief Executive Officer, President, and Director

Well, you probably (inaudible) last year, so we're seeing some increase in the loan commitment and loan outstanding in the area(ph). And we also see some new commercial C&I loans coming from different specialized industries.

Lana Chan -- BMO Capital Markets -- Analyst

Okay. And then on the --

Pin Tai -- Chief Executive Officer, President, and Director

And this is not from participation, I guess, it's not significantly from participation, sorry.

Lana Chan -- BMO Capital Markets -- Analyst

Okay. And my other question was around CRE. I think you guys had made some commentaries over last two quarters about just more competitive conditions on CRE side. Can you talk about that? And what we should expect in terms of that portfolio because it is a pretty big business in terms of your loan book?

Pin Tai -- Chief Executive Officer, President, and Director

The CRE loan is still very competitive. There is no change from the previous quarter. And given that we understand coming in 2019, 2020 the market might be softening so we are more careful in underwriting the new loans. So that's why we will see a growth in the CRE loan in the last couple of quarters.

Operator

And our final question comes from David Chiaverini with Wedbush Securities.

David Chiaverini -- Wedbush Securities -- Analyst

A question on -- first a clarification on the NIM guidance, the 3.8% to 3.85%, was that for the fourth quarter or for the full-year 2018?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Just for fourth quarter.

David Chiaverini -- Wedbush Securities -- Analyst

Okay. And could you talk about -- and since we're smacked out in the middle of that range at 3.83% for the third quarter, could you talk about what could potentially cause that to go to the upper end of the range and vice versa what could cause it to be at the lower end of the range?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Well, I think what could cause that to go up higher is if we have more prepayment penalties. So we are at 5 basis points right now. And then in terms of what could go lower, well, it's a same factor. And then if -- the risk for banks such as us is if money market deposit rates start to move significantly it only increased by 8 basis points in the Q3 from 68 to 79 -- I am sorry, let's say 11 basis points. So, we are starting to see movement there, but that's always a concern for us, the money market pricing.

David Chiaverini -- Wedbush Securities -- Analyst

That's helpful. And then can you provide what the period-end deposit rate was? I think the average was 1.05% for the quarter. Do you have what it was at September 30th?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

No. We just have it for the month of September handy. We normally don't compute it. So the month of September -- the average rate for interest-bearing liabilities was 1.22% versus it was 1.15% for the quarter.

David Chiaverini -- Wedbush Securities -- Analyst

And do you have a similar number for the loan side -- loan yield?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yes, I mean -- well, for earning assets that's 4.74% versus 4.67%.

David Chiaverini -- Wedbush Securities -- Analyst

Got it. 4.74% was for the month of September?

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Yes, but we would book our push as account accretions only at the end of the quarter, so it's skewed a little bit by that.

Operator

Ladies and gentlemen, thank you for your participation. I would now like to turn the call back over to Cathay General Bancorp's management for any closing remarks.

Pin Tai -- Chief Executive Officer, President, and Director

Thank you for joining us for this call and we look forward to speaking with you in our next quarterly earnings release date.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the presentation. You may all disconnect and have a wonderful day.

Duration: 29 minutes

Call participants:

Georgia Lo -- Investor Relations

Pin Tai -- Chief Executive Officer, President, and Director

Heng W. Chen -- Executive Vice President, Chief Financial Officer, and Treasurer

Aaron Deer -- Sandler O'Neill -- Analyst

Michael Young -- SunTrust Robinson Humphrey, Inc., Research Division -- Analyst

Matthew Timothy Clark -- Piper Jaffray Companies, Research Division -- Analyst

Chris McGratty -- KBW -- Analyst

Lana Chan -- BMO Capital Markets -- Analyst

David Chiaverini -- Wedbush Securities -- Analyst

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