UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

For the transition period from                        to                       

 

Commission file number       0-18630

 

CATHAY BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

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

 

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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). 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, 18,019,830 shares outstanding as of April 23, 2003.

 

 

CATHAY BANCORP, INC. AND SUBSIDIARY

1^ST QUARTER 2003 REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS (Unaudited)
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
	Business
	Recent Announcement
	Basis of Presentation
	Recent Accounting Pronouncements
	Financial Derivatives
	Earnings per Share
	Stock-Based Compensation
	Commitments and Contingencies
Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	Critical Accounting Policies
	Subsequent Events
	Income Statement Review
	Financial Condition Review
	Capital Resources
	Asset Quality Review
	Capital Adequacy Review
	Liquidity
Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	Market Risk
	Financial Derivatives
Item 4.  CONTROLS AND PROCEDURES
PART II - OTHER INFORMATION
Item 1.		LEGAL PROCEEDINGS
Item 2.		CHANGES IN SECURITIES AND USE OF PROCEEDS
Item 3.		DEFAULTS UPON SENIOR SECURITIES
Item 4.		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Item 5.		OTHER INFORMATION
Item 6.		EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
CERTIFICATIONS

 

2

 

PART I – FINANCIAL INFORMATION

 

 

Item 1. FINANCIAL STATEMENTS

(Unaudited)

 

3

 

CATHAY BANCORP, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

 

(In thousands, except share and per share data)			March 31, 2003			December 31, 2002			% change
Assets
Cash and due from banks			$	87,046		$	70,777		23
Federal funds sold and securities purchased under agreements to resell			8,000			19,000			(58	)
Cash and cash equivalents			95,046			89,777			6
Securities available-for-sale (amortized cost of $320,419 in 2003 and $238,740 in 2002)			327,440			248,273			32
Securities held-to-maturity (estimated fair value of  $477,544 in 2003 and $477,782 in 2002)			459,839			459,452			—
Loans			1,955,514			1,877,227			4
Less:	Allowance for loan losses		(25,963		)	(24,543		)	6
	Unamortized deferred loan fees		(4,821		)	(4,606		)	5
	Loans, net		1,924,730			1,848,078			4
Other real estate owned, net			653			653			—
Investments in real estate, net			21,647			21,678			—
Premises and equipment, net			29,463			29,788			(1	)
Customers’ liability on acceptances			10,696			10,608			1
Accrued interest receivable			13,188			14,453			(9	)
Goodwill			6,552			6,552			—
Other assets			23,354			24,686			(5	)
Total assets			$	2,912,608		$	2,753,998		6
Liabilities and Stockholders’ Equity
Deposits
Non-interest-bearing demand deposits			$	321,423		$	302,828		6
Interest-bearing deposits:
NOW deposits			156,474			148,085			6
Money market deposits			180,881			161,580			12
Savings deposits			297,194			290,226			2
Time deposits under $100			434,985			425,138			2
Time deposits of $100 or more			1,025,482			986,786			4
Total deposits			2,416,439			2,314,643			4
Securities sold under agreements to repurchase			125,500			28,500			340
Advances from the Federal Home Loan Bank			50,000			50,000			—
Acceptances outstanding			10,696			10,608			1
Other liabilities			13,264			62,286			(79	)
Total liabilities			2,615,899			2,466,037			6
Stockholders’ Equity
Preferred stock, $0.01 par value; 10,000,000 shares authorized, none issued			—			—			—
Common stock, $0.01 par value, 25,000,000 shares authorized, 18,320,900 issued and 18,000,990 outstanding in 2003 and 18,305,255 issued and 17,999,955 outstanding in 2002			183			183			—
Treasury stock, at cost (319,910 shares in 2003 and 305,300 in 2002)			(8,810		)	(8,287		)	6
Additional paid-in-capital			73,382			70,857			4
Unearned compensation			(1,840		)	—			—
Accumulated other comprehensive income, net			5,290			6,719			(21	)
Retained earnings			228,504			218,489			5
Total stockholders’ equity			296,709			287,961			3
Total liabilities and stockholders’ equity			$	2,912,608		$	2,753,998		6

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

4

 

CATHAY BANCORP, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

		Three months ended March 31,
(In thousands, except share and per share data)		2003			2002
INTEREST INCOME
Interest on loans		$	26,524		$	26,808
Interest on securities available-for-sale		2,987			3,951
Interest on securities held-to-maturity		5,884			5,286
Interest on federal funds sold and securities purchased under agreements to resell		173			210
Interest on deposits with banks		2			11
Total interest income		35,570			36,266
INTEREST EXPENSE
Time deposits of $100 or more		5,200			6,389
Other deposits		2,681			3,561
Other borrowed funds		1,254			733
Total interest expense		9,135			10,683
Net interest income before provision for loan losses		26,435			25,583
Provision for loan losses		1,650			1,500
Net interest income after provision for loan losses		24,785			24,083
NON-INTEREST INCOME
Securities gains (losses)		1,795			(42		)
Letters of credit commissions		498			472
Depository service fees		1,333			1,481
Other operating income		1,577			1,423
Total non-interest income		5,203			3,334
NON-INTEREST EXPENSE
Salaries and employee benefits		6,643			6,165
Occupancy expense		981			931
Computer and equipment expense		820			804
Professional services expense		997			1,090
FDIC and State assessments		130			124
Marketing expense		389			333
Other real estate owned expense (income)		46			(190		)
Operations of investments in real estate		525			616
Other operating expense		803			779
Total non-interest expense		11,334			10,652
Income before income tax expense		18,654			16,765
Income tax expense		6,120			5,377
Net income		12,534			11,388
Other comprehensive loss, net of tax:
Unrealized holding losses arising during the period		(292		)	(2,334		)
Unrealized gains (losses) on cash flow hedge derivatives		27			(66		)
Less:  reclassification adjustments included in net income		1,164			194
Total other comprehensive loss, net of tax		(1,429		)	(2,594		)
Total comprehensive income		$	11,105		$	8,794
Net income per common share:
Basic		$	0.70		$	0.63
Diluted		$	0.69		$	0.63
Cash dividends paid per common share		$	0.140		$	0.125
Basic average common shares outstanding		18,003,791			17,968,562
Diluted average common shares outstanding		18,117,001			18,044,876

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

5

 

CATHAY BANCORP, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		For the three months ended March 31,
(In thousands)		2003			2002
Cash Flows from Operating Activities
Net income		$	12,534		$	11,388
Adjustments to reconcile net income to net cash (used) provided by operating activities:
Provision for loan losses		1,650			1,500
Depreciation		416			387
Gain on sale of other real estate owned		—			(173		)
Gain on sale of loans		(140		)	(83		)
Gain on sale and call of investment securities		(1,897		)	(1		)
Write-downs on venture capital investment		102			43
Amortization of investment securities premiums, net		511			210
Amortization of intangibles		47			51
Stock-based compensation expense		97			—
Tax benefit from stock options		(41		)	10
Increase (decrease) in deferred loan fees, net		216			(52		)
Decrease in accrued interest receivable		1,265			1,154
Decrease (increase) in other assets, net		2,409			(532		)
Decrease in other liabilities		(49,022		)	(6,209		)
Total adjustments		(44,387		)	(3,695		)
Net cash (used) provided by operating activities		(31,853		)	7,693
Cash Flows from Investing Activities
Purchase of investment securities available-for-sale		(131,192		)	(92,211		)
Proceeds from maturity and call of investment securities available-for-sale		32,385			27,000
Proceeds from sale of investment securities available-for-sale		18,014			—
Proceeds from repayment of mortgage-backed securities available-for-sale		933			1,836
Purchase of investment securities held-to-maturity		(2,847		)	(1,463		)
Proceeds from maturity and call of investment securities held-to-maturity		10,921			11,260
Purchase of mortgage-backed securities held-to-maturity		(34,645		)	(9,225		)
Proceeds from repayment of mortgage-backed securities held-to-maturity		25,649			16,727
Proceeds from sale of loans		3,042			2,187
Net increase in loans		(81,420		)	(16,799		)
Purchase of premises and equipment		(91		)	(705		)
Proceeds from sale of other real estate owned		—			654
Net decrease (increase) in investments in real estate		31			(4,258		)
Net cash used in investing activities		(159,220		)	(64,997		)
Cash Flows from Financing Activities
Net increase in demand deposits, NOW deposits, money market and savings deposits		53,253			19,995
Net increase in time deposits		48,543			14,604
Net increase in securities sold under agreements to repurchase		97,000			8,782
Increase in advances from Federal Home Loan Bank		—			20,000
Cash dividends		(2,519		)	(2,244		)
Proceeds from shares issued to the Dividend Reinvestment Plan		588			437
Proceeds from exercise of stock options		—			34
Purchase of treasury stock		(523		)	—
Net cash provided by financing activities		196,342			61,608
Increase in cash and cash equivalents		5,269			4,304
Cash and cash equivalents, beginning of the period		89,777			86,514
Cash and cash equivalents, end of the period		$	95,046		$	90,818
Supplemental disclosure of cash flows information
Cash paid during the period:
Interest		$	9,365		$	11,282
Income taxes		$	21,558		$	16,773
Non-cash investing activities:
Transfer to investment securities available-for-sale within 90 days of maturity		$	125		$	273
Net change in unrealized holding gain on securities available-for-sale, net of tax		$	(1,456	)	$	(2,528	)
Net change in unrealized gains on cash flow hedge derivatives, net of tax		$	27		$	(66	)
Transfers to other real estate owned		$	—		$	156

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

6

 

CATHAY BANCORP, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Business

 

Cathay Bancorp, Inc. (the “Bancorp”) is the one-bank holding company for Cathay Bank (the “Bank” and together the “Company” or “we”, “us,” or “our”).  The Bank was founded in 1962 and offers a wide range of financial services.  The Bank now operates twelve branches in Southern California, eight branches in Northern California, three branches in New York State, one branch in Houston, Texas, and a representative office in Hong Kong, and in Shanghai, China.  In addition, the Bank’s subsidiary, Cathay Investment Company, maintains an office in Taiwan.  The Bank is a commercial bank, servicing primarily individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located.

 

Recent Announcement

 

On May 7, 2003, the Bancorp announced the signing of a merger agreement whereby GBC Bancorp (“GBC”) will merge into the Bancorp, the name of which will be changed to Cathay General Bancorp.  Simultaneously, General Bank, a wholly-owned subsidiary of GBC, will merge into the Bank.  If the transaction is completed, the Bancorp will pay cash of $162.4 million and will issue 6.75 million shares of its common stock for all the outstanding shares of GBC.  The number of the Bancorp shares is subject to increase or decrease at the option of a party under certain limited circumstances.  The allocation of the cash and stock consideration will be dependent, among other factors, on the elections made by GBC shareholders.

 

Completion of the merger, which has been approved by the boards of directors of both the Bancorp and GBC, is subject to certain conditions, including approval by the shareholders of both the Bancorp and GBC and applicable regulatory authorities.  The transaction is expected to close during the fourth quarter 2003.

 

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 (“GAAP”) 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 GAAP 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 ending December 31, 2003.  Certain reclassifications have been made to the prior year’s financial statements to conform to the March 31, 2003 presentation.  For further information, refer to the audited consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2002.

 

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.

 

7

 

Recent Accounting Pronouncements

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” an amendment of FASB Statement No. 123.  This Statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation.  In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements.  The Company adopted SFAS No. 148 prospectively on January 1, 2003.  See “Stock-Based Compensation,” in these Notes to Condensed Consolidated Financial Statements.

 

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34.”  This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued.  The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken.  The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002, and did not have a material effect on the Company’s financial statements.  The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002.  See “Commitments and Contingencies,” in these Notes to Condensed Consolidated Financial Statements.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51.  This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation.  The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003.  For public enterprises, such as the Company, with a variable interest in a variable interest entity created before February 1, 2003, the Interpretation applies no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003.  The application of this Interpretation is not expected to have a material effect on the Company’s financial statements.  The Interpretation requires certain disclosures in financial statements issued after January 31, 2003, if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.

 

As of March 31, 2003, the Company owned interests in two limited partnerships, for which it is reasonably possible that the limited partnerships may be construed to be variable interest entities subject to consolidation under Interpretation No. 46.  Both of these investments were formed for the purpose of investing in low-income housing projects, which qualify for federal low-income housing tax credits and/or California tax credits, and at March 31, 2003, the carrying amount of those investments in real estate was $4.84 million.  As of March 31, 2003, the Company had fully satisfied all capital commitments required under these two investments in real estate, and in addition, under the terms of both limited partnership agreements, the Company is not liable for the debts, liabilities, contracts, or any other obligation of these limited partnerships. Application of Interpretation No. 46 for the Company will be the third quarter of 2003.  The Company has not completed its analysis to determine the impact to the Company in adopting the application of Interpretation No. 46.  However, the Company expects that the adoption will not have a material impact on the Company’s results of operations or financial position.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. In particular, this Statement clarifies under what circumstances a

 

8

 

contract with an initial net investment meets the characteristic of a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows.  This Statement is generally effective for contracts entered into or modified after June 30, 2003, and is not expected to have a material impact on the Company’s financial statements.

 

Financial Derivatives

 

The Company enters into financial derivatives in order to seek mitigation of exposure to interest rate risks related to its interest-earning assets and interest-bearing liabilities. 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.

 

On March 21, 2000, the Company hedged a portion of its floating interest rate loans through an interest rate swap agreement with a $20.00 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 March 31, 2003 was less than eight quarters.  Amounts to be paid or received on the interest rate swap are reclassified into earnings upon the receipt of interest payments on the underlying hedged loans, including amounts totaling $292,000 that were reclassified into earnings during the three months ended March 31, 2003.  The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to be reclassified into earnings within the next 12 months is approximately $1.17 million.

 

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 and resulted in the issuance of common stock that then shared in earnings.

 

For the three months ended March 31, 2003, options to purchase an additional 179,167 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive effect.  All options to purchase shares of common stock at March 31, 2002, were included in the computation of diluted earnings per share.

 

The following table sets forth basic and diluted earnings per share calculations:

 

		Three months ended March 31,
(Dollars in thousands, except share and per share data)		2003			2002
Net income		$	12,534		$	11,388
Weighted-average shares:
Basic weighted-average number of common shares outstanding		18,003,791			17,968,562
Dilutive effect of weighted-average outstanding common shares equivalents		113,210			76,314
Diluted weighted-average number of common shares outstanding		18,117,001			18,044,876
Earnings per share:
Basic		$	0.70		$	0.63
Diluted		$	0.69		$	0.63

 

Stock-Based Compensation

 

Prior to 2003, the Company used the intrinsic-value method to account for stock-based compensation.  Accordingly, no expense was recorded in periods prior to 2003.  In 2003, the Company adopted prospectively the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock-Based Compensation,” as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of

 

9

 

FASB Statement No. 123,” and began recognizing the expense associated with stock options granted during 2003 using the fair value method, which resulted in a $97,000 charge to salaries and employee benefits.  Stock-based compensation expense for stock options is calculated based on the fair value of the award at the grant date, and is recognized as an expense over the vesting period of the grant.  The Company uses the Black-Scholes option pricing model to estimate the value of granted options.  This model takes into account the option exercise price, the expected life, the current price of the underlying stock, the expected volatility of the Company’s stock, expected dividends on the stock and a risk-free interest rate.  Since compensation cost is measured at the grant date, the only variable whose change would impact expected compensation expense recognized in future periods for 2003 grants is actual forfeitures.

 

If the compensation cost for the Company’s stock option plan had been determined with the fair value at the grant dates, for all awards under the Plan consistent with the method of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and earnings per share for the first quarter of 2003 and 2002 would have been reduced to the pro forma amounts indicated in the table below.

 

 

Commitments and Contingencies

 

In the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers.  These financial instruments include commitments to extend credit in the form of loans, or through commercial or standby letters of credit and financial guarantees.  Those instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying condensed consolidated statements of condition.  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.  Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.

 

(In thousands)		At March 31, 2003			At December 31, 2002
Commitments to extend credit		$	660,000		$	725,000
Standby letters of credit		16,000			15,000
Other letters of credit		29,000			37,000
Bill of lading guarantee		11,000			11,000
Total		$	716,000		$	788,000

 

Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the commitment agreement.  These commitments generally have fixed expiration dates and are expected to expire without being drawn upon.  The total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer’s

 

10

 

creditworthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the borrowers.

 

The Company’s exposure to credit risk from financial guarantees is essentially the same as if the Company was the owner of the corporation debt.  At March 31, 2003, and at December 31, 2002, the Company had no outstanding financial guarantees.

 

Letters of credit and bill of lading guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in making loans to customers.

 

11

 

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, 2002, of Cathay Bancorp, Inc. (“Bancorp”) and its wholly-owned subsidiary Cathay Bank (the “Bank” and together the “Company” or “we”, “us,” or “our”).

 

The statements in this report include 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,” “may,” “will,” “should,” “could,” “predicts,” “potential,” “continue” or similar expressions.  Forward-looking statements in this report include, but are not limited to, those regarding the proposed merger with GBC Bancorp, such as statements about the approvals and timing of the merger.  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:

 

•                  our expansion into new market areas;

•                  fluctuations in interest rates;

•                  demographic changes;

•                  increases in competition;

•                  deterioration in asset or credit quality;

•                  changes in the availability of capital;

•                  adverse regulatory developments;

•                  changes in business strategy or development plans, including the deregistration of the registered investment company, which became effective in March 2003, and the formation of a real estate investment trust, for which we received regulatory approval in February 2003;

•                  general economic or business conditions; and

•                  other factors discussed in Part II – Item 7 – “Factors that May Affect Future Results,” in our Annual Report on Form 10-K for the year ended December 31, 2002.

 

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

 

We invite you to visit us at our Web site at www.cathaybank.com, to access free of charge our annual report on Form 10-K, our quarterly reports on Form 10-Q, and our quarterly earnings releases.  In addition, you can write us to obtain a free copy of any of those reports at Cathay Bancorp, Inc., 777 North Broadway, Los Angeles, California 90012, Attn: Investor Relations.

 

12

 

Critical Accounting Policies

 

The discussion and analysis of our financial condition and results of operations are based upon our 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 has 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 “Allowance for Loan Losses.”

 

FIRST QUARTER HIGHLIGHTS:

•                  An increase of 10.06% in 1^st quarter 2003 net income to $12.53 million compared with $11.39 million during the same quarter a year ago.

•                  Strong total asset growth of $158.61 million or 5.76% to $2.91 billion at March 31, 2003, from year-end 2002 of $2.75 billion.

•                  Strong gross loan growth of $78.29 million or 4.17%, primarily in commercial mortgage loans and commercial loans.

•                  Strong deposit accounts growth of 4.40% or $101.80 million, of which $46.29 million was in transaction and money market accounts.

•                  Reflecting our emphasis on credit quality and credit management, non-performing assets (“NPAs”) to gross loans plus other real estate owned decreased by 10.26% to 0.35% at quarter-end, and decreased 57.83% from the same quarter in 2002.

•                  Net charge offs of $230,000 or 0.05% of average net loans compared with net charge-offs of $1.44 million or 0.36% of average net loans in the quarter of a year ago.

•                  Return on average stockholders’ equity (“ROE”) was 17.43% and return on average assets (“ROA”) was 1.79% for the quarter ended March 31, 2003.

•                  On February 20, 2003, the American Banker newspaper ranked Cathay Bancorp as the 8^th most efficient US bank holding company among the 500 largest, which is the highest among California institutions included in the rankings, based on year-to-date results as of the 3^rd quarter 2002.  Previously, the Company had been ranked 9^th by the American Banker newspaper, based on first quarter results for 2002.

 

Subsequent Event

 

On May 7, 2003, the Bancorp announced the signing of a merger agreement whereby GBC Bancorp ("GBC") will merge into the Bancorp, the name of which will be changed to Cathay General Bancorp. Simultaneously, General Bank, a wholly-owned subsidiary of GBC, will merge into the Bank. If the transaction is completed, the Bancorp will pay cash of $162.4 million and will issue 6.75 million shares of its common stock for all the outstanding shares of GBC. The number of the Bancorp shares is subject to increase or decrease at the option of a party under certain limited circumstances. The allocation of the cash and stock consideration will be dependent, among other factors, on the elections made by GBC shareholders.

 

Completion of the merger, which has been approved by the boards of directors of both the Bancorp and GBC, is subject to certain conditions, including approval by the shareholders of both the Bancorp and GBC and applicable regulatory authorities. The transaction is expected to close during the fourth quarter 2003.

 

Income Statement Review

 

Net Income

 

Net income for the first quarter of 2003 was $12.53 million or $0.69 per diluted share, a 10.06% increase in net income compared with net income of $11.39 million or $0.63 per diluted share for the same quarter a year ago.  Return on average stockholders’ equity was 17.43% and return on average assets was 1.79% for the first quarter of 2003 compared with a return on average stockholders’ equity of 18.45% and a return on average assets of 1.85% for the three months ended March 31, 2002.

 

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FINANCIAL PERFORMANCE

 

		1st Quarter 2003			1st Quarter 2002
(In thousands, except per share data)
Net income		$	12,534		$	11,388
Basic earnings per share		$	0.70		$	0.63
Diluted earnings per share		$	0.69		$	0.63
Return on average assets		1.79		%	1.85		%
Return on average stockholders’ equity		17.43		%	18.45		%
Efficiency ratio		35.82		%	36.84		%
Total average assets		$	2,844,276		$	2,501,688
Total average stockholders equity		$	291,608		$	250,365

 

Taxable-Equivalent Net Interest Income Before Provision for Loan Losses

 

Changes in net interest income and margin result from the interaction among 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 increased by $851,000 to $26.98 million compared to taxable-equivalent net interest income of $26.13 million in the year ago quarter.  The level of net interest income for the first three months of 2003 reflected the positive effect of the growth in average commercial mortgage loans and commercial loans, and the growth in lower-cost core deposits accounts (defined as total deposits less time deposit accounts of $100,000 or more), which helped mitigate the 50 basis point decrease in the target federal funds rate on November 7, 2002, by the Federal Open Market Committee (“FOMC”).  Sequentially, quarter-over-quarter, our net interest income decreased because of the aforementioned interest rate decrease by the FOMC, when compared with taxable-equivalent net interest income of $27.43 million during the fourth quarter 2002.

 

The taxable-equivalent net interest margin fell 43 basis points from 4.52% during the first quarter of 2002 to 4.09% for the 1^st quarter 2003.  The decrease of 43 basis points to the taxable-equivalent net interest margin during the past twelve months was primarily due to the following two factors: (1) approximately 28 basis points were due to the decreasing interest rate environment throughout 2002, including the 50 basis point drop in the federal funds rate in November of last year, and the related lagging effect to our interest-bearing time deposit accounts, and (2) during the first quarter 2002, the taxable-equivalent net interest margin included the recapture of interest income on three non-accrual loans totaling $861,000, or a contribution of approximately 15 basis points to our net interest margin.  In an effort to mitigate margin contraction due to our asset sensitive balance sheet, for the quarter ended March 31, 2003, we increased our net average interest-earning assets (defined as the difference between average interest-earning assets and average deposits and borrowings), by $54.49 million from the quarter ended March 31, 2002, and have changed the mix in our average interest-bearing liabilities by increasing our average lower-cost core deposits by $151.82 million or 69.61% of the $218.09 million growth in average deposits compared to 2002.  The taxable-equivalent interest rate earned on our average interest-earning assets was 5.48% and our cost of funds on average deposits and other borrowed funds equaled 1.49% during the first quarter 2003.  The comparable numbers for the first quarter of 2002 were a taxable-equivalent rate earned on our average interest-earning assets of 6.37% and a cost of funds on average deposits and other borrowings of 1.95%.

 

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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 were as follows:

 

Three months ended March 31,		2003								2002
Taxable-equivalent basis (Dollars in thousands)		Average Balances			Interest Income/ Expense			Average Yields/ Rates		Average Balances			Interest Income/ Expense			Average Yields/ Rates
Interest-earning assets
Federal funds sold and securities purchased
under agreements to resell		$	57,622		$	173		1.22	%	$	48,978		$	210		1.74	%
Securities available-for-sale		257,346			3,070			4.84		276,614			4,062			5.96
Securities held-to-maturity		471,492			6,349			5.46		377,391			5,724			6.15
Loans receivable, net		1,887,691			26,524			5.70		1,639,506			26,808			6.63
Deposits with banks		830			2			0.98		1,162			11			3.84
Total interest-earning assets		$	2,674,981		$	36,118		5.48	%	$	2,343,651		$	36,815		6.37	%
Interest-bearing liabilities
Interest-bearing checking deposits		$	337,922		$	459		0.55	%	$	272,187		$	440		0.66	%
Savings deposit		290,233			213			0.30		255,942			344			0.55
Time deposits		1,430,745			7,209			2.04		1,349,463			9,166			2.75
Total interest-bearing deposits		2,058,900			7,881			1.55		1,877,592			9,950			2.15
Other borrowed funds		139,589			1,254			3.64		80,838			733			3.68
Total interest-bearing liabilities		2,198,489			9,135			1.69		1,958,430			10,683			2.21
Non-interest-bearing demand deposits		295,042			—			—		258,262			—			—
Total deposits and other borrowed funds		$	2,493,531		$	9,135		1.49	%	$	2,216,692		$	10,683		1.95	%
Interest rate spread								3.99	%							4.42	%
Net interest income/margin					$	26,983		4.09	%				$	26,132		4.52	%

 

Provision for Loan Losses

 

We increased the provision for loan losses by $150,000 to $1.65 million during the first quarter of 2003 compared with $1.50 million for the first quarter of 2002.  The provision for loan losses represents the charge against current earnings that is determined by management, through a credit review process, as the amount needed to maintain an allowance that management believes is sufficient to absorb loan losses inherent in the Company’s loan portfolio.  Gross charge-offs for the first quarter of 2003 were $283,000, compared with charge-offs of $1.55 million during the first quarter of 2002.  Recoveries in the first quarter of 2003 equaled $53,000, compared with recoveries of $111,000 in the same quarter a year ago.  Also see “Allowance for Loan Losses” on this 1^st Quarter 2003 report on Form 10-Q.

 

Non-Interest Income

 

Non-interest income, which includes revenues from service charges on deposit accounts, letters of credit commissions, securities sales, loan sales, wire transfer fees, and other sources of fee income, rose $1.87 million or 56.06% to $5.20 million for the first quarter 2003, compared with $3.33 million for the same quarter in 2002.

 

To improve credit quality of our investment portfolio in these uncertain times, we sold corporate securities from the available-for-sale portfolio, totaling $16.13 million, and reinvested the proceeds into government agencies, resulting in gains totaling $1.89 million.  Offsetting these gains, during the first quarter 2003, investment securities calls and write-downs on venture capital investments resulted in a net loss of $92,000, bringing the net securities gains to $1.80 million for the first quarter 2003.  Depository service fees decreased by 9.99% to $1.33 million during the first quarter 2003 compared

 

15

 

with $1.48 million in the year ago quarter.  The decrease in depository service fees was due primarily to lower fees earned from wire transfer services due to more stringent requirements placed by the Bank before initiating wire transfers for non-customers of the Bank.  This decrease from wire transfer fees was partially offset by increases in other operating income, primarily on safe deposit fees and gains on sales of SBA loans.

 

Non-Interest Expense

 

Non-interest expense increased $682,000 to $11.33 million in the first quarter of 2003, compared to $10.65 million in the year ago quarter, primarily as a result of an increase of $478,000 in salaries and employee benefits expenses, reflecting primarily annual salary adjustments, and the salary expense to accommodate our new branches in Brooklyn, New York, which opened for business in June 2002, Sacramento, California, which opened for business in September 2002, and our new representative office in Shanghai, China, which opened for business in April 2002.  In addition, in the first quarter of 2003, we adopted prospectively the fair value recognition provisions of Statement No. 123, “Accounting for Stock-Based Compensation,” as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123,” which resulted in a $97,000 charge to salaries and employee benefits expense.

 

Income Taxes

 

The provision for income taxes was $6.12 million or an effective income tax rate of 32.81% for the first quarter 2003 compared with $5.38 million or an effective income tax rate of 32.07% in the year ago quarter.  The effective income tax rate during the first quarter of 2003 reflected tax credits from qualified low-income housing investments and the income tax benefit of a newly formed real estate investment trust (“REIT”), which received regulatory approval in February 2003.  The effective income tax benefit during the first quarter of 2002 reflected tax credits from qualified low-income housing investments and the income tax benefit of a registered investment company subsidiary of the Bank, which was deregistered in March 2003.

 

Financial Condition Review

 

Assets

 

Total assets increased by $158.61 million to $2.91 billion at March 31, 2003, up 5.76% from year-end 2002 of $2.75 billion.  The increase in total assets was driven primarily by strong growth in commercial mortgage loans and commercial loans totaling $102.08 million and an increase of $79.55 million in investment securities.  Cash and cash equivalents increased by $5.27 million from December 31, 2002.

 

Securities

 

Total securities were $787.28 million and represented 27.03% of total assets at March 31, 2003 compared with $707.73 million or 25.70% of total assets at December 31, 2002.  The increase was primarily due to purchases of U.S. agencies and collateralized mortgage obligations (“CMOs”) during the first quarter 2003.

 

Securities available-for-sale represented 9.62% of average interest-earning assets for the quarter ended March 31, 2003, compared with 11.38% for fourth quarter 2002.  The decrease in average securities available-for-sale (“AFS”) was the result of AFS securities called in the early part of the quarter, which was offset with purchases of AFS securities in the later part of the quarter.  The fair value of securities available-for-sale (“AFS”) at March 31, 2003 was $327.44 million compared to $248.27 million at December 31, 2002.  The net increase of $79.17 million in AFS securities for the three months ended

 

16

 

March 31, 2003, represented purchases of U.S. government agency securities, less securities called and sold during the quarter.  During the first quarter of 2003, the Bank sold AFS corporate bonds securities with a net book value of $16.13 million.  These AFS securities sales resulted in gains of $1.89 million, exclusive of gains on calls of AFS securities of $3,000, and $102,000 in write-downs on AFS venture capital investments.

 

The net unrealized gain on securities available-for-sale, which represented the difference between fair value and amortized cost, decreased to $7.02 million compared from a net unrealized gain of $9.53 million at year-end 2002.  Net unrealized gains and losses in the securities available-for-sale are included in accumulated other comprehensive income or loss, net of tax.

 

Securities held-to-maturity (“HTM”) represented 17.63% of average interest-earning assets for the first three months of 2003 compared with 14.99% for fourth quarter 2002.  The increase represented primarily purchases of HTM collateralized mortgage obligations securities and to a lesser degree HTM municipal bonds, partially offset by calls and maturities of HTM securities, which resulted in gains on calls of HTM securities totaling $7,000.

 

The average taxable-equivalent yield on investment securities decreased 83 basis points to 5.24% for the quarter ended March 31, 2003, compared with 6.07% during the same quarter a year-ago, as some matured or called securities were replaced at lower prevailing interest rates.

 

The following tables summarize the composition, amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale, as of March 31, 2003 and December 31, 2002:

 

		March 31, 2003
(In thousands)		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
US government agencies		$	261,086		$	7,747		$	328		$	268,505
State and municipal securities		125			1			—			126
Mortgage-backed securities		4,950			357			—			5,307
Collateralized mortgage obligations		697			36			—			733
Asset-backed securities		9,998			442			—			10,440
Corporate bonds		14,618			657			—			15,275
Equity securities		28,945			—			1,891			27,054
Total		$	320,419		$	9,240		$	2,219		$	327,440

 

		December 31, 2002
(In thousands)		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
US government agencies		$	162,287		$	7,896		$	—		$	170,183
State and municipal securities		100			—			—			100
Mortgage-backed securities		5,767			380			—			6,147
Collateralized mortgage obligations		808			39			—			847
Asset-backed securities		9,997			513			—			10,510
Corporate bonds		30,755			2,314			—			33,069
Equity securities		29,026			—			1,609			27,417
Total		$	238,740		$	11,142		$	1,609		$	248,273

 

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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 March 31, 2003 and December 31, 2002:

 

		March 31, 2003
(In thousands)		Carrying Value			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
US government agencies		$	39,996		$	1,748		$	—		$	41,744
State and municipal securities		74,575			4,835			7			79,403
Mortgage-backed securities		55,456			2,979			—			58,435
Collateralized mortgage obligations		187,420			2,401			997			188,824
Asset-backed securities		9,999			364			—			10,363
Corporate bonds		72,500			4,946			148			77,298
Other securities		19,893			1,584			—			21,477
Total		$	459,839		$	18,857		$	1,152		$	477,544

 

		December 31, 2002
(In thousands)		Carrying Value			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
US government agencies		$	49,996		$	2,032		$	—		$	52,028
State and municipal securities		72,770			5,392			6			78,156
Mortgage-backed securities		66,135			3,231			—			69,366
Collateralized mortgage obligations		168,055			1,664			60			169,659
Asset-backed securities		9,999			349			—			10,348
Corporate bonds		72,611			4,471			253			76,829
Other securities		19,886			1,510			—			21,396
Total		$	459,452		$	18,649		$	319		$	477,782

 

The following table summarizes the scheduled maturities by security type of securities available-for-sale as of March 31, 2003:

 

		As of March 31, 2003
(In thousands)		One Year or Less			After One Year to Five Years			After Five Years to Ten Years			Over Ten Years			Total
US government agencies		$	—		$	182,842		$	85,663		$	—		$	268,505
State and municipal securities		126			—			—			—			126
Mortgage-backed securities		58			—			871			4,378			5,307
Collateralized mortgage obligations		—			733			—			—			733
Asset-backed securities		—			10,440			—			—			10,440
Corporate bonds		10,051			5,224			—			—			15,275
Equity securities		27,054			—			—			—			27,054
Total		$	37,289		$	199,239		$	86,534		$	4,378		$	327,440

 

The following table summarizes the scheduled maturities by security type of securities held-to-maturity as of March 31, 2003:

 

		As of March 31, 2003
(In thousands)		One Year or Less			After One Year to Five Years			After Five Years to Ten Years			Over Ten Years			Total
US government agencies		$	—		$	39,996		$	—		$	—		$	39,996
State and municipal securities		600			13,607			28,100			32,268			74,575
Mortgage-backed securities		—			4,735			33,043			17,678			55,456
Collateralized mortgage obligations		—			2,888			46,452			138,080			187,420
Asset-backed securities		—			9,999			—			—			9,999
Corporate bonds		18,991			32,550			20,959			—			72,500
Other securities		—			9,988			9,905			—			19,893
Total		$	19,591		$	113,763		$	138,459		$	188,026		$	459,839

 

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Loans

 

Gross loans at March 31, 2003 were $1.96 billion compared with gross loans at year-end 2002 of $1.88 billion.  Gross loan growth during the first quarter equaled $78.29 million, an increase of 4.17% from year-end 2002, reflecting primarily increases in commercial mortgage loans and commercial loans.

 

Commercial mortgage loans increased $72.41 million or 7.68% to $1.02 billion at March 31, 2003, compared to $943.39 million at year-end 2002.  Commercial mortgage loans are typically secured by first deeds of trust on commercial properties, including primarily commercial retail properties, shopping centers and owner-occupied industrial facilities, and secondarily office buildings, multiple-unit apartments, and multi-tenanted industrial properties.  Although the portfolio of commercial mortgage loans increased, there continues to be no concentrations, and the portfolio consists primarily of shopping centers, commercial office buildings, warehouses, apartment structures.  At March 31, 2003, this portfolio represented approximately 51.95% of the Bank’s gross loans compared to 50.25% at year-end 2002.

 

Commercial loans were up $29.67 million or 5.26% to $593.34 million at March 31, 2003, compared to $563.68 at December 31, 2002.  Total commercial loans accounted for 30.34% of gross loans at March 31, 2003, compared to 30.03% at year-end 2002.  The majority of the growth was in the asset-based loans category of commercial loans, with international commercial loans increasing slightly due to the sluggish world economy.  The Company is continuing to focus primarily on commercial lending to small-to-medium size businesses within the Company’s geographic market area.

 

The increases in commercial mortgage loans and commercial loans were partially offset by a decrease in construction loans totaling $21.09 million during the quarter and sales of SBA loans.  During the first quarter 2003, the Bank sold $2.83 million of SBA loans, resulting in a gain on sale of loans of $140,000.

 

The following table sets forth the classification of loans by type, mix, and percentage change as of the dates indicated:

 

(Dollars in thousands)		March 31, 2003			% of Total		December 31, 2002			% of Total		% Change
Loans
Commercial loans		$	593,341		31	%	$	563,675		30	%	5
Residential mortgage loans		232,986			12		231,371			13		1
Commercial mortgage loans		1,015,804			53		943,391			51		8
Real estate construction loans		101,680			5		122,773			7		(17	)
Installment loans		11,244			1		15,570			1		(28	)
Other loans		459			—		447			—		3
Gross loans		1,955,514			102		1,877,227			102		4
Allowance for loan losses		(25,963		)	(2	)	(24,543		)	(2	)	6
Unamortized deferred loan fees		(4,821		)	—		(4,606		)	—		5
Net loans		$	1,924,730		100	%	$	1,848,078		100	%	4

 

Other Real Estate Owned

 

Other real estate owned at March 31, 2003, of $653,000, net of a valuation allowance of $131,000, remained unchanged from December 31, 2002, and consisted of  two outstanding other real estate owned properties, which included one parcel of land and one commercial building.

 

To reduce the carrying value of other real estate owned to the estimated fair value of the properties, we maintain a valuation allowance for other real estate owned 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

 

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in the current period.  Management did not make any provision for other real estate owned losses during the first three months of 2003.

 

Investments in Real Estate

 

As of March 31, 2003, our investments in real estate were comprised of seven limited partnerships, three of which were acquired in 2002.  We acquired an interest in the WNC Institutional Tax Credit Fund X New York — Series 3 in August 2002, with an additional contribution of $355,000 in January 2003.  We also acquired an interest in the WNC Institutional Tax Credit California Fund X — Series 2 in September 2002, with an additional contribution of $139,000 in January 2003.  The limited partnerships are formed for the purpose of investing in low income housing projects, which qualify for federal and/or state low income housing tax credits.

 

As of March 31, 2003, investments in real estate decreased $31,000 to $21.65 million from $21.68 million at year-end 2002.  During 2003, we recognized $525,000 in net operating losses from the limited partnerships, and contributed $494,000.

 

The following table summarizes the composition of our investments in real estate as of the dates indicated:

 

		Percentage of Ownership		Acquisition Date		Carrying Amount
(Dollars in thousands)						March 31, 2003			December 31, 2002
Las Brisas		49.5	%	December 1993		$	—		$	—
Los Robles		99.0	%	August 1995		375			386
California Corporate Tax Credit Fund III		32.5	%	March 1999		10,842			11,128
Wilshire Courtyard		99.9	%	May 1999		4,463			4,568
Lend Lease ITC XXIII		4.5	%	March 2002		4,476			4,546
WNC Institutional Tax Credit Fund X New York — Series 3		4.2	%	August 2002		854			529
WNC Institutional Tax Credit Fund X California — Series 2		6.0	%	September 2002		637			521
						$	21,647		$	21,678

 

Deposits

 

The increase in total assets from year-end 2002 was funded primarily by deposit growth of $101.80 million or 4.40%, to $2.42 billion.  Lower-cost core deposits (defined as total deposits less time deposit accounts of $100,000 or more) comprised $63.10 million or 61.99% of the total growth in deposits, while the remaining growth of $38.70 million or 38.01% resulted from an increase in time deposits of $100,000 or more.  Non-interest-bearing checking accounts, interest-bearing checking accounts, and savings accounts comprised 39.56% of total deposits at March 31, 2003, time deposit accounts of less than $100,000 comprised 18.00% of total deposits, while the remaining 42.44% was comprised of time deposit accounts of $100,000 or more.  At March 31, 2002, time deposits accounts of $100,000 or more, comprised 43.53% of total deposits.  This relative decrease in time deposit accounts of $100,000 or more reflects our efforts to grow more valuable core deposit accounts, while higher-cost time deposit accounts of $100,000 or more are not as emphasized.

 

20

 

The following tables display the deposit mix as of the dates indicated:

 

(Dollars in thousands)		March 31, 2003			% of Total		December 31, 2002			% of Total		% Change
Deposits
Non-interest-bearing demand deposits		$	321,423		13	%	$	302,828		13	%	6
Interest-bearing checking deposits		337,355			14		309,665			13		9
Savings deposits		297,194			12		290,226			13		2
Time deposits		1,460,467			61		1,411,924			61		3
Total deposits		$	2,416,439		100	%	$	2,314,643		100	%	4

 

As interest rate spreads widened between Jumbo CDs and other types of interest-bearing deposits under the prevailing interest rate environment, our Jumbo CD portfolio continued to grow.  Management believes our Jumbo CDs are generally less volatile primarily due to the following reasons:

 

•                  approximately 68.48% of the Bank’s total Jumbo CDs have stayed with the Bank for more than two years;

•                  the Jumbo CD portfolio continued to be diversified with 4,684 accounts averaging approximately $192,000 per account owned by 3,266 individual depositors as of January 14, 2003; and

•                  this phenomenon of having a relatively higher percentage of Jumbo CDs to total deposits exists in most of the Asian American banks in our California market due to the fact that the customers in this market tend to have a higher savings rate.

 

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 CDs, management has continued to make efforts in the following areas:

 

•                  to offer only retail interest rates on Jumbo CDs;

•                  to offer new transaction-based products, such as the tiered money market deposits;

•                  to promote transaction-based products from time to time, such as demand deposits; and

•                  to seek to diversify the customer base by branch expansion and/or acquisition as opportunities arise.

 

Borrowings

 

Our borrowings took the form of advances from the Federal Home Loan Bank of San Francisco (“FHLB”) and reverse repurchase agreements.  Total borrowings increased by $97.00 million to $175.50 million at March 31, 2003, compared with $78.50 million at year-end 2002.  The increase in borrowings were in short-term and long-term reverse repurchase agreements, with the majority of the funds being used for the purchase of investment securities.

 

Other Liabilities

 

Other liabilities decreased by $49.02 million at March 31, 2003.  The decrease was due primarily to a liability that was established for investments securities purchased in December 2002 that settled in January 2003.

 

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Capital Resources

 

Stockholders’ equity of $296.71 million at March 31, 2003, increased by $8.75 million, or 3.04%, compared to $287.96 million at December 31, 2002.  Stockholders’ equity equaled 10.19% of total assets at March 31, 2003.  The increase of $8.75 million in stockholders’ equity was due to the following:

 

•                  an addition of $12.53 million from net income, less dividends paid on common stock of $2.52 million;

•                  an increase of $588,000 from issuance of additional common shares through the Dividend Reinvestment Plan;

•                  a decrease of $1.43 million in accumulated other comprehensive income, as a result of:

•                  a decrease of $292,000 in the net unrealized holding gains on securities available-for-sale, net of tax;

•                  an increase of $27,000 from unrealized gains on cash flow hedging derivatives, net of tax;

•                  a decrease of $1.16 million in reclassifications adjustments included in net income.

•                  a decrease of $523,000 from stock repurchases.  Pursuant to the Company’s stock repurchase program, the Company repurchased a total of 14,610 shares of common stock during the first quarter 2003 at an average price of $35.77 per share.  In April 2001, the Board of Directors approved a stock repurchase program of up to $15 million of our common stock.  Cumulatively through March 31, 2003, the Company has repurchased 319,910 shares of our common stock for $8.81 million.

 

We declared cash dividends of 14 cents per common share in January 2003 on 17,999,955 shares outstanding, and on April 2003 on 18,000,990 shares outstanding.  Total cash dividends paid in 2003, including the $2.52 million paid in April, amounted to $5.04 million.

 

Under the Equity Incentive Plan adopted by the Board of Directors in 1998, we granted options to purchase 215,000 shares of common stock with an exercise price of $39.85 per share to eligible officers and directors on January 16, 2003.

 

Asset Quality Review

 

Non-performing Assets

 

Non-performing assets (“NPAs”) to gross loans plus other real estate owned continue to improve and declined to 0.35% at March 31, 2003, from 0.39% at December 31, 2002, and from 0.83% at March 31, 2002.  Total NPAs decreased to $6.83 million at March 31, 2003, compared with $7.25 million at December 31, 2002, and $13.92 million at March 31, 2002.  NPAs include accruing loans past due 90 days or more, non-accrual loans, and other real estate owned.

 

Non-performing loans decreased to $6.17 million at March 31, 2003, compared with year-end 2002 of $6.59 million, and $12.69 million at March 31, 2002.  The decrease in NPAs compared with December 31, 2002, resulted in large part from non-performing loans that paid off during the quarter.  On April 11, 2003, one non-accrual commercial mortgage loan in the amount of $2.03 million was paid off.

 

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The following table sets forth the breakdown of non-performing assets by categories as of the dates indicated:

 

 

(1)     Excludes $1.07 million of non-performing TDR loans, which is included with non-accrual loans.  Performing troubled debt restructuring loans are accruing interest at their restructured terms.

 

Non-accrual Loans

 

Non-accrual loans of $5.45 million at March 31, 2003, consisted mainly of $2.67 million in real estate loans and $2.78 million in commercial loans.  On April 11, 2003, one non-accrual commercial mortgage loan in the amount of $2.03 million was paid off.  The following table presents non-accrual loans by type of collateral securing the loans, as of the dates indicated:

 

		March 31, 2003									December 31, 2002
(In thousands)		Real Estate (1)			Commercial			Other			Real Estate (1)			Commercial			Other
Type of Collateral
Single/multi-family residence		$	510		$	153		$	—		$	386		$	117		$	—
Commercial real estate		2,156			1,809			—			132			1,099			—
Land		—			404			—			1,658			425			—
UCC		—			192			—			—			278			—
Other		—			129			6			—			—			17
Unsecured		—			91			1			—			9			3
Total		$	2,666		$	2,778		$	7		$	2,176		$	1,928		$	20

 

(1)  Real Estate includes commercial mortgage loans, real estate construction loans, and residential mortgage loans.

 

The following table presents non-accrual loans by type of businesses the borrowers are engaged in, as of the dates indicated:

 

		March 31, 2003									December 31, 2002
(In thousands)		Real Estate (1)			Commercial			Other			Real Estate (1)			Commercial			Other
Type of Business
Real estate development		$	2,027		$	99		$	—		$	1,658		$	96		$	—
Wholesale/Retail		—			1,446			—			—			1,557			—
Food/Restaurant		—			54			—			—			13			—
Import		—			139			—			—			127			—
Other		639			1,040			7			518			135			20
Total		$	2,666		$	2,778		$	7		$	2,176		$	1,928		$	20

 

(1)  Real Estate includes commercial mortgage loans, real estate construction loans, and residential mortgage loans.

 

Troubled Debt Restructurings

 

A troubled debt restructuring (“TDR”) 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, or extension of the maturity date.

 

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At March 31, 2003, troubled debt restructurings totaling $5.26 million were relatively unchanged from December 31, 2002.  All troubled debt restructurings at March 31, 2003, were performing under their revised terms.

 

Impaired Loans

 

A 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 evaluate all classified and restructured loans for 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 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 $19.06 million at March 31, 2003, compared with $19.59 million at year-end 2002.  Impaired commercial loans had a recorded investment of $8.98 million, an increase of $5.10 million from year-end 2002, primarily due to the inclusion of three commercial loans totaling $5.33 million, one of which is also included with non-accrual loans at March 31, 2003.  Impaired real estate loans decreased by $5.64 million to $10.07 million during the quarter compared with $15.71 million at year-end 2002.  During the first quarter 2003, two loans with a recorded investment of $7.61 million at December 31, 2002, were paid-off.  The decrease to impaired real estate loans was partially offset by the addition of one non-accrual commercial mortgage loan with a recorded investment of $2.03 million added during the first quarter.  This loan was paid off in April 2003.

 

The following tables present a breakdown of impaired loans and the related allowances as of the dates indicated:

 

 

(1)  Real Estate includes commercial mortgage loans, real estate construction loans, and residential mortgage loans.

 

Loan Concentration

 

There were no loan concentrations to multiple borrowers in similar activities which exceeded 10% of total loans as of March 31, 2003.

 

Allowance for Loan Losses

 

The Bank’s management is committed to managing the risk in its loan portfolio by maintaining the allowance for loan losses at a level that is considered to be equal to the estimated and known risks in the loan portfolio.  With a risk management objective, the Bank’s management has an established monitoring system that is designed to identify impaired and potential problem loans and permit periodic evaluation of impairment and the adequacy level of the allowance for loan losses in a timely

 

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manner.  The nature of the process by which the Bank determines the appropriate allowance for loan losses requires the exercise of considerable judgment.  The allowance for loan losses is increased by charges to the provision for loan losses.  Identified credit exposures that are determined to be uncollectible are charged against the allowance for loan losses.  Recoveries of previously charged off amounts, if any, are credited to the allowance for loan losses.

 

The allowance for loan losses amounted to $25.96 million at March 31, 2003, and represented the amount needed to maintain an allowance that we believe should be sufficient to absorb loan losses inherent in the Company’s loan portfolio.  The allowance for loan losses represented 1.33% of period-end gross loans and 420.66% of non-performing loans at March 31, 2003.  The comparable ratios were 1.31% of year-end 2002 gross loans and 372.31% of non-performing loans at December 31, 2002.  Total charge-offs decreased by $1.27 million to $283,000 in the first quarter 2003 compared with charge-offs of $1.55 million in the same quarter a year ago.  Commercial loan charge-offs totaled $143,000 during the first quarter of 2003 compared to commercial loan charge-offs of $1.55 million in the year-ago quarter.  In addition, during the first quarter 2003, we partially charged-off $135,000 on one non-accrual construction loan with a recorded investment of $1.66 million that was paid off during the first quarter 2003.

 

The following table sets forth information relating to the allowance for loan losses for the periods indicated:

 

(Dollars in thousands)		For the quarter ended March 31, 2003			For the year ended December 31, 2002
Balance at beginning of period		$	24,543		$	23,973
Provision for loan losses		1,650			6,000
Loans charged –off		(283		)	(5,976		)
Recoveries of loans charged off		53			546
Balance at end of period		$	25,963		$	24,543
Average net loans outstanding during the period		$	1,887,691		$	1,724,796
Ratio of net charge-offs to average net loans outstanding during the period (annualized)		0.05		%	0.31		%
Provision for loan losses to average net loans outstanding during the period (annualized)		0.35		%	0.35		%
Allowance to non-performing loans, at period-end		420.66		%	372.31		%
Allowance to gross loans, at period-end		1.33		%	1.31		%

 

Our allowance for loan losses consists of the following:

 

1.               Specific allowance: For impaired loans, we provide specific allowances based on an evaluation of impairment, and for each criticized loan, we allocate a portion of the general allowance to each loan based on a loss percentage assigned.  The percentage assigned depends on a number of factors including loan classification, the current financial condition of the borrowers and guarantors, the prevailing value of the underlying collateral, charge-off history, management’s knowledge of the portfolio and general economic conditions.

 

2.               General allowance: The unclassified portfolio is segmented on a group basis.  Segmentation is determined by loan type and by identifying risk characteristics that are common to the groups of loans.  The allowance is provided to each segmented group based on the group’s historical loan loss experience, trends in delinquencies and non-accrual loans, and other significant factors, such as national and local economy, trends and conditions, strength of management and loan staff, underwriting standards and the concentration of credit.

 

To determine the adequacy of the allowance in each of these two components, the Bank employs two primary methodologies, the classification process and the individual loan review analysis methodology.

 

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These methodologies support the basis for determining allocations between the various loan categories and the overall adequacy of the Bank’s allowance to provide for probable loss in the loan portfolio.

 

With these above methodologies, the specific allowance is for those loans internally classified and risk graded as Special Mention, Substandard, Doubtful, or Loss.  Additionally, the Bank’s management allocates a specific allowance for “Impaired Credits,” in accordance with SFAS No. 114 “Accounting by Creditors for Impairment of a Loan.”  The level of the general allowance is established to provide coverage for management’s estimate of the credit risk in the loan portfolio by various loan segments not covered by the specific allowance.

 

Total commercial loans grew from $563.68 million at year-end 2002 to $593.34 million on March 31, 2003, with the largest portion of this growth occurring within the asset-based loans category of commercial loans.  Within the total commercial loans, international commercial loans increased slightly during the first quarter 2003.  This slight increase in international commercial loans was primarily the result of sluggish U.S. and international economies.  While as a group, the various commercial loan segments grew steadily during 2002, with the exception of the first quarter of 2002, the continued sluggish economy slowed the growth from the $21.68 million pace during the third quarter 2002 to $11.39 million during the fourth quarter 2002, but showed renewed growth during the first quarter 2003 by achieving a net growth of $29.67 million.  The growth in commercial loans during the first quarter 2003 was primarily from corporate commercial and asset-based loans, exclusive of the growth in SBA loans.  Delinquencies over 29 days in this segment trended downward during 2002 and ended the year at $9.44 million before trending upward to $15.88 million at March 31, 2003, as the growth in commercial loans turned upward.  Allocated allowances were $11.06 million as of March 31, 2003, an increase of $2.00 million or 22.12% from the year-end 2002 allocation of $9.06 million.  A management decision for a larger increase in the short-run was somewhat offset by the recent downward trend in loan losses experienced by the Bank in this segment.

 

The portfolio of residential mortgage loans, including home equity lines of credit, decreased to $231.37 million at December 31, 2002, from $235.91 million at year-end 2001.  At the end of the first quarter 2003, these mortgages rose slightly to $232.99 million, primarily from rate-sensitive borrowers, as low interest rates continued to prevail throughout most of 2002 into 2003.  While delinquencies over 29 days had been trending downward for most of 2002, from the $1.65 million at December 31, 2001, a surge in delinquencies during the fourth quarter 2002 boosted the total delinquencies to $2.42 million at year-end 2002 before easing back to $1.95 million at the end of the first quarter 2003.  Rising unemployment in a sluggish early-stage economic recovery during the fourth quarter of 2002 caused the $2.42 million delinquencies at year-end 2002 compared to a low point of $880,000 at the end of the third quarter of 2002.  First quarter 2003 delinquencies decreased to $1.95 million in spite of the continued rise in unemployment as borrowers moderate their spending patterns.  Even though actual charge-offs have not occurred in this segment over the last year into the first quarter of 2003, management has nevertheless determined that it is prudent to maintain an allowance in this loan category at a minimum risk rate.  This is in view of the current origination volume and the rise in loss potential associated with increases in unemployment during a sluggish recovery in the economy.

 

Commercial mortgage loans grew 27.77% or $205.01 million during 2002 while the allowance allocation increased $756,000 or 9.82% to a level of $8.46 million from the $7.70 million level in 2001.  This loan segment growth continued into 2003 with 7.68% growth during the first quarter 2003.  Simultaneously, the allowance allocation was increased by 11.54% to $8.25 million at March 31, 2003.  Most of the growth in this loan segment took place during the third and fourth quarters of 2002 and the first quarter of 2003, as rate-sensitive borrowers utilized the rate decrease by the FOMC in November

 

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of 2002 to refinance high variable-interest rate loans from an earlier refinancing period to low fixed rates.  Although the portfolio of commercial mortgage loans increased, there continues to be no concentrations, and the portfolio consists primarily of shopping centers, commercial office buildings, warehouses, hotels, and apartment structures. At March 31, 2003, the commercial mortgage loan portfolio represented 51.95% of the Bank’s gross loans.  Delinquencies over 29 days in this loan segment vacillated from a high of $11.19 million to a low of $3.33 million in 2002, with an average delinquent amount of $7.26 million, then decreased to $1.78 million at the end of the first quarter 2003.  Total delinquency in this segment climbed to $9.73 million in the fourth quarter 2002, but 8.87% below the year-end total of $10.68 million for 2001.  Within this delinquency aggregate, 90+ day delinquent accounts fell from $2.83 million at March 31, 2002, to zero at March 31, 2003, a substantial decrease, while non-accrual loans also decreased from $374,000 at year-end 2001 to $254,000 at year-end 2002 to $129,000 at March 31, 2003.  Loan losses have been nominal during the last ten quarters despite the variance in delinquencies.  However, management has concluded that the borrower’s future debt service capability during 2003 will depend to some degree on the direction of the economy, which, thus far, has been only a gradual recovery from the recent recession.  Because of the increased volume in this loan segment coupled with a sluggish recovery and an uncertain degree of impact on the real estate variables (such as appreciation, rate sensitivity, debt service capability, and long-term profitability) that drive these types of loans, management is maintaining the present allowance in this segment at a minimum risk factor allocation rate until a clear positive direction of the economy can be determined.

 

Unlike commercial mortgage loans, the outstanding construction loans have continued to decrease over 2002.  As of the fourth quarter 2002, the balance of this segment was $122.77 million compared to $166.42 million at the end of year 2001.  This downward trend of construction loans has carried over into 2003, ending the first quarter at $101.68 million.  While the smaller residential construction projects remain relatively strong lending candidates, the larger nonresidential new volume has substantially decreased along with large pay offs, resulting in a net decrease in the construction loan segment in 2002 and in the first quarter of 2003.  Delinquencies over 29 days in this segment correspondingly decreased from $11.49 million at year-end 2001 to $3.97 million by the fourth quarter 2002 and further declined to $2.03 million in the first quarter of 2003.  This reduction in the construction loan delinquency is the result of lower volume and the resolution of two out of four major delinquent loans.  A portion or $163,000 of one remaining loan was charged-off in the fourth quarter 2002, as it was deemed uncollectible, thereby causing the non-accrual loans to also move upward from the year-end 2002 level of $1.66 million to $2.03 million on March 31, 2003.  However, even though the loan volume and delinquencies have decreased, the allocated allowance remained approximately $2.2 million for the last two consecutive quarters of 2002.  While the allocated allowance is down from the first quarter of 2002, the Bank believes it to be prudent to hold the present level of allocation based on the inherent risk in this loan segment: this loan segment is subject to the longer-term, higher risk nature of construction projects that have the potential of exceeding the projected interest reserves.  Thus far, management has not observed borrowers encountering above-normal difficulty in obtaining permanent takeout financing, sizable concentrations of commercial office building loans, or an increased number of extensions to borrowers for completion of construction.  Management has surmised therefore that the risk allocation for the construction portfolio should be viewed from a longer economic view and has temporarily deferred a decrease in the minimum risk allocation factor to compensate for a current weak leasing market for office buildings in Southern and Northern California.  This segment represents a smaller portion of the portfolio and the allowance allocation has been maintained until there is a clearer direction of the economy.

 

Allocated allowances for installment and consumer loans have been gradually declining as the total loan volume in this segment has declined from $20.32 million at December 31, 2001 to $15.57 million

 

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as of December 31, 2002, and further declined to $11.24 million at March 31, 2003.  The Bank has not actively competed for this type of loan, but has simply provided such loans, when necessary, strictly on an accommodation basis to Bank customers.  Delinquencies over 29 days moved downward nominally from $122,000 at year-end 2001 to $22,000 at year-end  2002, and down to $20,000 by the end of the first quarter 2003.  Delinquent loans over 90 days were zero during the past two quarters.  Loans on non-accrual were nominal throughout 2003, 2002, and 2001.  Similarly, loans charged-off have also been nominal with the decreasing loan volume.  Management has therefore correspondingly continued to decrease the allocated allowance with the decrease in loan volume from $197,000 at December 31, 2001 to the present level of $64,000 on March 31, 2003.  The rationale for decreasing the allowance in this segment is based upon the assumption that the Bank will continue its accommodation policy and not actively seek these types of consumer loans, and hence the volume is expected to remain under the $15 million level.  In view of this lending approach by the Bank, the present allowance is decreased to a perceived minimum risk rate as of March 31, 2003.

 

Allowances for other risks of potential loan losses equaled $2.17 million as of March 31, 2003, compared to $2.06 million at December 31, 2002.  The components of the other risks that have a potential of affecting the Bank’s portfolio are comprised of two basic elements.  First, the Bank has set aside funds to cover the risk factors of a recessionary state of a national economy and the uncertain economic forecast in the short-run.  Thus far, the government’s efforts to stimulate the economy through various monetary policies such as tax cuts and aggressively lowering interest rates over the last two years have only resulted in the early stage of a sluggishly uncertain recovery as evidenced by eroding consumer confidence and demand for non-durables, and the lack of business investment.  The September 11^th event, subsequent corporate scandals in various large companies, and the war in Iraq have only clouded the economic outlook instead of giving clear visibility to the direction of the economy.  It appears clear at this juncture, that without the business investment based upon consumer demand for non-durables, it is questionable whether the economy is capable of moving to the late stage of recovery.  The economy could experience a second downturn and companies will not be able to avoid further substantial short falls in sales and earnings, business closures and downsizing, which will result in increased risk to the Bank’s portfolio.  The second component of other portfolio risk is the potential errors in loan classification and review methodologies. Based on these two above components of other risks, management has increased the allocation of the allowance.

 

After the review of all relevant factors affecting collectibility of the various loan segments, management believes that the allowance for credit losses is appropriate given its comprehensive analysis of the current first quarter of 2003 and the year ended December 31, 2002.

 

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Capital Adequacy Review

 

Management seeks to maintain the Company’s capital at a level sufficient to support future growth, protect depositors and stockholders, and comply with various regulatory requirements.

 

Both the Bancorp’s and the Bank’s regulatory capital continued to well exceed the regulatory minimum requirements as of March 31, 2003.  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 Bancorp’s capital and leverage ratios as of March 31, 2003 and December 31, 2002:

 

 

The following table presents the Bank’s capital and leverage ratios as of March 31, 2003 and December 31, 2002:

 

 

(1) Excluding accumulated other comprehensive income of $5,290,000 and intangibles of $8,635,000.

 

(2) Excluding accumulated other comprehensive income of $6,719,000 and intangibles of $8,682,000.

 

(3) Average assets represent average balances for the first quarter of 2003 and the fourth quarter of 2002.

 

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Liquidity

 

Liquidity is our ability to maintain sufficient cash flow to meet maturing financial obligations and customer credit needs, and to take advantage of investment opportunities as they are presented in the marketplace.  Our 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”).  At March 31, 2003, our liquidity ratio (defined as net cash, short-term and marketable securities to net deposits and short-term liabilities) increased to 33.24% compared to 29.14% at year-end 2002.

 

To supplement its liquidity needs, the Bank maintains a total credit line of $52.50 million for federal funds with three correspondent banks, and master agreements with seven brokerage firms whereby up to $380.00 million would be available through the sale of securities subject to repurchase.  The Bank is also a shareholder of the FHLB, which enables the Bank to have access to lower cost FHLB financing when necessary.  At March 31, 2003, the Bank had a total approved credit line with the FHLB of San Francisco totaling $687.85 million, of which $599.34 million was approved credit for terms over five years.  The total credit outstanding with the FHLB of San Francisco at March 31, 2003, was $50.00 million.  These advances are non-callable and bear fixed interest rates, with $10.00 million maturing in 2003, $20.00 million maturing in 2004, and $20.00 million maturing in 2005.  These borrowings are secured by residential mortgages.

 

Liquidity can also be provided through the sale of liquid assets, which consist of federal funds sold, securities sold under agreements to repurchase and securities available-for-sale. At March 31, 2003, such assets at fair value totaled $335.44 million, with $116.10 million pledged as collateral for borrowings and other commitments. The remaining $219.34 million was available as additional liquidity, of which $211.34 was AFS securities available to be pledged as collateral for additional borrowings.

 

We had a significant portion of our time deposits maturing within one year or less as of March 31, 2003.  Management anticipates that there may be some outflow of these deposits upon maturity due to the keen competition in the Bank’s marketplace.  However, based on our historical runoff experience, we expect that 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.

 

The Bancorp obtains funding for its activities primarily through dividend income contributed by the Bank, and proceeds from the Dividend Reinvestment Plan and the exercise of stock options.  Dividends paid to the Bancorp by the Bank are subject to regulatory limitations.  The business activities of the Bancorp consist primarily of the operation of the Bank with limited activities in other investments.  Management believes the Bancorp’s liquidity generated from its prevailing sources is sufficient to meet its operational needs.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market Risk

 

Market risk is the risk of loss from adverse changes in market prices and rates.  The principal market risk to the Company 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 rate, 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 its interest rate exposure.  Due to the limitation 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 time frame.  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 maturity or repricing and rate sensitivity of our interest-earning assets and interest-bearing liabilities as of March 31, 2003.  Our exposure, as reflected in the table, represents the estimated difference between the amount of interest-earning assets and interest-bearing liabilities repricing during future periods based on certain assumptions.  The interest rate sensitivity of our assets and liabilities presented in the table may vary if different assumptions were used or if actual experience differs from the assumptions used.  As reflected in the table below, we were asset sensitive at March 31, 2003, with a gap ratio of a positive 27.06% within three months and a positive cumulative gap ratio of 3.93% within one year, compared with a positive gap ratio of 28.99 % within three months and a positive cumulative gap ratio of 4.40% within one year at year-end 2002.

 

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		March 31, 2003 Interest Rate Sensitivity Period
(Dollars in thousands)		Within 3 Months			Over 3 Months to 1 Year			Over 1 Year to 5 Years			Over 5 Years			Non-interest Sensitive			Total
Interest-earning Assets:
Cash and due from banks		$	470		$	—		$	—		$	—		$	86,576		$	87,046
Federal funds sold		8,000															8,000
Securities available-for-sale (1)		37,231			58			199,239			90,912			—			327,440
Securities held-to-maturity		—			19,591			113,764			326,484			—			459,839
Loans receivable, gross (2)		1,508,718			50,639			77,687			313,019			—			1,950,063
Non-interest-earning assets, net		—			—			—			—			80,220			80,220
Total assets		$	1,554,419		$	70,288		$	390,690		$	730,415		$	166,796		$	2,912,608
Interest-bearing Liabilities:
Deposits
Demand deposits		$	—		$	—		$	—		$	—		$	321,423		$	321,423
Money market and NOW deposits (3)		14,180			50,125			138,339			134,711			—			337,355
Savings deposit (3)		11,932			63,854			144,176			77,232			297,194
TCDs under $100		226,107			182,475			26,324			79			—			434,985
TCDs $100 and over		490,910			389,149			145,423			—			—			1,025,482
Total deposits		743,129			685,603			454,262			212,022			321,423			2,416,439
Securities sold under agreements to repurchase and other short-term borrowings		23,000			28,500			74,000			—			—			125,500
Advances from FHLB		—			30,000			20,000			—			—			50,000
Non-interest-bearing other liabilities		—			—			—			—			23,960			23,960
Stockholders’ equity		—			—			—			—			296,709			296,709
Total liabilities and stockholders’ equity		$	766,129		$	744,103		$	548,262		$	212,022		$	642,092		$	2,912,608
Interest sensitivity gap		$	788,290		$	(673,815	)	$	(157,572	)	$	518,393		$	(475,296	)	—
Cumulative interest sensitivity gap		$	788,290		$	114,475		$	(43,097	)	$	475,296		—			—
Gap ratio (% of total assets)		27.06		%	(23.13		%)	(5.41		%)	17.80		%	(16.32		)%	—
Cumulative gap ratio		27.06		%	3.93		%	(1.48%		)	16.32		%	—			—

 

Since interest rate sensitivity analysis does not measure the timing differences in the repricing of assets and liabilities, we use a net interest income simulation model to measure the extent of the differences in the behavior of the lending and funding rates to changing interest rates, so as to project future earnings or market values under alternative interest rate scenarios.  Interest rate risk arises primarily through the Company’s traditional business activities of extending loans and accepting deposits.  Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the spread between interest earned on assets and interest paid on liabilities.  The net interest income simulation model is designed to measure 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.  The Company monitors its interest rate sensitivity and attempts to reduce the risk of a significant decrease in net interest income caused by a change in interest rates.

 

The impact of interest rate changes to our net interest income is measured using a net interest income simulation model.  The various products in our balance sheet are modeled to simulate their interest income and expense, and cash flow behavior in relation to immediate and sustained changes in interest rates.  Interest income and interest expense for the next 12 months are calculated for current interest

 

(1)          Includes $3.96 million of venture capital investments and $23.10 million of variable-rate agency preferred stock in the “Within three months” column.  All other available-for-sale debt securities are fixed-rate and are allocated based on their contractual maturity date.

(2)          Excludes allowance for loan losses of $25.96 million, unamortized deferred loan fees of $4.82 million and $5.45 million of non-accrual loans, which are included in non-interest-earning assets.  Adjustable-rate loans are included in the “within three months” column, as they are subject to interest adjustments depending upon the terms on the loans.

(3)          The Company’s own historical experience and decay factors are used to estimate the money market, NOW, and savings deposit runoff.

 

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rates and for immediate and sustained rate shocks.  The net interest income simulation model includes various assumptions regarding the repricing relationships for each product.  Many of our assets are floating rate loans, which are assumed to reprice immediately and to the same extent as the change in the forecasted market rates according to their contracted index.  Our non-term deposit products reprice more slowly, usually changing less than the change in market rates and at our discretion.  Our term deposits reprice based on their contractual maturity.  This net interest income modeling analysis indicates the impact of change in net interest income for a given set of rate changes.  In addition, the model assumes that the balance sheet does not grow and remains similar to the structure at the beginning of the simulation period.  As such, the model does not account for all the factors that could impact a change to interest rates, including changes by management to mitigate the impact of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change.  Furthermore, loan and investment spread relationships change regularly, whereas the model spread relationships are kept constant.  Interest rate changes create changes in actual loan and investment prepayment rates that will differ from the market estimates incorporated in the analysis.  In addition, the proportion of adjustable-rate loans in our portfolio could decrease or increase in future periods if market interest rates remain at or decrease or increase from current levels.  The repricing of certain categories of assets and liabilities are subject to competitive and other pressures beyond the Company’s control.  As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes.  As a result of the above constraints, actual results will differ from simulated results.

 

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 net interest rate simulation projects that our tolerance level will be met or exceeded, we seek corrective action after considering, among other things, market conditions, customer reaction, and the estimated impact on profitability.  At March 31, 2003, if interest rates were to increase instantaneously by 100 basis points, the simulation indicated that our net interest income over the next twelve months would increase by 6.58%, and if interest rates were to increase instantaneously by 200 basis points, the simulation indicated that our net interest income over the next twelve months would increase by 12.62%.  Conversely, if interest rates were to decrease instantaneously by 100 basis points, the simulation indicated that our net interest income over the next twelve months would decrease by 8.34%, and if interest rates were to decrease instantaneously by 200 basis points, the simulation indicated that our net interest income over the next twelve months would decrease by 18.64%.

 

The Company’s simulation model also projects the net economic value of our portfolio of assets and liabilities. We have established a tolerance level to value the net economic value of our portfolio of assets and liabilities in our policy to a change of plus or minus 30% when the hypothetical rate change is plus or minus 200 basis points. At March 31, 2003, if interest rates were to increase instantaneously by 200 basis points, the simulation indicated that the net economic value of our portfolio of assets and liabilities would decrease by 16.27%, and conversely, if interest rates were to decrease instantaneously by 200 basis points, the simulation indicated that the net economic value of our assets and liabilities would increase by 10.29%.

 

Financial Derivatives

 

It is the policy of the Company not to speculate on the future direction of interest rates. However, the Company enters into financial derivatives in order to seek mitigation of exposure to interest rate risks 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

 

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Company’s assets or liabilities and against risk in specific transactions. In such instances, the Company 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.

 

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.

 

On March 21, 2000, we entered into an interest rate swap agreement with a major financial institution in the notional amount of $20.00 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 March 31, 2003, was approximately eight quarters.  At March 31, 2003, the fair value of the interest rate swap, excluding accrued interest, was $2.13 million, or $1.22 million net of tax compared to $2.27 million, or $1.19 million net of tax, at December 31, 2002.  For the three months ended March 31, 2003, net amounts totaling $292,000 were reclassified into earnings.  The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to reclassify into earnings within the next 12 months is approximately $1.17 million.

 

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ITEM 4.  CONTROLS AND PROCEDURES

 

The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-14(c) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) within 90 days of the filing date of this Quarterly Report on Form 10-Q.  Based upon their evaluation, the principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation.

 

PART II - OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

The Bancorp’s wholly-owned subsidiary, Cathay Bank, has been a party to ordinary routine litigation from time to time incidental to various aspects of its operations.

 

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.

 

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

 

Not applicable.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

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ITEM 5.  OTHER INFORMATION

 

Not applicable.

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

Exhibits:

 

Exhibit 99.1                               CEO CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

Exhibit 99.2                          CFO CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

Reports on Form 8-K:

 

None

 

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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.

 

 

	Cathay Bancorp, Inc.
	(Registrant)
Date:  May 15, 2003	By /s/ DUNSON K. CHENG
	Dunson K. Cheng
	Chairman and President
Date:  May 15, 2003	By /s/ ANTHONY M. TANG
	Anthony M. Tang
	Chief Financial Officer

 

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CERTIFICATIONS

 

I, Dunson K. Cheng, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Cathay Bancorp, Inc.;

 

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date:  May 15, 2003	By /s/ DUNSON K. CHENG
	Dunson K. Cheng
	Chairman and President

 

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I, Anthony M. Tang, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Cathay Bancorp, Inc.;

 

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date:  May 15, 2003	By /s/ ANTHONY M. TANG
	Anthony M. Tang
	Chief Financial Officer

 

39