Back to GetFilings.com



 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

 

 

 

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the quarterly period ended  June 30, 2003

 

 

 

 

OR

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the transition period from                    to                    

 

 

 

 

Commission file number 0-18630

 

CATHAY BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4274680

(State of other jurisdiction of incorporation
or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

777 North Broadway, Los Angeles, California

 

90012

(Address of principal executive offices)

 

(Zip Code)

 

 

 

Registrant’s telephone number, including area code: (213) 625-4700

 

 

 

 

 

 

(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, 18,036,196 shares outstanding as of August 8, 2003.

 

 



 

CATHAY BANCORP, INC. AND SUBSIDIARIES

2NDQUARTER 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

 

 

 

Investment Securities

 

 

 

Trust Preferred Securities

 

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

 

Critical Accounting Policies

 

 

 

Proposed Merger with GBC

 

 

 

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.

 

2



 

PART I – FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

(Unaudited)

 

3



 

CATHAY BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

 

(In thousands, except share and per share data)

 

June 30, 2003

 

December 31, 2002

 

% change

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Cash and due from banks

 

$

63,522

 

$

70,777

 

(10.25

)%

Federal funds sold and securities purchased under agreements to resell

 

14,000

 

19,000

 

(26.32

)

Cash and cash equivalents

 

77,522

 

89,777

 

(13.65

)

Securities available-for-sale (amortized cost of $890,347 in 2003 and $238,740 in 2002)

 

909,557

 

248,273

 

266.35

 

Securities held-to-maturity (estimated fair value of $477,782 in 2002)

 

 

459,452

 

(100.00

)

Loans

 

1,954,286

 

1,877,227

 

4.10

 

Less:  Allowance for loan losses

 

(27,672

)

(24,543

)

12.75

 

Unamortized deferred loan fees

 

(5,138

)

(4,606

)

11.55

 

Loans, net

 

1,921,476

 

1,848,078

 

3.97

 

Other real estate owned, net

 

653

 

653

 

 

Investments in real estate, net

 

21,676

 

21,678

 

(0.01

)

Premises and equipment, net

 

29,586

 

29,788

 

(0.68

)

Customers’ liability on acceptance

 

12,418

 

10,608

 

17.06

 

Accrued interest receivable

 

13,988

 

14,453

 

(3.22

)

Goodwill

 

6,552

 

6,552

 

 

Other assets

 

19,202

 

24,686

 

(22.22

)

 

 

 

 

 

 

 

 

Total assets

 

$

3,012,630

 

$

2,753,998

 

9.39

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Non-interest-bearing demand deposits

 

$

320,723

 

$

302,828

 

5.91

 

Interest-bearing deposits:

 

 

 

 

 

 

 

NOW deposits

 

155,354

 

148,085

 

4.91

 

Money market deposits

 

176,223

 

161,580

 

9.06

 

Savings deposits

 

309,994

 

290,226

 

6.81

 

Time deposits under $100

 

440,457

 

425,138

 

3.60

 

Time deposits of $100 or more

 

1,042,128

 

986,786

 

5.61

 

Total deposits

 

2,444,879

 

2,314,643

 

5.63

 

 

 

 

 

 

 

 

 

Federal funds purchased and securities sold under agreements to repurchase

 

152,500

 

28,500

 

435.09

 

Advances from the Federal Home Loan Bank

 

50,000

 

50,000

 

 

Acceptances outstanding

 

12,418

 

10,608

 

17.06

 

Trust preferred securities

 

19,701

 

 

100.00

 

Other liabilities

 

17,965

 

62,286

 

(71.16

)

Total liabilities

 

2,697,463

 

2,466,037

 

9.38

 

 

 

 

 

 

 

 

 

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, 18,341,657 issued and 18,021,747 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 shares in 2002)

 

(8,810

)

(8,287

)

6.31

 

Additional paid-in-capital

 

74,169

 

70,857

 

4.67

 

Unearned compensation

 

(1,743

)

 

 

Accumulated other comprehensive income, net

 

12,138

 

6,719

 

80.65

 

Retained earnings

 

239,230

 

218,489

 

9.49

 

Total stockholders’ equity

 

315,167

 

287,961

 

9.45

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

3,012,630

 

$

2,753,998

 

9.39

 

 

 

 

 

 

 

 

 

Book value per share

 

$

17.49

 

$

16.00

 

9.31

 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

4



 

CATHAY BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

(In thousands, except share and per share data)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

Interest on loans

 

$

26,819

 

$

25,788

 

$

53,343

 

$

52,596

 

Interest on securities available-for-sale

 

5,250

 

4,103

 

8,237

 

8,054

 

Interest on securities held-to-maturity

 

3,426

 

5,186

 

9,310

 

10,472

 

Interest on federal funds sold and securities purchased under agreements to resell

 

128

 

182

 

301

 

392

 

Interest on deposits with banks

 

12

 

8

 

14

 

19

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

35,635

 

35,267

 

71,205

 

71,533

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Time deposits of $100 or more

 

5,032

 

5,641

 

10,232

 

12,030

 

Other deposits

 

2,598

 

3,373

 

5,279

 

6,934

 

Other borrowed funds

 

1,417

 

821

 

2,671

 

1,554

 

 

 

 

 

 

 

 

 

 

 

Total interest expense

 

9,047

 

9,835

 

18,182

 

20,518

 

 

 

 

 

 

 

 

 

 

 

Net interest income before provision for loan losses

 

26,588

 

25,432

 

53,023

 

51,015

 

Provision for loan losses

 

1,650

 

1,500

 

3,300

 

3,000

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

 

24,938

 

23,932

 

49,723

 

48,015

 

 

 

 

 

 

 

 

 

 

 

NON-INTEREST INCOME

 

 

 

 

 

 

 

 

 

Securities gains

 

3,858

 

502

 

5,653

 

460

 

Letters of credit commissions

 

496

 

466

 

994

 

938

 

Depository service fees

 

1,472

 

1,480

 

2,805

 

2,961

 

Other operating income

 

1,370

 

1,574

 

2,947

 

2,997

 

 

 

 

 

 

 

 

 

 

 

Total non-interest income

 

7,196

 

4,022

 

12,399

 

7,356

 

 

 

 

 

 

 

 

 

 

 

NON-INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

7,081

 

6,248

 

13,724

 

12,413

 

Occupancy expense

 

924

 

817

 

1,905

 

1,748

 

Computer and equipment expense

 

832

 

780

 

1,652

 

1,584

 

Professional services expense

 

947

 

764

 

1,944

 

1,854

 

FDIC and state assessments

 

127

 

122

 

257

 

246

 

Marketing expense

 

460

 

438

 

849

 

771

 

Other real estate owned expense (income)

 

83

 

(195

)

129

 

(385

)

Operations of investments in real estate

 

703

 

502

 

1,228

 

1,118

 

Other operating expense

 

872

 

738

 

1,675

 

1,517

 

 

 

 

 

 

 

 

 

 

 

Total non-interest expense

 

12,029

 

10,214

 

23,363

 

20,866

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense

 

20,105

 

17,740

 

38,759

 

34,505

 

Income tax expense

 

6,860

 

5,502

 

12,980

 

10,879

 

 

 

 

 

 

 

 

 

 

 

Net income

 

13,245

 

12,238

 

25,779

 

23,626

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized holding gains arising during the period

 

7,418

 

3,527

 

7,126

 

1,193

 

Unrealized gains (losses) on cash flow hedge derivatives

 

(216

)

141

 

(189

)

75

 

Less: reclassification adjustments included in net income

 

354

 

718

 

1,518

 

912

 

Total other comprehensive income, net of tax:

 

6,848

 

2,950

 

5,419

 

356

 

Total comprehensive income

 

$

20,093

 

$

15,188

 

$

31,198

 

$

23,982

 

 

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.74

 

$

0.68

 

$

1.43

 

$

1.31

 

Diluted

 

$

0.73

 

$

0.67

 

$

1.42

 

$

1.31

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.140

 

$

0.140

 

$

0.280

 

$

0.265

 

 

 

 

 

 

 

 

 

 

 

Basic average common shares outstanding

 

18,016,015

 

17,992,971

 

18,009,937

 

17,980,834

 

Diluted average common shares outstanding

 

18,155,180

 

18,133,705

 

18,136,125

 

18,089,358

 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

5



 

CATHAY BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For the six months ended June 30,

 

(In thousands)

 

2003

 

2002

 

Cash Flows from Operating Activities

 

 

 

 

 

Net income

 

$

25,779

 

$

23,626

 

Adjustments to reconcile net income to net cash (used) provided by operating activities:

 

 

 

 

 

Provision for loan losses

 

3,300

 

3,000

 

Depreciation

 

836

 

779

 

Gain on sale of other real estate owned

 

 

(395

)

Proceeds from sale of loans

 

6,530

 

10,473

 

Gain on sale of loans

 

(294

)

(187

)

Gain on sale and call of investment securities

 

(5,966

)

(869

)

Write-downs on venture capital investment

 

313

 

204

 

Amortization of investment securities premiums, net

 

1,879

 

322

 

Amortization of intangibles

 

109

 

104

 

Stock-based compensation expense

 

194

 

 

Tax benefit from stock options

 

6

 

142

 

Increase in deferred loan fees, net

 

532

 

91

 

Decrease (Increase) in accrued interest receivable

 

465

 

(182

)

Decrease (Increase) in other assets, net

 

1,117

 

(1,407

)

Decrease in other liabilities

 

(44,321

)

(4,909

)

Total adjustments

 

(35,300

)

7,166

 

Net cash (used) provided by operating activities

 

(9,521

)

30,792

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Purchase of investment securities available-for-sale

 

(255,281

)

(177,730

)

Proceeds from maturity and call of investment securities available-for-sale

 

71,110

 

135,999

 

Proceeds from sale of investment securities available-for-sale

 

42,986

 

5,030

 

Purchase of mortgage-backed securities available-for-sale

 

(102,484

)

 

Proceeds from repayment of mortgage-backed securities available-for-sale

 

8,761

 

2,919

 

Purchase of investment securities held-to-maturity

 

(3,469

)

(32,134

)

Proceeds from maturity and call of investment securities held-to-maturity

 

32,590

 

12,070

 

Purchase of mortgage-backed securities held-to-maturity

 

(34,645

)

(9,225

)

Proceeds from repayment of mortgage-backed securities held-to-maturity

 

52,051

 

33,092

 

Net increase in loans

 

(83,466

)

(74,648

)

Purchase of premises and equipment

 

(634

)

(1,412

)

Proceeds from sale of other real estate owned

 

 

1,704

 

Net decrease (increase) in investments in real estate

 

2

 

(3,757

)

Net cash used in investing activities

 

(272,479

)

(108,092

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Net increase in demand deposits, NOW deposits, money market and savings deposits

 

59,575

 

45,815

 

Net increase in time deposits

 

70,661

 

38,480

 

Net increase in federal funds purchased and securities sold under agreements to repurchase

 

124,000

 

6,392

 

Increase in advances from Federal Home Loan Bank

 

 

20,000

 

Issuance of trust preferred securities

 

19,701

 

 

Cash dividends

 

(5,038

)

(4,761

)

Proceeds from shares issued to the Dividend Reinvestment Plan

 

1,336

 

964

 

Proceeds from exercise of stock options

 

33

 

276

 

Purchase of treasury stock

 

(523

)

 

Net cash provided by financing activities

 

269,745

 

107,166

 

 

 

 

 

 

 

(Decrease) increase in cash and cash equivalents

 

(12,255

)

29,866

 

Cash and cash equivalents, beginning of the period

 

89,777

 

86,514

 

Cash and cash equivalents, end of the period

 

$

77,522

 

$

116,380

 

 

 

 

 

 

 

Supplemental disclosure of cash flows information

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

18,387

 

$

20,997

 

Income taxes

 

$

35,499

 

$

16,869

 

Non-cash investing activities:

 

 

 

 

 

Transfer from investment securities held-to-maturity to investment securities available-for-sale, at fair value

 

$

412,122

 

$

10,484

 

Net change in unrealized holding gains on securities available-for-sale, net of tax

 

$

5,608

 

$

281

 

Net change in unrealized gains on cash flow hedge derivatives, net of tax

 

$

(189

)

$

75

 

Transfers to other real estate owned

 

$

 

$

407

 

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

6



 

CATHAY BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Business

 

Cathay Bancorp, Inc. (the “Bancorp”) is the holding company for Cathay Bank (the “Bank”) and Cathay Capital Trust I (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.  Cathay Capital Trust I is a statutory trust formed under the laws of the state of Delaware in June, 2003, which issued trust preferred securities for raising capital in connection with the proposed merger with GBC Bancorp.

 

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.  At the closing of the merger, 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, subject to adjustment under certain conditions.  The allocation of the cash and stock consideration among the GBC shareholders will be dependent, among other factors, on the elections made by GBC shareholders.

 

Completion of the merger, is subject to certain conditions, including approval by the shareholders of both the Bancorp and GBC and applicable regulatory authorities.  Subject to obtaining such approvals, the transaction is expected to close before the end of 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 June 30, 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 Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“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 the fair value method of accounting for stock options 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 June 30, 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 June 30, 2003, the carrying amount of those investments in real estate was $4.72 million.  The Company had satisfied all capital commitments required for the two investments in real estate prior to 2003, 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 does not expect that the adoption will 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

 

8



 

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 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.

 

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity."  This Statement establishes standards for how an issuer classifies and measures certain financial instrument that is within its scope as a liability (or an asset in some circumstances).  Many of those instruments were previously classified as equity.  This Statement is effective for Cathay Bancorp for the first interim period beginning after June 15, 2003.  The Company has not completed its analysis to determine the impact of adopting this Statement.  However, the Company does not expect that the adoption will have a material impact on the Company’s results of operations or financial position.

 

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 June 30, 2003 was less than seven 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 $589,000 that were reclassified into earnings during the six months ended June 30, 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 $1.24 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 June 30, 2003 and 2002, all options to purchase shares of common stock were included in the computation of diluted earnings per share. For the six months ended June 30, 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 were included in the computation of diluted earnings per share for the six months ended June 30, 2002.

 

9



 

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

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

(Dollars in thousands, except share and per share data)

 

2003

 

2002

 

2003

 

2002

 

Net income

 

$

13,245

 

$

12,238

 

$

25,779

 

$

23,626

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares:

 

 

 

 

 

 

 

 

 

Basic weighted-average number of common shares outstanding

 

18,016,015

 

17,992,971

 

18,009,937

 

17,980,834

 

Dilutive effect of weighted-average outstanding common shares equivalents

 

139,165

 

140,734

 

126,188

 

108,524

 

Diluted weighted-average number of common shares outstanding

 

18,155,180

 

18,133,705

 

18,136,125

 

18,089,358

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.74

 

$

0.68

 

$

1.43

 

$

1.31

 

Diluted

 

$

0.73

 

$

0.67

 

$

1.42

 

$

1.31

 

 

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, because the stock’s fair market value did not exceed the exercise price at the date of grant.  In 2003, the Company adopted prospectively the fair value recognition provisions of 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 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 the second quarter of 2003 and a $194,000 charge to the first six months of 2003 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 using 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 periods presented would have been reduced to the pro forma amounts indicated in the table below.

 

 

 

For the Three Months ended
June 30, 2003

 

For the Six Months ended
June 30, 2003

 

 

 

2003

 

2002

 

2003

 

2002

 

Net income, as reported

 

$

13,245

 

$

12,238

 

$

25,779

 

$

23,626

 

Add:  Stock-based employee compensation expense included in reported net income, net of related tax effects

 

56

 

 

112

 

 

Deduct:  Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(124

)

(53

)

(248

)

(105

)

Pro forma net income

 

$

13,177

 

$

12,185

 

$

25,643

 

$

23,521

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic - as reported

 

$

0.74

 

$

0.68

 

$

1.43

 

$

1.31

 

Basic - pro forma

 

0.73

 

0.68

 

1.42

 

1.31

 

 

 

 

 

 

 

 

 

 

 

Diluted - as reported

 

0.73

 

0.67

 

1.42

 

1.31

 

Diluted - pro forma

 

0.73

 

0.67

 

1.41

 

1.30

 

 

10



 

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.  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 June 30, 2003

 

At December 31, 2002

 

Commitments to extend credit

 

$

743,000

 

$

725,000

 

Standby letters of credit

 

16,000

 

15,000

 

Other letters of credit

 

39,000

 

37,000

 

Bill of lading guarantee

 

12,000

 

11,000

 

Total

 

$

810,000

 

$

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 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.

 

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.

 

Investment Securities

 

During the second quarter of 2003, the Company reduced its holdings in US dollar-denominated corporate bonds issued by certain Hong Kong entities to $2.61 million, after selling bonds with a net book value of $20.94 million.  Management had intended to hold these bonds to maturity at the time of purchase, and therefore, designated these securities as held-to-maturity.  However, as the SARS situation persisted in Hong Kong, management came to believe that there was a risk that the credit rating of these bonds may potentially be adversely impacted.  As a result of the sales of these held-to-maturity securities, the remaining securities in the portfolio were tainted and were transferred to the available-for-sale portfolio as of May 31, 2003.  At the time of transfer, the securities held-to-maturity portfolio was primarily comprised of US government agencies, state and municipal securities, mortgage-backed securities, collateralized mortgage obligations, assets-backed securities, and corporate bonds.  The carrying value and the estimated fair value of the securities in the held-to-maturity portfolio were $411.40 million and $429.89 million, respectively at the time of transfer to the securities available-for-sale portfolio.  The net unrealized gains were $18.49 million.

 

11



 

Trust Preferred Securities

 

In connection with the proposed merger with GBC, Cathay Bancorp completed the issuance of $20.00 million of trust preferred securities in June 2003, which qualify as Tier 1 capital under current regulatory guidelines.  The trust preferred securities have a variable interest rate of three-month LIBOR plus 3.15%, with an interest rate cap of 11.75% during the first five years, the no-call period.  The trust preferred securities are redeemable, in whole or in part, at the option of Cathay Bancorp, once each quarter, beginning five years after their issuance.  The trust preferred securities carry a 30-year term.

 

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 has 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;

                  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; and

                  risks described in our registration statement on Form S-4 (which we filed in connection with the proposed merger with GBC) under the section entitled “risk factors.”

 

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.

 

12



 

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, current reports on Form 8-K, amendments to those reports and our quarterly earnings releases, all of which are made available as soon as practicable after we electronically file such materials with, or furnish it to the SEC.  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.

 

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.”

 

SECOND QUARTER HIGHLIGHTS:

                  An increase of 8.23% in second quarter 2003 net income to $13.25 million compared with $12.24 million during the same quarter a year ago.

                  Strong total asset growth of $258.63 million or 9.39% to $3.01 billion at June 30, 2003, from December 31, 2002 of $2.75 billion.

                  Gross loan growth from December 31, 2002  of $77.06 million or 4.10%, primarily in commercial mortgage loans and commercial loans.

                  Deposit accounts growth of $130.24 million or 5.63%, of which $39.81 million was in transaction and money market accounts.

                  Net recoveries of $60,000 compared with net charge-offs of $3.50 million in the year ago quarter.

                  Return on average stockholders’ equity was 17.35% and return on average assets was 1.81% for the quarter ended June 30, 2003.

                  The announcement on May 7 of the signing of a definitive agreement by which GBC Bancorp will be merged into Cathay Bancorp.

                  On May 29, 2003, the American Banker newspaper ranked Cathay Bancorp as the 13th most efficient US bank holding company among the 500 largest, which is the highest among California institutions included in the rankings, based on the results in the year 2002.  Previously, the Company had been ranked 8th by the American Banker newspaper, based on the year-to-date results as of the third quarter 2002.

 

Proposed Merger with GBC Bancorp

 

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.  At the closing of the merger, 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

 

13



 

the cash and stock consideration among the GBC shareholders 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 by applicable regulatory authorities.  Subject to obtaining such approvals, the transaction is expected to close before the end of 2003.

 

Income Statement Review

 

Net Income

 

Net income for the second quarter of 2003 was $13.25 million or $0.73 per diluted share, a 8.23% increase, compared to net income of $12.24 million or $0.67 per diluted share for the same quarter a year ago.  Return on average stockholders’ equity was 17.35% and return on average assets was 1.81% for the second quarter of 2003, compared with a return on average stockholders’ equity of 19.03% and return on average assets of 1.93% for the second quarter of 2002.

 

FINANCIAL PERFORMANCE

 

(In thousands, except per share data)

 

2nd Quarter 2003

 

2nd Quarter 2002

 

Net income

 

$

13,245

 

$

12,238

 

Basic earnings per share

 

$

0.74

 

$

0.68

 

Diluted earnings per share

 

$

0.73

 

$

0.67

 

Return on average assets

 

1.81

%

1.93

%

Return on average stockholders’ equity

 

17.35

%

19.03

%

Efficiency ratio

 

35.61

%

34.68

%

Total average assets

 

$

2,929,110

 

$

2,539,688

 

Total average stockholders’ equity

 

$

306,279

 

$

257,955

 

 

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 $1.14 million to $27.10 million, compared to taxable-equivalent net interest income of $25.96 million in the year ago quarter.  The level of net interest income for the second quarter of 2003 reflected the positive effect of the growth in average commercial mortgage loans, commercial loans and securities, and the growth in lower-cost core deposits accounts (defined as total deposits less time deposit accounts of $100,000 or more), which helped to 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 tax-equivalent net interest income increased slightly due to increased investments in tax-exempt state and municipal securities, when compared with taxable-equivalent net interest income of $26.98 million during the first quarter 2003.

 

The taxable-equivalent net interest margin fell 44 basis points from 4.35% during the second quarter of 2002 to 3.91% for the second quarter 2003.  The decrease was primarily due to the decreasing interest rate environment throughout 2002 and into 2003, including the 50 basis point drop in the federal funds rate in November 2002, the prepayment and calls of higher yielding securities, and the related lagging effect of our interest-bearing time deposit accounts.  For the quarter ended June 30, 2003, we increased our net average interest-earning assets (defined as the difference between average interest-earning assets and average interest-bearing liabilities), by $83.55 million from the quarter ended June 30, 2002,

 

14



 

and have changed the mix in our average interest-bearing liabilities by increasing our average lower-cost core deposits by $115.41 million, or 55.96% of the $206.23 million growth in average deposits compared to 2002.  The taxable-equivalent interest rate earned on our average interest-earning assets was 5.22% and our cost of funds on average interest-bearing liabilities equaled 1.59% during the second quarter 2003.  The comparable numbers for the second quarter of 2002 were a taxable-equivalent rate earned on our average interest-earning assets of 6.00% and a cost of funds on average interest-bearing liabilities of 1.99%.

 

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:

 

 

 

For the Three Months Ended

 

 

 

June 30, 2003

 

June 30, 2002

 

Taxable-equivalent basis
(Dollars in thousands)

 

Average
Balances

 

Interest
Income/
Expense(
1)

 

Average
Yields/
Rates

 

Average
Balances

 

Interest
Income/
Expense(1)

 

Average
Yields/
Rates

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold and securities purchased under agreements to resell

 

$

42,544

 

$

128

 

1.21

%

$

42,093

 

$

182

 

1.73

%

Investment securities

 

819,657

 

9,192

 

4.50

 

667,348

 

9,819

 

5.90

 

Loans(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

558,108

 

6,468

 

4.65

 

503,326

 

6,411

 

5.11

 

Residential mortgage

 

230,960

 

3,556

 

6.18

 

230,761

 

3,856

 

6.70

 

Commercial mortgage

 

1,007,216

 

15,017

 

5.98

 

772,903

 

12,842

 

6.66

 

Real estate construction

 

106,025

 

1,599

 

6.05

 

157,733

 

2,371

 

6.03

 

Installment

 

10,826

 

170

 

6.30

 

16,115

 

298

 

7.42

 

Others

 

458

 

9

 

7.88

 

538

 

10

 

7.46

 

Total loans(3)

 

1,913,593

 

26,819

 

5.62

 

1,681,376

 

25,788

 

6.15

 

Deposits with banks

 

1,193

 

12

 

4.03

 

938

 

8

 

3.42

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

2,776,987

 

36,151

 

5.22

 

2,391,755

 

35,797

 

6.00

 

Allowance for loan losses

 

(26,626

)

 

 

 

 

(23,647

)

 

 

 

 

Cash and due from banks

 

59,549

 

 

 

 

 

59,707

 

 

 

 

 

Other non-earning assets

 

119,200

 

 

 

 

 

111,873

 

 

 

 

 

Total assets

 

$

2,929,110

 

 

 

 

 

$

2,539,688

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking deposits

 

$

152,924

 

93

 

0.24

 

$

140,027

 

 

113

 

0.32

%

Money market deposit

 

188,116

 

363

 

0.77

 

148,533

 

380

 

1.03

 

Savings deposit

 

304,498

 

225

 

0.30

 

267,014

 

360

 

0.54

 

Time deposits under $100

 

445,030

 

1,917

 

1.73

 

419,581

 

2,520

 

2.41

 

Time deposits $100 and over

 

1,027,681

 

5,032

 

1.96

 

936,864

 

5,641

 

2.42

 

Total interest-bearing deposits

 

2,118,249

 

7,630

 

1.44

 

1,912,019

 

9,014

 

1.89

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds purchased and securities sold under repurchase agreements

 

3,516

 

11

 

1.25

 

242

 

1

 

1.66

 

Other borrowings

 

162,170

 

1,406

 

3.48

 

69,991

 

820

 

4.70

 

Total interest-bearing liabilities

 

2,283,935

 

9,047

 

1.59

 

1,982,252

 

9,835

 

1.99

 

Non-interest-bearing demand deposits

 

306,260

 

 

 

 

 

262,938

 

 

 

 

 

Other liabilities

 

32,636

 

 

 

 

 

36,543

 

 

 

 

 

Stockholders’ equity

 

306,279

 

 

 

 

 

257,955

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

2,929,110

 

 

 

 

 

$

2,539,688

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest spread

 

 

 

 

 

3.63

%

 

 

 

 

4.01

%

Fully taxable-equivalent net interest income

 

 

 

$

27,104

 

 

 

 

 

$

25,962

 

 

 

Net interest margin

 

 

 

 

 

3.91

%

 

 

 

 

4.35

%

 


(1)          The amount of interest earned on certain securities of states and political subdivisions and other securities held have been adjusted to a fully taxable-equivalent basis based on marginal corporate federal tax rate of 35%.

(2)          Includes average non-accrual loans of $3,672 and $6,930 for 2003 and 2002, respectively.

(3)          Loan income includes loan fees of $741 and $711 for 2003 and 2002, respectively.

 

15



 

Provision for Loan Losses

 

We increased the provision for loan losses by $150,000 to $1.65 million during the second quarter of 2003 compared with $1.50 million for the second 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 should be sufficient to absorb loan losses inherent in the Company’s loan portfolio.  Gross charge-offs for the second quarter of 2003 were $48,000, compared with charge-offs of $3.67 million during the second quarter of 2002.  Recoveries in the second quarter of 2003 equaled $108,000, compared with recoveries of $168,000 in the same quarter a year ago.  Also see “Allowance for Loan Losses” on this second 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 gains (losses), loan gains (losses), wire transfer fees, and other sources of fee income, rose $3.17 million or 78.92% to $7.20 million for the second quarter of 2003, compared with $4.02 million for the same quarter in 2002.

 

In the second quarter of 2003, the Company sold $20.94 million of its holdings in US dollar-denominated corporate bonds issued by certain Hong Kong entities whose credit ratings may potentially be adversely impacted by the effect of SARS, and reduced its remaining holdings to $2.61 million.  The gain on the sale was $4.03 million.  During the second quarter 2003, investment securities calls and write-downs on venture capital investments resulted in a net loss of $176,000, bringing the net securities gains to $3.86 million for the second quarter 2003.  Depository service fees decreased slightly to $1.47 million during the second quarter 2003, compared with $1.48 million in the year ago quarter.  Other operating income decreased by 12.96% to $1.37 million during the second quarter 2003, compared with $1.57 million in the year ago quarter.  The decrease in other operating income was due to lower fees earned on various bank services.

 

Non-Interest Expense

 

Non-interest expense increased $1.82 million to $12.03 million in the second quarter of 2003, compared to $10.21 million in the year ago quarter, primarily as a result of an increase of $833,000 in salaries and employee benefits expenses, reflecting primarily incentive accruals, annual salary adjustments, and a higher number of employees resulting in part from the opening of additional branches in 2002 and stock option expense.  During 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 the second quarter of 2003, and a $194,000 charge to the first six months of 2003 to salaries and employee benefits expense for the first six months of 2003.

 

Income Taxes

 

The provision for income taxes was $6.86 million or an effective income tax rate of 34.12% for the second quarter 2003 compared with $5.50 million or an effective income tax rate of 31.01% in the year ago quarter.  The effective income tax rate during the second 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 second 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.  The increase in the effective tax rate from 2002 to 2003

 

16



 

resulted from the lower level of assets in the real estate investment trust in 2003, compared to those in the registered investment company in 2002.

 

Year-to-Date Income Statement Review

 

Net income was $25.78 million or $1.42 per diluted share for the six months ended June 30, 2003, an increase of 9.11% over net income of $23.63 million or $1.31 per diluted share for the same period a year ago. The Company’s net interest income before provision for loan losses increased by $2.01 million for the six months ended June 30, 2003 to $53.02 million, up 3.94%, compared to $51.02 million for the same period in 2002.  The net interest margin for the six months ended June 30, 2003 decreased 43 basis points to 3.90%, compared to 4.33% during the six months ended June 30, 2002.  On a tax-equivalent basis, the net interest margin was 3.98% for the first half of 2003, compared to 4.42% for the like period of 2002. The 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:

 

 

 

For the Six Months Ended

 

 

 

June 30, 2003

 

June 30, 2002

 

Taxable-equivalent basis
(Dollars in thousands)

 

Average
Balances

 

Interest
Income/
Expense(
1)

 

Average
Yields/ Rates

 

Average
Balances

 

Interest
Income/
Expense(
1)

 

Average
Yields/ Rates

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold and securities purchased under agreements to resell

 

$

50,041

 

$

301

 

1.21

%

$

45,517

 

$

392

 

1.74

%

Investment securities

 

774,498

 

18,611

 

4.85

 

655,064

 

19,605

 

6.04

 

Loans(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

573,686

 

13,008

 

4.57

 

500,831

 

13,940

 

5.61

 

Residential mortgage

 

232,493

 

7,233

 

6.22

 

231,937

 

7,870

 

6.79

 

Commercial mortgage

 

983,167

 

29,428

 

6.04

 

758,978

 

25,317

 

6.73

 

Real estate construction

 

111,199

 

3,280

 

5.95

 

162,955

 

4,803

 

5.94

 

Installment

 

12,173

 

377

 

6.25

 

17,338

 

645

 

7.50

 

Others

 

485

 

17

 

7.07

 

553

 

21

 

7.66

 

Total loans(3)

 

1,913,203

 

53,343

 

5.62

 

1,672,592

 

52,596

 

6.34

 

Deposits with banks

 

1,013

 

14

 

2.79

 

1,049

 

19

 

3.65

 

Total interest-earning assets

 

2,738,755

 

72,269

 

5.32

 

2,374,222

 

72,612

 

6.17

 

Allowance for loan losses

 

(25,876

)

 

 

 

 

(23,924

)

 

 

 

 

Cash and due from banks

 

60,972

 

 

 

 

 

59,331

 

 

 

 

 

Other non-earning assets

 

113,076

 

 

 

 

 

115,207

 

 

 

 

 

Total assets

 

$

2,886,927

 

 

 

 

 

$

2,524,836

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking deposits

 

$

151,295

 

179

 

0.24

 

$

137,830

 

 

221

 

0.32

%

Money market deposit

 

188,195

 

739

 

0.79

 

142,588

 

715

 

1.01

 

Savings deposit

 

297,405

 

436

 

0.30

 

261,495

 

701

 

0.54

 

Time deposits under $100

 

440,196

 

3,925

 

1.80

 

419,936

 

5,297

 

2.54

 

Time deposits $100 and over

 

1,011,648

 

10,232

 

2.04

 

933,045

 

12,030

 

2.60

 

Total interest-bearing deposits

 

2,088,739

 

15,511

 

1.50

 

1,894,894

 

18,964

 

2.02

 

Federal funds purchased and securities sold under repurchase agreements

 

1,895

 

12

 

1.28

 

7,276

 

42

 

1.16

 

Other borrowings

 

150,815

 

2,659

 

3.56

 

72,508

 

1,512

 

4.21

 

Total interest-bearing liabilities

 

2,241,449

 

18,182

 

1.64

 

1,974,678

 

20,518

 

2.10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest-bearing demand deposits

 

300,682

 

 

 

 

 

260,656

 

 

 

 

 

Other liabilities

 

45,812

 

 

 

 

 

35,321

 

 

 

 

 

Stockholders’ equity

 

298,984

 

 

 

 

 

254,181

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

2,886,927

 

 

 

 

 

$

2,524,836

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest spread

 

 

 

 

 

3.68

%

 

 

 

 

4.07

%

Fully taxable-equivalent net interest income

 

 

 

$

54,087

 

 

 

 

 

$

52,094

 

 

 

Net interest margin

 

 

 

 

 

3.98

%

 

 

 

 

4.42

%

 


(1)          The amount of interest earned on certain securities of states and political subdivisions and other securities held have been adjusted to a fully taxable-equivalent basis based on marginal corporate federal tax rate of 35%.

(2)          Includes average non-accrual loans of $3,570 and $7,020 for 2003 and 2002, respectively.

(3)          Loan income includes loan fees of $1,493 and $1,528 for 2003 and 2002, respectively.

 

17



 

Non-interest income increased 68.56% to $12.40 million for the first six months of 2003, compared to $7.36 million in the like period a year ago.  The increase is primarily due to gains recognized in 2003 on the sale of corporate bonds with a net book value of $37.06 million.  The total gains from the sales were $5.92 million.

 

Return on average stockholders’ equity was 17.39% and return on average assets was 1.80% for the first six months of 2003, compared to a return on average stockholders’ equity of 18.74%, and a return on average assets of 1.89% for the six months ended June 30, 2002.  The efficiency ratio for the six months ended June 30, 2003 was 35.71%, compared to 35.75% for the same period a year ago.

 

Financial Condition Review

 

Assets

 

Total assets increased by $258.63 million to $3.01 billion at June 30, 2003, up 9.39% 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 $96.36 million and an increase of $201.83 million in investment securities.  Cash and cash equivalents decreased by $12.26 million from December 31, 2002.

 

Securities

 

Total securities were $909.56 million and represented 30.19% of total assets at June 30, 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 mortgage-backed securities during the first six months of 2003.  Average total securities represented 29.52% of average interest-earning assets for the quarter ended June 30, 2003, compared with 26.99% for the first quarter of 2003 and 25.08% for fourth quarter of 2002.

 

Average securities available-for-sale (“AFS”) as a percentage of average interest-earning assets increased to 29.52% for the second quarter of 2003, from 9.53% for the first quarter of 2003 and 10.23% for the fourth quarter of 2002.  The increase was primarily due to the transfer of the held-to-maturity (“HTM”) portfolio to the AFS portfolio in the second quarter of 2003.  The Company sold $20.94 million of its holdings in US dollar-denominated corporate bonds issued by certain Hong Kong entities, whose credit rating may potentially be adversely impacted by the effect of SARS, and reduced its remaining holdings to $2.61 million.  As a result of the sales from the HTM portfolio, the remaining securities in the HTM portfolio were transferred to the AFS portfolio as of May 31, 2003.  Securities HTM represented 17.46% of average interest-earning assets for the first three months of 2003 and 14.85% for the fourth quarter 2002.  Secondarily, the increase in the AFS portfolio for the six months ended June 30, 2003 was from purchases of U.S. government agency securities, mortgage-backed securities and collateralized mortgage obligations less securities called, matured, and sold during the six months ended June 30, 2003.

 

During the first six months of 2003, the Bank sold corporate bonds securities with a net book value totaling $37.06 million, resulted in a gain of $5.92 million, exclusive of gains on calls of AFS and HTM securities of $45,000, and $313,000 in write-downs on AFS venture capital investments.

 

The fair value of the AFS securities, primarily as a result of the transfer from the held-to-maturity portfolio, increased to $909.56 million at June 30, 2003 compared to $248.27 million at December 31, 2002. The net unrealized gain on securities available-for-sale, which represented the difference between fair value and amortized cost increased to $19.21 million at June 30, 2003, compared to $9.53

 

18



 

million at year-end 2002.  Net unrealized gains on the AFS securities are included in accumulated other comprehensive income, net of tax at June 30, 2003.

 

The average taxable-equivalent yield on investment securities decreased 140 basis points to 4.50% for the second quarter of 2003, compared with 5.90% during the same quarter a year-ago, as higher-yielding securities matured, prepaid or were sold.

 

The following tables summarize the composition, amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale, as of June 30, 2003 and December 31, 2002:

 

 

 

June 30, 2003

 

 

 

Amortized Cost

 

Gross Unrealized Gains

 

Gross Unrealized Losses

 

Fair Value

 

(In thousands)

 

 

 

 

 

 

 

 

 

US government agencies

 

$

334,661

 

$

10,563

 

$

 

$

345,224

 

State and municipal securities

 

74,654

 

4,647

 

25

 

79,276

 

Mortgage-backed securities

 

151,062

 

2,945

 

254

 

153,753

 

Collateralized mortgage obligations

 

165,125

 

920

 

398

 

165,647

 

Asset-backed securities

 

19,999

 

670

 

 

20,669

 

Corporate bonds

 

56,069

 

2,807

 

60

 

58,816

 

Money market fund

 

40,000

 

 

21

 

39,979

 

Equity securities

 

28,879

 

 

4,273

 

24,606

 

Other securities

 

19,898

 

1,689

 

 

21,587

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

890,347

 

$

24,241

 

$

5,031

 

$

909,557

 

 

 

 

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

 

 

The following table summarizes the scheduled maturities by security type of securities available-for-sale as of June 30, 2003:

 

 

 

As of June 30, 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

 

$

 

$

205,613

 

$

139,611

 

$

 

$

345,224

 

State and municipal securities

 

600

 

13,761

 

32,194

 

32,721

 

79,276

 

Mortgage-backed securities

 

483

 

2,786

 

29,719

 

120,765

 

153,753

 

Collateralized mortgage obligations

 

 

9,271

 

38,562

 

117,814

 

165,647

 

Asset-backed securities

 

10,347

 

10,322

 

 

 

20,669

 

Corporate bonds

 

19,273

 

39,543

 

 

 

58,816

 

Money  market fund

 

39,979

 

 

 

 

39,979

 

Equity securities

 

24,606

 

 

 

 

24,606

 

Other securities

 

10,292

 

11,295

 

 

 

21,587

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

105,580

 

$

292,591

 

$

240,086

 

$

271,300

 

$

909,557

 

 

Under our investment policy, we transferred securities held-to-maturity to the available-for-sale category when those securities are within 90 days to maturity, to further enhance the Company’s liquidity.  Prior to the transfer triggered by the sale of certain corporate bonds from the held-to-maturity portfolio, securities held-to-maturity transferred to the available-for-sale portfolio totaled $720,000 for the first five months of 2003.  As of May 31, 2003, the carrying value and fair value of the remaining securities transferred from the held-to-maturity portfolio to the available-for-sale portfolio were $411.40 million and $429.89 million, respectively.  As of June 30, 2003, the Company no longer has a held-to-maturity portfolio.

 

Loans

 

Gross loans at June 30, 2003 were $1.95 billion compared with gross loans at year-end 2002 of $1.88 billion.  Loan growth during the six months ended June 30, 2003 equaled $77.06 million, an increase of 4.10% from year-end 2002, reflecting primarily increases in commercial mortgage loans and commercial loans.

 

19



 

 

Commercial mortgage loans increased $89.53 million or 9.49% to $1.03 billion at June 30, 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.  At June 30, 2003, this portfolio represented approximately 52.85% of the Bank’s gross loans compared to 50.25% at year-end 2002.

 

Commercial loans were up $6.84 million or 1.21% to $570.51 million at June 30, 2003, compared to $563.68 at December 31, 2002.  Total commercial loans accounted for 29.19% of gross loans at June 30, 2003, compared to 30.03% at year-end 2002.  The majority of the growth was in the Small Business Administration (“SBA”) loans category, with commercial and international commercial loans increasing slightly.  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 and commercial loans were partially offset by a decrease in construction loans totaling $14.33 million during the six months ended June 30, 2003.  During the first six months of 2003, the Bank sold $6.05 million of SBA loans, resulting in a gain on sale of loans of $294,000.

 

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

 

(Dollars in thousands)

 

June 30, 2003

 

% of Total

 

December 31, 2002

 

% of Total

 

% Change

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

 

 

 

 

 

 

 

 

 

 

Commercial loans

 

$

570,512

 

29.69

%

$

563,675

 

30.50

%

1.21

%

Residential mortgage loans

 

230,767

 

12.01

 

231,371

 

12.52

 

(0.26

Commercial mortgage loans

 

1,032,917

 

53.76

 

943,391

 

51.05

 

9.49

 

Real estate construction loans

 

108,448

 

5.64

 

122,773

 

6.64

 

(11.67

)

Installment loans

 

11,113

 

0.58

 

15,570

 

0.84

 

(28.63

)

Other loans

 

529

 

0.03

 

447

 

0.02

 

18.34

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross loans

 

1,954,286

 

101.71

 

1,877,227

 

101.57

 

4.10

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

(27,672

)

(1.44

)

(24,543

)

(1.32

)

12.75

 

Unamortized deferred loan fees

 

(5,138

)

(0.27

)

(4,606

)

(0.25

)

11.55

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loans

 

$

1,921,476

 

100.00

%

$

1,848,078

 

100.00

%

3.97

%

 

Other Real Estate Owned

 

Other real estate owned was at $653,000 as of June 30, 2003, net of a valuation allowance of $131,000, and remained unchanged from December 31, 2002.  The portfolio is 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 in the current period.  Management did not make any provision for other real estate owned losses during the first six months of 2003.

 

Investments in Real Estate

 

As of June 30, 2003, our investments in real estate were comprised of eight limited partnerships.  In June 2003, we entered into an agreement to invest in Potrero Partners, L.P. for a 99.9% limited-partnership interest.  The initial and first contributions made in June 2003 totaled $593,000.  In addition, during the six months ended June 30, 2003, we made additional contributions to WNC Institutional Tax Credit Fund X New York — Series 3 for $473,000 and to WNC Institutional Tax

 

20



 

Credit Fund California – Series 2 for $160,000.  These eight limited partnerships were 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 June 30, 2003, net investments in real estate remained unchanged at $21.68 million as compared to year-end 2002.  During the first half of 2003, we recognized $1.23 million in net operating losses from the limited partnerships, and contributed $1.23 million.

 

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

 

(Dollars in thousands)

 

Percentage of
Ownership

 

Acquisition
Date

 

Carrying Amount

 

June 30, 2003

 

December 31, 2002

Las Brisas

 

49.5

%

December 1993

 

$

 

$

 

Los Robles

 

99.0

%

August 1995

 

363

 

386

 

California Corporate Tax Credit Fund III

 

32.5

%

March 1999

 

10,557

 

11,128

 

Wilshire Courtyard

 

99.9

%

May 1999

 

4,358

 

4,568

 

Lend Lease ITC XXIII

 

4.5

%

March 2002

 

4,227

 

4,546

 

WNC Institutional Tax Credit Fund X New York — Series 3

 

4.2

%

August 2002

 

942

 

529

 

WNC Institutional Tax Credit Fund X California — Series 2

 

6.0

%

September 2002

 

636

 

521

 

Potrero Partners, L.P.

 

99.9

%

June 2003

 

593

 

 

 

 

 

 

 

 

$

21,676

 

$

21,678

 

 

Deposits

 

The increase in total assets from year-end 2002 was funded primarily by deposit growth of $130.24 million or 5.63%, to $2.44 billion.  Lower-cost core deposits (defined as total deposits less time deposit accounts of $100,000 or more) comprised $74.89 million or 57.51% of the total growth in deposits, while the remaining growth of $55.34 million or 42.49% resulted from an increase in time deposits of $100,000 or more.  This includes the Bank’s purchase of $2.12 million in deposits from CITIC International Financial Holdings Limited, which was completed in May 2003.  As of June 30, 2003, non-interest-bearing demand deposits, interest-bearing checking accounts, and savings accounts comprised 39.36% of total deposits, time deposit accounts of less than $100,000 comprised 18.02% of total deposits, while the remaining 42.62% was comprised of time deposit accounts of $100,000 or more.  At June 30, 2002, time deposit accounts of $100,000 or more represented 43.45% of total deposits.  This relative decrease in time deposit accounts of $100,000 or more reflects our efforts to grow lower cost core deposits, while placing less emphasis on higher-cost time deposit accounts of $100,000 or more.

 

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

 

(Dollars in thousands)

 

June 30, 2003

 

% of Total

 

December 31, 2002

 

% of Total

 

% Change

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

Non-interest-bearing demand deposits

 

$

320,723

 

13.12

%

$

302,828

 

13.08

%

5.91

%

Interest-bearing checking deposits

 

331,577

 

13.56

 

309,665

 

13.38

 

7.08

 

Savings deposits

 

309,994

 

12.68

 

290,226

 

12.54

 

6.81

 

Time deposits

 

1,482,585

 

60.64

 

1,411,924

 

61.00

 

5.00

 

Total deposits

 

$

2,444,879

 

100.00

%

$

2,314,643

 

100.00

%

5.63

%

 

As interest rate spreads widened between time deposits of $100,000 or more (“Jumbo CD”) 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:

 

21



 

                  approximately 68.75% 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 4,824 accounts averaging approximately $195,000 per account owned by 3,350 individual depositors as of July 3, 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 interest-bearing accounts;

              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, federal funds purchased, reverse repurchase agreements, and trust preferred securities.  Total borrowings increased by $143.70 million to $222.20 million at June 30, 2003, compared with $78.50 million at year-end 2002.  The increase in borrowings were in short-term and long-term federal funds purchased and reverse repurchase agreements, and trust preferred securities, with the majority of the funds being used for the purchase of investment securities.

 

Other Liabilities

 

Other liabilities decreased by $44.32 million at June 30, 2003.  The decrease was due primarily to a liability that was established for investment securities purchased in December 2002 that settled in January 2003.

 

Capital Resources

 

Stockholders’ equity of $315.17 million at June 30, 2003, increased by $27.21 million, or 9.45%, compared to $287.96 million at December 31, 2002.  Stockholders’ equity equaled 10.46% of total assets at June 30, 2003.  The increase of $27.21 million in stockholders’ equity was due to the following:

 

                  an addition of $25.78 million from net income, less dividends paid on common stock of $5.04 million;

                  an increase of $1.34 million from issuance of additional common shares through the Dividend Reinvestment Plan;

                  an increase of $5.42 million in accumulated other comprehensive income, as a result of:

                  an increase of $7.13 million in the net unrealized holding gains on securities available-for-sale, net of tax; mainly due to the transfer of securities in the held-to-maturity portfolio to the available-for-sale portfolio,

                  a decrease of $189,000 from unrealized gains on cash flow hedging derivatives, net of tax;

                  a decrease of $1.52 million in reclassification 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

 

22



 

approved a stock repurchase program of up to $15 million of our common stock.  Cumulatively through June 30, 2003, the Company has repurchased 319,910 shares of our common stock for $8.81 million; and

                  stock-based compensation amortization of $194,000.

 

We declared cash dividends of 14 cents per common share in January 2003 on 17,999,955 shares outstanding, in April 2003 on 18,000,990 shares and in July 2003 on 18,021,747 shares outstanding.  Total cash dividends paid in 2003, including the $2.52 million paid in July, amounted to $7.56 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.

 

In June 2003, Cathay Bancorp completed the issuance of $20.00 million of trust preferred securities which qualify as Tier 1 capital under current regulatory guidelines.  The trust preferred securities have a variable interest rate of three-month LIBOR plus 3.15%, with an interest rate cap of 11.75% during the first five years, the no-call period.  The trust preferred securities are redeemable, in whole or in part, at the option of Cathay Bancorp, once each quarter, beginning five years after their issuance.  The trust preferred securities carry a 30-year term.  Cathay Bancorp intends to raise an additional $20.00 million in trust preferred securities on or before the proposed merger with GBC.  There is a risk, however, that Cathay Bancorp may not be able to raise these additional amounts in commercially reasonable terms, if at all.

 

Asset Quality Review

 

Non-performing Assets

 

Non-performing assets to gross loans plus other real estate owned increased to 0.67% at June 30, 2003, from 0.39% at December 31, 2002, and from 0.45% at June 30, 2002.  Total non-performing assets increased to $13.16 million at June 30, 2003, compared with $7.25 million at December 31, 2002, and $7.80 million at June 30, 2002.  Non-performing assets include accruing loans past due 90 days or more, non-accrual loans, and other real estate owned.

 

Non-performing loans increased to $12.50 million at June 30, 2003, compared with year-end 2002 of $6.59 million, and $7.15 million at June 30, 2002.  The increase in non-performing loans was due to increase in accruing loans past due 90 days or more, which totaled $8.38 million at June 30, 2003 compared with $2.47 million at December 31, 2002.  This increase was primarily due to two commercial loans in process of renewal.  One of those loans for $2.35 million was renewed in July 2003.

 

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

 

(Dollars in thousands)

 

June 30, 2003

 

December 31, 2002

 

Accruing loans past due 90 days or more

 

$

8,384

 

$

2,468

 

Non-accrual loans

 

4,118

 

4,124

 

Total non-performing loans

 

12,502

 

6,592

 

Other real estate owned

 

653

 

653

 

Total non-performing assets

 

$

13,155

 

$

7,245

 

 

 

 

 

 

 

Troubled debt restructurings(1)

 

$

4,211

 

$

5,266

 

Non-performing assets as a percentage of gross loans and other real estate owned

 

0.67

%

0.39

%

Allowance for loan losses as a percentage of non-performing loans

 

221.34

%

372.31

%

 


(1)          Excludes $2.05 million of non-performing troubled debt restructuring loans,  of which $1.01 million is included with non-accrual loans, and $1.04 million is included in accruing loans past due 90 days or more.  Troubled debt restructuring loans as shown are accruing interest at their restructured terms.

 

23



 

 

Non-accrual Loans

 

Non-accrual loans were $4.12 million as of June 30, 2003, a decrease of $1.33 million from the end of the first quarter of 2003, and a slight decrease from year-end 2002.  The portfolio consisted mainly of $1.41 million in real estate loans and $2.69 million in commercial loans.  The following table presents non-accrual loans by type of collateral securing the loans, as of the dates indicated:

 

 

 

June 30, 2003

 

December 31, 2002

 

(In thousands)

 

Real Estate (1)

 

Commercial

 

Other

 

Real Estate (1)

 

Commercial

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Type of Collateral

 

 

 

 

 

 

 

 

 

 

 

 

 

Single/multi-family residence

 

$

1,286

 

$

71

 

$

 

$

386

 

$

117

 

$

 

Commercial real estate

 

124

 

1,746

 

 

132

 

1,099

 

 

Land

 

 

382

 

 

1,658

 

425

 

 

UCC

 

 

492

 

 

 

278

 

 

Other

 

 

 

17

 

 

 

17

 

Unsecured

 

 

 

 

 

9

 

3

 

Total

 

$

1,410

 

$

2,691

 

$

17

 

$

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 the types of businesses the borrowers are engaged in, as of the dates indicated:

 

 

 

June 30, 2003

 

December 31, 2002

 

(In thousands)

 

Real Estate (1)

 

Commercial

 

Other

 

Real Estate (1)

 

Commercial

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Type of Business

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate development

 

$

1,286

 

$

71

 

$

 

$

1,658

 

$

96

 

$

 

Wholesale/Retail

 

 

1,633

 

 

 

1,557

 

 

Food/Restaurant

 

 

 

 

 

13

 

 

Import

 

 

124

 

 

 

127

 

 

Other

 

124

 

863

 

17

 

518

 

135

 

20

 

Total

 

$

1,410

 

$

2,691

 

$

17

 

$

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 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.

 

At June 30, 2003, troubled debt restructurings totaled $4.21 million, a decrease of $1.06 million from December 31, 2002.  The decrease is due to three restructured loans outstanding at December 31, 2002 which became past due over 90 days as of June 30, 2003, and were included in the non-performing loans, under the accruing loans past due 90 days or more category.

 

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 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

 

24



 

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 $15.48 million at June 30, 2003, compared with $19.59 million at year-end 2002.  Impaired commercial loans had a recorded investment of $8.53 million, an increase of $4.64 million from year-end 2002.  The impaired commercial loans are made up of loans to five borrowers.  Three loans to two borrowers, totaling $1.78 million, were also included with non-accrual loans, and two loans, totaling $4.21 million to one borrower were included with troubled debt restructurings at June 30, 2003.  Impaired real estate loans decreased by $8.76 million to $6.95 million at June 30, 2003, compared with $15.71 million at year-end 2002 due to payoffs.  Two loans with a recorded investment of $7.61 million at December 31, 2002 were paid off in the first quarter of 2003, and one loan with a recorded investment of $2.21 million at December 31, 2002 was paid off in the second quarter.

 

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

 

 

 

At June 30, 2003

 

At December 31, 2002

 

(In thousands)

 

Recorded
Investment

 

Allowance

 

Net
Balance

 

Recorded
Investment

 

Allowance

 

Net
Balance

 

Commercial

 

$

8,526

 

$

1,279

 

$

7,247

 

$

3,883

 

$

629

 

$

3,254

 

Real Estate (1)

 

6,950

 

1,042

 

5,908

 

15,707

 

2,356

 

13,351

 

Other

 

 

 

 

1

 

1

 

 

Total

 

$

15,476

 

$

2,321

 

$

13,155

 

$

19,591

 

$

2,986

 

$

16,605

 

 


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

 

Loan Concentrations

 

There were no loan concentrations to multiple borrowers in similar activities which exceeded 10% of total loans as of June 30, 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 to permit periodic evaluation of impairment and the adequacy level of the allowance for loan losses in a timely 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 $27.67 million at June 30, 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 1.42% of period-end gross loans and 221.34% of non-performing loans at June 30, 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 $3.62 million to $48,000 in the second quarter 2003 compared with

 

25



 

charge-offs of $3.67 million in the same quarter a year ago.  Commercial loan charge-offs which totaled $3.64 million in the year-ago quarter, decreased to $47,000 during the second quarter of 2003.

 

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

 

(Dollars in thousands)

 

For the six months ended
June 30, 2003

 

For the year ended
December 1, 2002

 

 

 

 

 

 

 

Balance at beginning of period

 

$

24,543

 

$

23,973

 

Provision for loan losses

 

3,300

 

6,000

 

Loans charged-off

 

(331

)

(5,976

)

Recoveries of loans charged-off

 

160

 

546

 

Balance at end of period

 

$

27,672

 

$

24,543

 

 

 

 

 

 

 

Average net loans outstanding during the period

 

$

1,887,327

 

$

1,724,796

 

Ratio of net charge-offs to average net loans outstanding during the period (annualized)

 

0.02

%

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

 

221.34

%

372.31

%

Allowance to gross loans, at period-end

 

1.42

%

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.  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 include commercial, international commercial, asset-based and Small Business Administration loans.  The portfolio grew slightly, from $563.68 million at year-end 2002 to $570.51 million at June 30, 2003, with the majority of growth, $4.07 million from Small Business Administration loans.  Total commercial loans grew steadily during the first quarter of 2003 over year-end 2002, but dropped roughly 4% as of the second quarter-end 2003 from the first quarter-end 2003.

 

26



 

Commercial loans, including international commercial loans, which are sensitive to the economic setting and conditions, grew slightly in the second quarter of 2003.  Asset-based loans increased to $161.09 million at June 30, 2003, from $146.68 million at year-end 2002, although they decreased by $7.28 million from the first quarter 2003.  As a group, delinquencies over 29 days trended upward, from $8.03 million at year-end 2002, to $15.88 million at March 31, 2003, and to $16.37 million at  June 30, 2003. There were no delinquency in asset-based loans as of June 30, 2003.  The overall portfolio increase in delinquencies appears to be the result of businesses experiencing temporary delays in their cash flows.  Allocated allowances were $10.87 million as of June 30, 2003, compared to $11.81 million from the year-end 2002.

 

The portfolio of residential mortgage loans, including home equity lines of credit, decreased slightly to $230.77 million at June 30, 2003, from $231.37 million at year-end 2002.  During the six-month period ending June 30, 2003, residential mortgage loans decreased by $12.38 million from $182.41 million at year-end 2002 to $170.03 million, while home equity lines of credit increased by $11.78 million from $48.96 million at year-end 2002 to $60.74 million at June 30, 2003.  The decline in residential mortgage loans reflects high prepayments due to low market interest rates.  During the first six months of 2003, originations in residential mortgage loans totaled $39.20 million, which was offset by $57.04 million of payoffs.  In terms of past due loans, delinquencies over 29 days trended downward from $2.42 million at year-end 2002 to $1.95 million at March 31, 2003, and $165,000 at June 30, 2003.  The $165,000 is comprised of two classified residential mortgage loans, which were included with non-accrual loans.  These residential mortgage loans are adequately secured and are expected to have sufficient collateral to repay the defaulted loans. There were no delinquencies in the home equity lines of credit as of the end of the second quarter 2003.  Although charge-offs have not occurred in this segment over the last year into the second quarter of 2003, in view of the expected slow increase in per capita income, sluggish job growth and the persistent unemployment rate, management has determined that it is prudent to maintain an allowance in this loan category, at a minimum risk rate.  As of the second quarter-end 2003, management allocated the same level of allowance to this loan segment as year-end 2002, $959,000.

 

Commercial mortgage loans, consisting primarily of loans to finance shopping centers, commercial office buildings, warehouses, hotels, and apartment structures, have grown steadily since 2001, as a result of new business development efforts.  For the six-month period ended June 30, 2003, the portfolio increased by 9.49% or $89.53 million to $1.03 billion, from $943.39 million at year-end 2002.  This loan segment has increased to represent 52.85% of the Bank’s total loan portfolio, compared to 50.25% at year-end 2002.  Loans past due from 30 to 90 days were relatively flat at $8.76 million at June 30, 2003, compared to $9.48 million at year-end 2002.  Loans past due 30 days or more decreased by $1.57 million, with an offsetting increase in past due 90 days by $1.02 million.  As of June 30, 2003, non-accrual loans increased by $991,000 from year-end 2002, to $1.24 million at June 30, 2003.  Despite the zero loan loss experience for the last six quarters, and the relatively low delinquency as a percentage of total commercial mortgage loans, management allocated an allowance of $8.10 million to this loan segment, compared to $8.46 million at year-end 2002.

 

Real estate construction loans continue to decrease from $122.77 million at year-end 2002 to $108.45 million as of June 30, 2003 due to payoffs.  Delinquencies over 29 days in this segment correspondingly decreased from $3.97 million as of fourth quarter-end of 2002 to $201,000 as of the second quarter-end of 2003.  Charge-offs for the first quarter 2003 were $135,000, and there were no charge-offs in the second quarter 2003.  Management allocated an allowance for $1.33 million to this loan segment as of June 30, 2003.  The allocated allowance was at $1.63 million as of March 31, 2003, and $2.61 million at year-end 2002.  While the allocated allowance is down from the first quarter of 2003 and year-end 2002, management believes the present level of allocation should be sufficient to cover the inherent risk in this loan segment.

 

27



 

Allocated allowances for installment and consumer loans have gradually declined as the total loan volume in this segment has declined from $20.32 million at December 31, 2001 to $15.57 million as of December 31, 2002, and further declined to $11.11 million at June 30, 2003.  The Bank continues to provide consumer loan products strictly on an accommodation basis to Bank customers.  Delinquencies over 29 days moved downward from $122,000 at year-end 2001 to $22,000 at year-end  2002, and increased slightly to $28,000 by the end of the second quarter 2003.  Delinquent loans over 90 days were zero during the six months ending June 30, 2003.  Loans on non-accrual were at $17,000 as of June 30,  2003, the same as year-end 2002, and were comprised of two automobile loans.  Charge-offs of installment and consumer loans have been nominal.  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 $49,000 at June 30, 2003.

 

Allowances for other risks of potential loan losses equaled $4.34 million as of June 30, 2003, compared to $2.17 million at March 31, 2003 and $2.06 million at December 31, 2002.  In view of the uncertainty in the global and the US economy, and the potential that those uncertainties may increase the risks to the Bank’s loan portfolio as a whole, management has, therefore, increased the allocation of the allowance.

 

After the review of all relevant factors affecting collectibility of the various loan segments, management believes that the level of allowance for loan losses is appropriate based on the analysis performed in the second quarter of 2003.

 

Capital Adequacy Review

 

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

 

As of June 30, 2003, both the Bancorp’s and the Bank’s regulatory capital continued to exceed the regulatory minimum requirements.  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 June 30, 2003 and December 31, 2002:

 

 

 

Cathay Bancorp, Inc.

 

 

 

June 30, 2003

 

December 31, 2002

 

(Dollars in thousands)

 

Balance

 

%

 

Balance

 

%

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to risk-weighted assets)

 

$

311,627

(1)

13.33

%

$

271,613

(2)

11.93

%

Tier 1 capital minimum requirement

 

93,515

 

4.00

 

91,043

 

4.00

 

Excess

 

$

218,112

 

9.33

%

$

180,570

 

7.93

%

 

 

 

 

 

 

 

 

 

 

Total capital (to risk-weighted assets)

 

$

339,299

(1)

14.51

%

$

296,156

(2)

13.01

%

Total capital minimum requirement

 

187,030

 

8.00

 

182,085

 

8.00

 

Excess

 

$

152,269

 

6.51

%

$

114,071

 

5.01

%

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to average assets)

 

 

 

 

 

 

 

 

 

– Leverage ratio

 

$

311,627

(1)

10.67

%

$

271,613

(2)

10.11

%

Minimum leverage requirement

 

116,820

 

4.00

 

107,439

 

4.00

 

Excess

 

$

194,807

 

6.67

%

$

164,174

 

6.11

%

 

 

 

 

 

 

 

 

 

 

Risk-weighted assets

 

$

2,337,875

 

 

 

$

2,276,063

 

 

 

Total average assets

 

$

2,920,496

(3)

 

 

$

2,685,983

(3)

 

 

 

28



 

The following table presents the Bank’s capital and leverage ratios as of June 30, 2003 and December 31, 2002:

 

 

 

Cathay Bank

 

 

 

June 30, 2003

 

December 31, 2002

 

(Dollars in thousands)

 

Balance

 

%

 

Balance

 

%

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to risk-weighted assets)

 

$

282,591

(1)

12.11

%

$

262,874

(2)

11.57

%

Tier 1 capital minimum requirement

 

93,328

 

4.00

 

90,876

 

4.00

 

Excess

 

$

189,263

 

8.11

%

$

171,998

 

7.57

%

 

 

 

 

 

 

 

 

 

 

Total capital (to risk-weighted assets)

 

$

310,263

(1)

13.30

%

$

287,417

(2)

12.65

%

Total capital minimum requirement

 

186,655

 

8.00

 

181,752

 

8.00

 

Excess

 

$

123,608

 

5.30

%

$

105,665

 

4.65

%

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to average assets)

 

 

 

 

 

 

 

 

 

– Leverage ratio

 

$

282,591

(1)

9.69

%

$

262,874

(2)

9.80

%

Minimum leverage requirement

 

116,641

 

4.00

 

107,258

 

4.00

 

Excess

 

$

165,950

 

5.69

%

$

155,616

 

5.80

%

 

 

 

 

 

 

 

 

 

 

Risk-weighted assets

 

$

2,333,193

 

 

 

$

2,271,902

 

 

 

Total average assets

 

$

2,916,037

(3)

 

 

$

2,681,438

(3)

 

 

 


(1) Excluding accumulated other comprehensive income of $12,138,000 and intangibles of $8,843,000.

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

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

 

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, securities sold under agreements to repurchase, and advances from the Federal Home Loan Bank (“FHLB”).  At June 30, 2003, our liquidity ratio (defined as net cash, short-term and marketable securities to net deposits and short-term liabilities) increased to 32.35% compared to 28.23% 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 June 30, 2003, the Bank had a total approved credit line with the FHLB of San Francisco totaling $632.48 million, of which $630.14 million was approved credit for terms over five years.  The total credit outstanding with the FHLB of San Francisco at June 30, 2003, was $90.00 million including $40.00 in overnight federal funds.  The remaining $50.00 million 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.  In addition, in June 2003, Cathay Bancorp completed the issuance of $20.00 million of trust preferred securities maturing in 2033.  The trust preferred securities have a variable interest rate and are non-callable during the first five years.  The securities are redeemable, in whole or in part, once each year, beginning five years after their issuance.

 

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 June 30, 2003, such assets at fair value totaled $923.56 million, with $255.39 million pledged as collateral for borrowings

 

29



 

and other commitments. The remaining $668.17 million was available as additional liquidity, of which $654.17 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 June 30, 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, 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.

 

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 June 30, 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 June 30, 2003, with a gap ratio of a positive 24.77% within three months and a positive cumulative gap ratio of

 

30



 

5.09% 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.

 

 

 

June 30, 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

 

$

1,790

 

$

 

$

 

$

 

$

61,732

 

$

63,522

 

Federal funds sold and securities purchased under agreements to resell

 

14, 000

 

 

 

 

 

14,000

 

Securities available-for-sale (1)

 

65,185

 

40,395

 

292,592

 

511,385

 

 

909,557

 

Loans receivable, gross (2)

 

1,519,469

 

49,015

 

84,356

 

297,328

 

 

1,950,168

 

Non-interest-earning assets, net

 

 

 

 

 

75,383

 

75,383

 

Total assets

 

$

1,600,444

 

$

89,410

 

$

376,948

 

$

808,713

 

$

137,115

 

$

3,012,630

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

$

 

$

 

$

 

$

 

$

320,723

 

$

320,723

 

Money market and NOW deposits (3)

 

13,937

 

49,267

 

135,969

 

132,404

 

 

331,577

 

Savings deposit (3)

 

12,446

 

66,605

 

150,385

 

80,558

 

 

309,994

 

TCDs under $100

 

271,986

 

150,726

 

17,745

 

 

 

440,457

 

TCDs $100 and over

 

515,895

 

357,176

 

169,057

 

 

 

1,042,128

 

Total deposits

 

814,264

 

623,774

 

473,156

 

212,962

 

320,723

 

2,444,879

 

Federal funds purchased and securities sold under agreements to repurchase

 

40,000

 

28,500

 

84,000

 

 

 

152,500

 

Advances from FHLB

 

 

30,000

 

20,000

 

 

 

50,000

 

Trust preferred securities

 

 

 

 

19,701

 

 

19,701

 

Non-interest-bearing other liabilities

 

 

 

 

 

30,383

 

30,383

 

Stockholders’ equity

 

 

 

 

 

315,167

 

315,167

 

Total liabilities and stockholders’ equity

 

$

854,264

 

$

682,274

 

$

577,156

 

$

232,663

 

$

666,273

 

$

3,012,630

 

Interest sensitivity gap

 

$

746,180

 

$

(592,864

)

$

(200,208

)

$

576,050

 

$

(529,158

)

 

Cumulative interest sensitivity gap

 

$

746,180

 

$

153,316

 

$

(46,892

)

$

529,158

 

 

 

Gap ratio (% of total assets)

 

24.77

%

(19.68

)%

(6.65

)%

19.12

%

(18.22

)%

 

Cumulative gap ratio

 

24.77

%

5.09

%

(1.56

)%

17.56

%

%

 

 


(1)          Includes $3.88 million of venture capital investments and $20.73 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 $27.67 million, unamortized deferred loan fees of $5.14 million and $4.12 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 of the loans.

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

 

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

 

31



 

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 June 30, 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 5.7%, 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 10.4%.  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 3.8%, 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 8.8%.

 

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 June 30, 2003, the Company was within such guidelines.

 

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 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

 

32



 

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 June 30, 2003, was approximately seven quarters.  At June 30, 2003, the fair value of the interest rate swap, excluding accrued interest, was $1.97 million, or $1.01 million net of tax compared to $2.27 million, or $1.19 million net of tax, at December 31, 2002.  For the six months ended June 30, 2003, net amounts totaling $589,000 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 $1.24 million.

 

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 13(a)-15(e) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) as of the end of the period covered by this quarterly report.  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 has not been any change in our internal control over financial reporting, that occurred during the fiscal quarter covered by this report, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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.

 

33



 

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

 

An annual meeting of stockholders of Cathay Bancorp, Inc. was held on April 21, 2003 for the purpose of considering and acting upon the following:

 

Election of Directors:  Four directors were elected as Class I directors to serve until the 2006 Annual Meeting and the votes cast for or withheld were as follows:

 

 

 

FOR

 

WITHHELD

 

AGAINST

 

BROKER
NON-VOTE

Michael M.Y. Chang

 

14,108,589

 

192,456

 

None

 

None

Patrick S.D. Lee

 

14,109,368

 

191,617

 

None

 

None

Anthony M. Tang

 

14,088,611

 

212,433

 

None

 

None

Thomas G. Tartaglia

 

13,527,000

 

774,045

 

None

 

None

 

Other Directors whose terms of office continued after the meeting:

 

Term ending in 2004 (Class II)

 

Term ending in 2005 (Class III)

 

 

 

Ralph Roy Buon-Cristiani

 

George T.M. Ching

Kelly L. Chan

 

Wing K. Fat

Dunson K. Cheng

 

Wilbur K. Woo

Joseph Chi-Hung Poon

 

 

 

ITEM 5.  OTHER INFORMATION

 

Not applicable.

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

Exhibits:

 

Exhibit 31.1  Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

34



 

Exhibit 31.2  Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Exhibit 32.1  Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Exhibit 32.2  Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Reports on Form 8-K:

 

A Form 8-K, reporting under Item 12, was filed on April 17, 2003, announcing the Company’s first quarter 2003 financial results.  A Form 8-K, reporting under Item 5, was furnished on May 7, 2003, announcing the definitive agreement providing for the merger of GBC Bancorp into the Company; on June 23, 2003, announcing the appointment of Mr. Heng W. Chen as Executive Vice President and Chief Financial Officer of the Company; and on June 27, 2003, announcing the completion of an offering of $20.00 million of trust preferred securities.

 

 

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:  August 14, 2003

By

/s/ DUNSON K. CHENG

 

 

Dunson K. Cheng

 

Chairman and President

 

 

 

 

Date:  August 14, 2003

By

/s/ HENG W. CHEN

 

 

Heng W. Chen

 

Chief Financial Officer

 

35