Good afternoon, ladies and gentlemen, and welcome to Cathay General Bancorp's third quarter of 2023 earnings conference call. My name is Rocco, and I will be your coordinator for today. At this time, all participants are in listen-only mode. Following the prepared remarks, there will be a question and answer session. If you would like to participate in this portion of the call, please press star followed by one at any time during the conference. If assistance is needed any time during the call, please press star followed by zero, and a coordinator will be happy to assist you. Today's call is being recorded and will be available for replay at www.cathaygeneralbancorp.com. I would now like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp. Please go ahead.
Thank you, Rocco, and good afternoon. Here to discuss the financial results today are Mr. Chang Liu, our President and Chief Executive Officer, and Mr. Heng Chen, our Executive Vice President and Chief Financial Officer. Before we begin, we wish to remind you that the speakers on this call may make forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 concerning future results and events, and that these statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are further described in the company's annual report on Form 10-K for the year ended December 31st, 2022, at Item 1A in particular, and in other reports and filings with the Securities and Exchange Commission from time to time.
As such, we caution you not to place undue reliance on such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and except as required by law, we undertake no obligation to update or review any forward-looking statements to reflect future circumstances, developments or events, or the occurrence of unanticipated events. This afternoon, Cathay General Bancorp issued an earnings release outlining its third quarter 2023 results. To obtain a copy of our earnings release as well as our earnings presentation, please visit our website at www.cathaygeneralbancorp.com. After comments by management today, we will open up this call for questions. I will now turn the call over to our President and Chief Executive Officer, Mr. Chang Liu.
Thank you, Georgia, and good afternoon, everyone. Welcome to our 2023 third quarter earnings conference call. This afternoon, we reported net income of $82.4 million for the third quarter of 2023, an 11.6% decrease as compared to a net income of $93.2 million for the second quarter of 2023. Diluted earnings per share decreased 11.8% to $1.13 per share for the third quarter of 2023, compared to $1.28 per share for the second quarter of 2023.
In the third quarter of 2023, our gross loans increased $71 million, or 1.6% annualized, primarily driven by increases of $218 million, or 9.9% annualized in commercial real estate loans and $143 million or 10.9% annualized in residential mortgage loans, offset by a decrease of $227 million or 27.4% annualized in commercial loans. The slower loan growth during the third quarter resulted in part from paydown of several large commercial loans originated in the second quarter of 2023. We continue to monitor our commercial real estate loans. Turning to slide 7 of our earnings presentation, as of September 30, 2023, the average loan to value of our commercial real estate loans was 50%.
As of September 30, 2023, our retail property loan portfolio at slide eight comprises 23% of our total commercial real estate loan portfolio, or 11% of our total loan portfolio. 89% of the $2.2 billion in retail loans is secured by retail store, building, neighborhood, mixed use or strip centers, and only 10% is secured by shopping centers. At slide nine, office property loans represent 16% of our total commercial real estate loan portfolio, or 8% of total loan portfolio. Only 34% of the $1.5 billion in office property loans are collateralized by pure office buildings, and only 4% of the office property loans are in central business districts. Another 25% of office property loans are collateralized by office retail stores, office mixed use, and medical offices.
The remaining 28% of office property loans are collateralized by office condos. For the third quarter of 2023, we reported net charge-offs of $6.6 million, of which $4.3 million had been reserved for in prior quarters, compared to net charge-offs of $2 million in the second quarter of 2023. Our non-accrual loans were 0.41% of total loans as of September 30, 2023, which increased by $8.3 million to $77.3 million as compared to the end of the second quarter of 2023. Turning to slide 12, as of September 30, 2023, classified loans increased slightly to $202 million from $193 million as of June 30, 2023.
Our special mention loans also increased slightly to $278 million from $260 million as of June 30, 2023. We recorded a provision for credit loss of $7 million in the third quarter of 2023, as compared to a $9.2 million in provision for credit losses for the second quarter of 2023. We are pleased that total deposits increased by $539 million, or 11.6% annualized during the third quarter of 2023. As a result, we were able to reduce our borrowings from Federal Home Loan Bank by $800 million during the quarter to $15 million as of September 30, 2023....
Total uninsured deposits were $9 billion, but excluding $0.8 billion in collateralized deposits, the uninsured and uncollateralized deposits were reduced to $8.2 billion or 41.7% of total deposits as of September 30, 2023. Our unused borrowing capacity from the Federal Home Loan Bank was $7.2 billion and unplaced securities was $1.4 billion. These sources of available liquidity were more than 100% of uninsured and uncollateralized deposits as of September 30, 2023. Total time deposits increased $237 million, or 31.2% annualized during the third quarter of 2023 compared to the second quarter of 2023. Total core deposits increased by $301 million, or 10.5% annualized, primarily due to organic growth and seasonal increases.
I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the third quarter 2023 financial results in more detail.
Thank you, Chang, and good afternoon, everyone. For the third quarter of 2023, net income decreased by $10.8 million, or 11.6% to $82.4 million, compared to $93.2 million for the second quarter of 2023, primarily due to a $6.2 million unrealized loss on equity securities, or $0.06 per share in the third quarter of 2023, as compared to a $10.7 million unrealized gain on equity securities or $0.10 per share in the second quarter of 2023. Our net interest margin was 3.38% in the third quarter of 2023, as compared to 3.44% for the second quarter of 2023.
In the third quarter of 2023, interest recoveries and prepayment penalties added 6 basis points to the net interest margin, as compared to 2 basis points for the second quarter of 2023. We have revised our net interest margin expectations for 2023 to be between 3.45%-3.50%. Non-interest income during the third quarter of 2023 decreased by $15.3 million to $7.8 million, when compared to $23.1 million in the second quarter of 2023. The decrease was primarily due to a $16.9 million decrease in annualized gains on equity securities, offset in part by a $1.5 million increase in commissions from wealth management when compared to the second quarter of 2023.
Non-interest expenses increased by $1.2 million, or 1.2% to $94 million in the third quarter of 2023, when compared to $92.8 million in the second quarter of 2023. The increase was primarily due to $1.7 million in higher salaries and benefits and $1.4 million in higher amortization of new Solar Tax Credit Investments, offset by $1 million in lower professional expenses. As a result of expenses incurred in 2023 to strengthen the bank's information security infrastructure, enterprise risk management and from higher FDIC insurance premiums, we expect core non-interest expense, excluding tax credit and core deposit intangible amortizations and OREO expense to increase between 8.5%-9.5% from 2022 to 2023.
This excludes the impact of any special FDIC assessment for bank failures expected to be finalized during the fourth quarter of 2023. During the first nine months, approximately $3 million in non-recurring professional expenses related to information security, enterprise risk management and internal control processes were incurred. In addition, we're taking a hard look in our other expenses during the fourth quarter of 2023 to reduce the rate of non-interest expense growth in 2024. The effective tax rate for the third quarter of 2023 was 11%, as compared to 9.2% for the second quarter of 2023. For full year 2023, we expect an effective tax rate of between 12.5% and 13%. We expect solar tax credit investment amortization of $12 million in Q4 of 2023.
As of September 30, 2023, our Tier 1 leverage capital ratio decreased to 10.44%, as compared to 10.45% as of June 30, 2023. Our Tier 1 risk-based capital ratio increased to 12.7% from 12.38% as of June 30, 2023, and our total risk-based capital ratio increased to 14.21% from 13.88% as of June 30, 2023.
Thank you, Heng. We will now proceed to the question and answer portion of the call.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. We ask that you please limit yourself to one question and one follow-up question. You may then return to the queue. If your question has been answered or you wish to remove yourself from the queue, please press star then two. To prevent any background noise, we ask that you please place yourself on mute once your question has been stated. Your first question today comes from Matthew Clark at Piper Sandler. Please go ahead.
Hey, good afternoon.
Hi.
Just a couple of questions around the margin. Did you have any I guess I was looking to quantify the prepay, prepay fees and any recoveries in the loan yield. It looked like the loan yield was up a little more, up about 20 basis points, this quarter. Just wondering if anything was kind of elevated on that front?
Well, we had about $2 million of interest recoveries. Yeah, as I mentioned, it was six basis points of NIM, but-
Okay.
- the rest of it would be just, improved pricing for loans.
Got it. I think you had about $1 million last quarter. Is that right?
A little less than that.
Is that right?
Yes.
Okay, I can come back to that later. And then if you have the spot rate on, spot rate on deposits, interest bearing or total, and the average margin in the month of September?
Yeah. Let me go through. So the spot rate at September thirtieth on total interest-bearing deposits at the end of the month was 3.28. What was the next part of the question, Matt, Matthew?
If you had the average, average margin in September, I'd take it.
Yeah. The average, you know, it's a little bit noisy because we had interest recoveries throughout the quarter, but it was 3.42.
Okay. Understood.
For the month of September. Yes.
Okay, great. And then just maybe one more housekeeping item, and I'll get back in the queue. The low-income housing amortization for the year, I know you gave solar, but, is it still about $41 million?
Let's see, yes. Yes.
Okay. Thank you.
Thank you.
Our next question today comes from Gary Tenner at D.A. Davidson. Please go ahead.
Thanks. Heng, first I had a question on expenses. I may have misheard what you were saying in terms of the expected core expense run rate. I heard 8.5%-9.5%, which I thought you were saying for 2023, but you said it excluded any potential FDIC special assessment. So now I was confused if you were talking about 2023 or 2024.
We're talking about 2023. As you know, there's a proposal that's not final, and under GAAP, whenever it's finalized, banks are expected to accrue it.
Okay. All right. Thank you. I just was wanting to clarify that. In terms of the loan pipeline, at your guidance, still, it looks like it suggests, you know, still a solid level of loan growth through the fourth quarter. I just wonder if you could give any kind of updates in terms of kind of where the pipeline strength is coming from, you know, areas that you'd expect loan growth to kind of continue through the fourth quarter.
Sure, Gary. I think we're still seeing some strength, surprisingly, in the residential mortgage market. That pipeline is holding up pretty well, and about 90% of that organic pipeline is about purchases, actually. So, that kind of makes sense given today's market. So the activity there is still fairly strong across the states that we're in. Commercial real estate is, you know, definitely slowing down, but we're still seeing continued activity, both from mostly from our current client base. Some new relationships, but that we're vetting very carefully. And then on the C&I side, you know, we're looking for, you know, kind of really supporting our clients and looking at their credit metrics, and make sure they're prepared going forward into 2024.
Not a lot of new activity coming out of that or new business coming in, but to the extent that we find some good prospects, we're definitely continuing on with that path.
Thanks. I appreciate that. And just one last question. I think in the prepared remarks, there was a note of some larger commercial loans that were originated in the second quarter, paid off during the third quarter. Were those anticipated payoffs? Forgive me if you had talked about it previously, and I don't recall.
They were commercial lines of credit that were drawn down during the second quarter, and we got some pay downs, not payoffs, but pay downs during the third quarter.
Yeah, and one of those borrowers borrowed again here in October.
Okay. Thanks very much.
Thank you. And our next question comes from Brandon King at Truist Securities. Please go ahead.
Hey, good evening.
Hi.
So just wanted to get how you're thinking about deposit growth, near term in the fourth quarter? And also, could you give some context around the growth you saw in DDA and how you expect DDA trends or non-stream deposit trends to play out, in the fourth quarter?
Yeah. We were pleasantly surprised at the amount of deposit growth in the third quarter. There may be- I mean, there's a small amount that was temporary. We had a customer that deposited, was gonna, you know, some money and pending another, pending a real estate purchase and that deposit. It's a money market that will go out in October, late October. But I think the DDA trend. It's- there's nothing special there.
It's really a collective effort, I think, of our kind of network, retail network. And they know that, you know, bringing in CDs and retaining them, that's part of the job. But really the key is driving the DDA deposits, and we're getting hit enough as it is on the cost of funds on the CDs, even the money markets. But the DDA growth is really where we need to concentrate into in order to offset some of that cost increase just on our funds.
Got it. And for that outflow, how much of that are you expecting to outflow in the fourth quarter?
On that one? It was $65 million.
Okay. You say that was the money market?
Yeah.
Okay.
It was the money market, yes. It's a long-term deposit. Yeah.
Okay. Okay. And then going back to the question on loan yields, how are you expecting that to trend near term? Are you expecting kind of a similar sort of increase in the fourth quarter? What are your expectations?
We think so. I mean, one thing that we see is in residential mortgage, yeah, that's very large. It's our residential mortgage, it's almost $6 billion, and it's been for each of the three quarters in 2023, that pool of loans set has gone up 20 basis points every quarter. So in the third quarter, residential mortgage is 4.96%. We're banking a couple hundred million in loans every quarter, $250 or so in the almost 7% range. So that pulls it up, and we continue to see prepayments from our three-one and five-one arms. They tend to pay off when they get, when they finish the initial fixed rate period. And then I mean, on CRE, we're trying to get in the sevens.
Right. CRE, we're pricing them at about 2.50+, if we can get them over the 5-year with the 3-year. So that's kind of the rate range that we're looking at. We're still seeing some activity, some purchases, some refinance from floating rate, but so we're seeing some steady.
Got it. Got it. And then just to kind of sum up, you, you expect kind of a similar increase in the fourth quarter. Is that, did I hear that correctly?
You know.
Probably pretty close to what we had in the third quarter.
Okay.
Yes. Yep.
Okay. Okay, great. Okay. I'll hop back in the queue. Thanks for taking my questions.
Thank you.
Thank you. Our next question today comes from Andrew Terrell with Stephens. Please go ahead.
Hey, good afternoon.
Hello, Andrew.
Just, maybe just square out the discussion on the loan yields, up 20 basis points this quarter, but that did include the impact from the interest recovery or prepayment. That was 2 basis points to the NIM last quarter, 6 basis points this quarter. I guess, are you assuming that the prepay or interest recovery continues at 6 basis points to the margin whenever you talk about loan yields going up a similar amount in 4Q, or should that normalize lower going forward?
Yeah, it should. We don't see any big non-accruals paying off. So you just subtract, you know, maybe $1.5 million from that. Yeah, for the one-time non-accrual gains.
Understood. Okay. I appreciate it. And then on, on credit quality, I just want to ask around the, the construction non-accruals went up from 0 to, I think, right around $17 million or so. Can you just talk about the, the underlying credit or credits that, that drove that increase this quarter? And then similar question for the, the OREO addition this quarter. It looks like about $10 million addition to the OREO asset.
Sure. On the construction portfolio side, I can talk about that a little bit. One of them was a Southern California, Inland Empire hospitality. It was an existing asset with a reflag, reposition, with some significant renovation to the property. We're at plus 90% to completion. There's some. As a result of some significant delays, there's a partner dispute between the partnership. We're pretty comfortable with the asset. It's got a pretty low LTV. It's well located. It's got a good operating history. Unfortunately, that partnership dispute has led us to where we are.
Yeah, that's because that loan became 90 days past maturity.
Right.
That's why we had to put on non-accrual.
The other is a NorCal office building. We've got a buyer that's been identified, and we've got some reserve that's set against it, and that one was also sort of a reposition play there as well.
And then the OREO is a single-family house in Pacific Palisades. It came out of non-accrual.
Right.
Okay. Understood. I appreciate all the color there. And then if I could sneak one more in. The wealth management fee income this quarter was really strong. Can you just talk about what drove the lift this quarter? And then is that low $5 million a quarter number kind of a good run rate to think about the wealth management fees moving forward?
There's still I'll take a stab at it. There's still kind of on budget for this year. I think the first half of the year, and they were kind of behind budget, so effectively it was kind of the third quarter catch up on some of their business and volume and their backlog of the pipeline. And so I think that's really where we saw that pickup.
Yeah, I think fee volume. There's a lot of deals that close in the third and fourth quarter.
Okay. So maybe a fair way to think about it is more on an annual basis around, like, an $18 million number?
Let me see. Yeah. Yeah. Yeah.
Okay. Well, thank you for taking the questions. I appreciate it.
Thanks.
And as a reminder, if you'd like to ask a question, please press star then one. Today's next question comes from Chris McGratty at KBW. Please go ahead.
Hi, this is Nick Bottecher on for Chris.
Oh, hi. Hi, Nick.
Maybe just on a higher level, just given where capital levels are at and your stock price, you know, any appetite at all for a buyback in the near term, the next 12 months or so?
Oh, absolutely. We talked about it briefly in our second quarter conference call. The approval process takes a little bit longer than compared to the past, but in the next few months, we'll get going on it. Once it's approved by the Fed, we'll put out a press release. But it's the way I look at it, you know, it's the capital builds up over there, so we can catch up with buybacks when things are more certain.
Okay. And then maybe just on the tax rate as well. If you look out longer term into 2024, do you think the 12.5%-13% tax rate for next year is a good run rate as well?
It's probably a little low. We had 2 solar tax credit funds that overlapped this year. And then next year, we'll have some runoff from the second fund that we give, and then we'll go into a new one. But it should go up a little bit. We'll give guidance when we in January for 2024.
Okay.
If you're modeling to the extent that the tax rate is higher, the solar amortization is lower, you know, almost dollar for dollar.
Okay. Thank you for taking my questions.
Thank you. Our next question is a follow-up from Matthew Clark at Piper Sandler. Please go ahead.
Hey, thank you. Can you remind us what your SNC exposure is, Shared National Credits?
It's less than 5% of our total loans, Matthew.
Okay, got it. And then, I'm asking, I guess, an update on office CRE and the related reserve and any amount that might be criticized. I'm assuming the reserve is consistent with the commercial real estate reserve, but not sure if you guys tweaked anything this quarter. But again, the reserve and the amount criticized.
Well, our office reserve is. We're reserving it at about 85 basis points. What was the other part of your question? Oh, the amount that's criticized? I don't have that handy. I can tell you, in non-accruals, we have, I think, about $10 million in CRE, and that's office.
Okay. Okay. Thank you.
Thank you.
Thank you for your participation. I will now turn the call back over to Cathay General Bancorp's management for closing remarks.
I'd like to thank everyone for joining us on our call, and we look forward to speaking with you at our next quarterly earnings release call.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.