Cathay General Bancorp

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Cathay General Bancorp is a bank holding company primarily serving the Chinese-American community in Southern California, with a growing presence in other areas. They offer a wide array of financial services focusing primarily on lending.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Cathay General Bancorp operates as a diversified commercial bank, primarily catering to the Chinese-American community in the United States, with a significant presence in California. They offer a broad spectrum of financial products and services, with a focus on real estate lending. The Bank operates through many branches spread across California, New York, Washington, Illinois, Texas, Maryland, Massachusetts, Nevada, New Jersey, and Hong Kong and the bank’s commercial loan book are diversified geographically. They serve individuals, professionals, and small to medium sized businesses. They provide real estate loans, commercial loans, installment loans, and other loans, while offering deposit accounts such as savings, checking, and money market accounts.

Revenue Distribution

The bank generates revenue mainly from:

  • Net Interest Income: This is derived from the difference between interest earned on loans and the interest paid on deposits and borrowings.
  • Fee and Commission Income: Income from services like Wealth Management, Brokerage and transaction advisory.
  • Trading Income: Income from their trading division.

In recent times, banks have been shifting from net interest income to fee and commission income, which is a great indicator of how they diversify.

The banking industry is experiencing a consolidation trend and also facing headwinds from the current rising rates and the possibility of economic slowdown.

  • Economic Cycle: Banks are naturally cyclical as their performance and profitability is tied to the economic cycle.
  • Rising Rates: Increase the cost of debt, which is essential for bank profitability
  • Tech disruption: Fintech startups have entered the banking world and are applying technology to make it leaner and more effective for customers.

Margins

The net interest income is often the main profit generating segment for a bank but in the case of CATY we see that they are actually trying to diversify into other segments which are better at the moment.

The bank has been trying to diversify its source of income. The bank has a net interest margin that is sensitive to changes in interest rates due to the high percentage of floating-rate loans in the portfolio.

Competitive Landscape

The banking industry, in general, is fiercely competitive. Cathay General Bancorp is in competition with many other commercial banks and non-banking financial firms.

  • Large Banks: The company faces tough competition from large national and international banks, which can offer a wider variety of products and more favorable interest rates.
  • Fintechs: Fintech startups are challenging traditional financial institutions by providing alternative financial solutions that might not require a branch.

The bank’s competitive strategy is to focus on serving the Chinese-American community, by offering tailored solutions and a personal relationship with their customers.

What Makes the Company Different?

  • Customer Focus: The bank positions itself as providing banking products tailored to the Chinese-American community and offers them a personalized experience.
  • Geographic Reach: Its strong foothold in key Chinese-American communities across the U.S. makes them more competitive.
  • Long Established Brand: The bank is one of the largest bank holding companies founded by Chinese Americans.

Financials In-Depth

Here’s an overview of some significant points based on the latest filings.

Key points from recent quarterly (Q3 2024) report

Net income increased to $184.4 million in the third quarter of 2024, or $1.33 per diluted common share, compared with $163.9 million in the third quarter of 2023. This increase is primarily due to increased net interest income, non-interest income, and a reduction in credit losses.

  • Loans: Total loans were $19.4 billion in the third quarter of 2024, a decrease of 0.6%, mostly because of a reduction in construction and land loan balance. The main loan component still remains commercial real estate at $7.9 billion.
  • Deposits: Total deposits stood at $20.4 billion as of September 30, 2024. Interest rates paid on time deposits and interest-bearing deposits increased during the quarter by 10 basis points each.
  • Net Interest Income: Net interest income increased from $283.8 million last year to $335.2 million due to increases in the rates earned on loans.
  • Non-interest income: Noninterest income decreased from $30.6 million to $24.7 million, largely because of a $6.8 million decrease in net gains from the sale of investment securities.

Recent Concerns and Controversies

  • The bank is anticipating a rise in credit losses as the Federal Reserve is projecting a “soft landing” for the economy and the possibility of economic stagnation. Management acknowledged that while they have maintained strong credit quality, a future economic downturn could result in loan losses for the bank.
  • They are also actively managing their liability portfolio to increase deposit gathering. They are continuing their branch expansion and focusing on new strategies for deposit generation.
  • The management mentioned that the margin is being impacted and that they will try to reduce reliance on wholesale deposits in the future.

Moat: 2/5

While Cathay General Bancorp has a strong position within its niche market, it does not have a very wide economic moat. The bank’s strengths are:

  • Customer relationships and reputation among the Chinese-American community. This offers a form of customer captivity that is somewhat sticky.
  • Geographic Concentration in key regions which gives the bank local knowledge and operational efficiencies.
  • Strong management team which seems to have a plan for the future.

However, these strengths are not unique and can be replicated by competitors, resulting in a narrow moat.

Their key weakness is that they do not have strong switching costs which means their profitability is largely dependent on the interest rate conditions.

The moat rating is 2/5 for a narrow moat

Legitimate Risks that Could Harm the Moat and Business Resilience

  • Interest Rate Risk: Being a lender means the company’s main profit generator depends on interest rates, a rise or fall in which could affect the business severely. While they are actively trying to diversify, their current margins are not that strong.
  • Economic Slowdown: If there are prolonged recessions or economic slowdowns, the bank may incur more credit losses which can impair their profitability. This has been the main concern of the management.
  • Regulatory Risks: The banking industry is prone to many regulations and any new regulations could make the business landscape significantly different.
  • Intensifying competition: They face competition from both larger banks and more agile fintechs which means they need to be continuously innovative and adapt to changes in consumer behavior.
  • Cyber Security & Data Breaches Since they are a financial institution, the bank can face significant reputational and financial risks if any of their data is exposed or if there are any data breaches.

Despite these risks, the bank’s strong focus on their primary market and improving their customer relationships can give it the resilience to tackle these headwinds.

Understandability: 3/5

The business of Cathay General Bancorp is relatively complex. While its core operations—taking deposits and lending loans—are straightforward, the intricacies of the banking industry, including accounting policies, financial regulations, interest rate management, credit risk assessment, and more mean it’s not a simple business to understand. There is also a considerable amount of data provided by the bank which are difficult to interpret for people who have less knowledge of the sector, and all of this makes the business difficult to comprehend. Understandability: 3/5

Balance Sheet Health: 4/5

Overall the balance sheet is quite strong, with high cash deposits and stable equity levels. However they have higher level of risk from non-performing assets.

Here are some key points:

  • Debt: The total debt stood at $4.88 billion as of September 30, 2024.
  • Cash and cash equivalents: Cash and cash equivalents were $7.2 billion for the same period.
  • Loan Portfolio: The bank’s commercial real estate loan book makes up 49% of the total loan portfolio.
  • Non-performing assets: Non-performing assets were $192.5 million, up 12% from 156.2 million, from the previous quarter.
  • Tier 1 capital: 15.2%
  • Leverage Ratio: 9.2%

Overall, their balance sheet looks healthy, but does have concerns regarding loan quality and the increasing competition. Balance sheet health: 4/5