Despite my previous concerns about Cathay General’s (CATY) declining net interest income, the situation has not improved in the last few months. The market currently anticipates only one rate cut in early 2024, contributing to CATY’s rising cost of deposits.
The high Loan to Deposit ratio limits the bank’s ability to issue new debt to offset increasing interest expenses. These factors warrant a ‘sell’ recommendation, especially if upcoming inflation data exceeds expectations.
CATY’s loan portfolio reached $19.50 billion in Q1 2024, reflecting a 3.50% increase. CRE loans continue to dominate the portfolio, comprising 51%, despite a recent drop in commercial real estate prices. Additionally, 15% of the $9.80 billion in CRE loans are tied to office buildings.
The bank’s CRE concentration ratio is approaching the maximum recommended threshold of 300%, raising concerns about excessive exposure to this sector. While the average Loan to Value ratio for these loans is 50%, the potential for significant value declines in commercial real estate during a recession remains a risk. This could impact the income statement if credit quality deteriorates.
The commercial property price index has been falling since 2022, and there are indications that the bottom has yet to be reached. Management expresses confidence in the quality of its loans but acknowledges the need to monitor the situation closely. While there are currently no signs of credit deterioration, it is anticipated towards the end of 2024.
The high Loans to Deposit ratio limits the bank’s ability to sustain net loan growth. The ratio has remained elevated since last year, and there are limited options to increase deposits. As a result, the loan composition is likely to remain unchanged, with yields potentially varying slightly.
Fixed-rate and hybrid loans account for 64% of the total, with the remaining tied to market rates. In Q1 2024, total loans averaged a yield of 6.24%, a mere 3 basis point increase. CRE loans have already experienced a 5 basis point decrease in average yield, suggesting that the potential for further yield increases is limited.
However, the cost of deposits has room to rise. Total deposits declined by 1% in Q1 2024, with a shift towards more expensive time deposits. As a result, the cost of total deposits increased to 3.14%, leading to a significant decline in net interest margin. Net interest income also fell by 7.40% from the previous quarter.
While CATY is considered a sound bank, its current characteristics are not well-suited to the macroeconomic environment. The high Loan to Deposit ratio and the cost of deposits are major concerns. Management’s ability to address these issues is limited, and the role of the Fed’s rate cuts becomes crucial in providing some relief.
The market expects only one rate cut in 2024, while CATY’s performance is negatively correlated with the number of anticipated cuts. Management anticipates cuts in September and December but acknowledges the possibility of one less cut. If management’s guidance proves inaccurate, the NIM could face further downward revisions.
CATY’s significant exposure to CRE loans requires close monitoring. An economic slowdown could result in credit deterioration and impact profitability. Overall, the analyst recommends caution and suggests considering other investment options amid the current market conditions.
