Talk about a strange brew.
Cathay General Bancorp in Los Angeles was hit by an enforcement action in December, tapped the equity markets this week and is now contemplating expansion.
The $11.6 billion-asset company said it lined up as much as $132.25 million of new capital this week, which would bring the total raised over the past 13 months to roughly $250 million.
That money would help Cathay satisfy a memorandum of understanding the Federal Reserve Board issued in December as well as work through problem loans.
Heng Chen, Cathay's chief financial officer, said the capital could also help it do some deals.
"In our market there has been quite a bit of customer dislocation because of weak and failed banks," Chen said. "We are seeing more new business and it is possible we may have an acquisition in the future — not short term, but longer term."
One notable example of this dislocation is the failure of the $11.2 billion-asset United Commercial Bank in San Francisco, which was acquired by East West Bank in Pasadena, Calif.
Observers expect Cathay to win customers turned off by the deal, especially now that Cathay appears to be getting its problem loans under control.
In the fourth quarter, Cathay's nonaccrual loans fell 22%, to $280.6 million, from the third quarter. Other real estate owned fell 19%, to $71 million. The ratio of nonperforming assets plus loans 90 days past due to total assets fell 95 basis points, to 3.51%.
Cathay was considered "well capitalized" by regulatory standards before this week's announced capital raise. At yearend 2009, Cathay reported a Tier 1 risk-based capital ratio of 13.55%, a total risk-based capital ratio of 15.43% and a leverage ratio of 9.64%.
In its Dec. 17 MOU, the Fed required Cathay to come up with a plan to maintain sufficient capital. It also required Cathay to devise new policies for dividends and liquidity.
So why are investors buying when regulators are criticizing Cathay?
Brett Rabatin, an analyst with Sterne, Agee & Leach Equity Research, said regulators often fixate on what has happened while investors focus on potential future performance. In other words, where regulators saw problems and a need for more capital because of Cathay's problem loans, investors saw growth potential.
"The MOU is partially in place to reflect the things that happened in 2009," he said. "We are in 2010 and Cathay has been addressing credit quality. There is a bit of a disconnect. The regulators obviously had an opinion about things that are somewhat backward looking with the knowledge that if they add capital then Cathay has better prospects ahead."
While Cathay has worked through many of the problems in its construction loan portfolio, commercial real estate problems have been mounting.
According to a report from D.A. Davidson & Co., residential construction loans were 70% of the company's inflow of nonperforming assets near the beginning of 2009, and now roughly 70% of the inflow of nonperforming assets are in the commercial real estate portfolio. Commercial real estate represents almost 60% of Cathay's total loan portfolio.
With commercial real estate problems expected to persist, analysts said the additional capital will help Cathay work through troubled credits.
In the fourth quarter, Cathay raised a total of $88.7 million of new capital, bringing the total for 2009 to $120 million. On Monday the company said it would raise $100 million, plus underwriters had a 15% option, but on Tuesday Cathay expanded the offer to $115 million. The total amount raised with the underwriter's option is $132.25 million.
Chen said Cathay was thrilled by the response and has no near-term plans to raise any more capital.
"It is pretty rare for a bank our size to launch and price on an overnight basis," he said. "That usually requires more marketing."
Rabatin said the capital raise "sets them up to continue to be aggressive in addressing credit quality and takes care of their capital needs."
"It may not position them to do a big FDIC transaction, but they are headed in the right direction from that perspective as well," he said. "They want to be an acquiring and growth company again, as opposed to playing defense."
Despite the MOU, several analysts agreed that Cathay could become a failed-bank acquirer.
Typically, an MOU prevents companies from activities like acquisitions. But with the added capital and because there are few Chinese-American banks able to do failed-bank acquisitions, the Federal Deposit Insurance Corp. may turn to Cathay.
"They operate in a very small banking niche," said Chris Stulpin, an analyst with D.A. Davidson. "If any other Chinese-American bank failed, I think there aren't many options where the failed bank would go. Cathay would be an option."
Regulators have been much more active issuing enforcement actions in the past year, and very few banks have been able to satisfy regulators' concerns and get the orders lifted. In 2009, regulators issued 450 enforcement actions, up from 111 in 2008, according to Carson Medlin Co.
But Aaron James Deer, an analyst with Sandler O'Neill & Partners LP, said Cathay's enforcement order could be lifted after its next exam at midyear. "Given this additional capital and if we continue to see improving credit trends, the MOU could be lifted," he said.