Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007
 
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 GENERAL BANCORP
(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 R  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer R 
Accelerated filer ¨
Non-accelerated filer ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨  No R
 
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, 49,816,286 shares outstanding as of October 31, 2007.
 
1

CATHAY GENERAL BANCORP AND SUBSIDIARIES
3RD QUARTER 2007 REPORT ON FORM 10-Q
TABLE OF CONTENTS


PART I - FINANCIAL INFORMATION
4
   
Item 1. FINANCIAL STATEMENTS (Unaudited)
4
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
17
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
40
Item 4. CONTROLS AND PROCEDURES
41
   
PART II - OTHER INFORMATION
41
   
Item 1. LEGAL PROCEEDINGS
41
Item 1A.RISK FACTORS
42
Item 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
42
Item 3. DEFAULTS UPON SENIOR SECURITIES
43
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
43
Item 5. OTHER INFORMATION
43
Item 6. EXHIBITS
44
   
SIGNATURES
45
 
2
 
Forward-Looking Statements
 
In this quarterly Report on Form 10-Q, the term “Bancorp” refers to Cathay General Bancorp and the term “Bank” refers to Cathay Bank. The terms “Company,” “we,” “us,” and “our” refer to Bancorp and the Bank collectively. The statements in this report include forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 regarding management’s beliefs, projections, and assumptions concerning future results and events. These forward-looking statements may include, but are not limited to, such words as "believes," "expects," "anticipates," "intends," "plans," "estimates," "may," "will," "should," "could," "predicts," "potential," "continue," or the negative of such terms and other comparable terminology or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such risks and uncertainties and other factors include, but are not limited to adverse developments or conditions related to or arising from: 
 
·
expansion into new market areas;
 
·
acquisitions of other banks, if any;
 
·
fluctuations in interest rates;
 
·
demographic changes;
 
·
earthquake or other natural disasters;
 
·
competitive pressures;
 
·
deterioration in asset or credit quality;
·
legislative and regulatory developments;
 
·
changes in business strategy; and
 
·
general economic or business conditions in California and other regions where the Bank has operations.
 
These and other factors are further described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, (at Item 1A in particular) its reports and registration statements filed with the Securities and Exchange Commission (“SEC”) and other filings it makes in the future with the SEC from time to time. 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. The Company has no intention and undertakes 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. 
 
The Company’s filings with the SEC are available to the public from commercial document retrieval services and at the website maintained by the SEC at http://www.sec.gov, or by requests directed to Cathay General Bancorp, 777 North Broadway, Los Angeles, California 90012, Attn: Investor Relations (213) 625-4749.

3
 
PART I - FINANCIAL INFORMATION
 
Item 1. FINANCIAL STATEMENTS (Unaudited).

CATHAY GENERAL BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

   
September 30, 2007
  
December 31, 2006
  
% change
  
   
(In thousands, except share and per share data)
      
Assets
                    
Cash and due from banks
  
$
83,276
  
$
114,798
    
(27
)
Federal funds sold
   
-
   
18,000
   
(100
)
Cash and cash equivalents
    
83,276
   
132,798
   
(37
)
Short-term investments
    
17,152
   
16,379
   
5
 
Securities purchased under agreements to resell
    
360,000
   
-
   
100
 
Long-term certificates of deposit
    
50,000
   
-
   
100
 
Securities available-for sale, at fair value (amortized cost of $2,060,542 at September 30, 2007 and $1,543,667 at December 31, 2006)
    
2,043,529
   
1,522,223
   
34
 
Trading securities
    
10,171
   
5,309
   
92
 
Loans
    
6,439,407
   
5,747,546
   
12
 
Less:  Allowance for loan losses
    
(66,277
)
  
(64,689
)
  
2
 
Unamortized deferred loan fees, net
    
(11,054
)
  
(11,984
)
  
(8
)
Loans, net
    
6,362,076
   
5,670,873
   
12
 
Federal Home Loan Bank stock
    
51,620
   
34,348
   
50
 
Other real estate owned, net
    
374
   
5,259
   
(93
)
Affordable housing investments, net
    
94,669
   
87,289
   
8
 
Premises and equipment, net
    
74,905
   
72,934
   
3
 
Customers’ liability on acceptances
    
32,685
   
27,040
   
21
 
Accrued interest receivable
    
54,313
   
39,267
   
38
 
Goodwill
    
319,873
   
316,752
   
1
 
Other intangible assets, net
    
37,883
   
42,987
   
(12
)
Other assets
    
35,854
   
53,050
   
(32
)
                     
Total assets
  
$
9,628,380
  
$
8,026,508
    
20
 
                     
Liabilities and Stockholders’ Equity
                    
Deposits
                    
Non-interest-bearing demand deposits
  
$
778,690
  
$
781,492
    
(0
)
Interest-bearing deposits:
                    
NOW deposits
    
228,659
   
239,589
   
(5
)
Money market deposits
    
697,721
   
657,689
   
6
 
Savings deposits
    
336,743
   
358,827
   
(6
)
Time deposits under $100,000
    
1,095,348
   
1,007,637
   
9
 
Time deposits of $100,000 or more
    
2,933,645
   
2,630,072
   
12
 
Total deposits
    
6,070,806
   
5,675,306
   
7
 
                     
Federal funds purchased
   
98,000
   
50,000
   
96
 
Securities sold under agreement to repurchase
    
1,108,710
   
400,000
   
177
 
Advances from the Federal Home Loan Bank
    
1,089,680
   
714,680
   
52
 
Other borrowings
   
3,351
   
10,000
   
(66
)
Other borrowings for affordable housing investments
    
19,670
   
19,981
   
(2
)
Long-term debt
    
171,136
   
104,125
   
64
 
Acceptances outstanding
    
32,685
   
27,040
   
21
 
Minority interest in consolidated subsidiary
    
8,500
   
8,500
   
-
 
Other liabilities
    
76,923
   
73,802
   
4
 
Total liabilities
    
8,679,461
   
7,083,434
   
23
 
Commitments and contingencies
    
-
   
-
   
-
 
Stockholders’ Equity
                    
Preferred stock, $0.01 par value; 10,000,000 shares authorized, none issued
    
-
   
-
   
-
 
Common stock, $0.01 par value, 100,000,000 shares authorized, 53,471,096 issued and 49,813,181 outstanding at September 30, 2007 and 53,309,317 issued and 51,930,955 outstanding at December 31, 2006
    
535
   
533
   
0
 
Additional paid-in-capital
    
477,039
   
467,591
   
2
 
Accumulated other comprehensive loss, net
    
(9,860
)
  
(12,428
)
  
(21
)
Retained earnings
    
591,424
   
520,689
   
14
 
Treasury stock, at cost (3,657,915 shares at September 30, 2007 and 1,378,362 shares at December 31, 2006)
    
(110,219
)
  
(33,311
)
  
231
 
Total stockholders’ equity
    
948,919
   
943,074
   
1
 
Total liabilities and stockholders’ equity
  
$
9,628,380
  
$
8,026,508
    
20
 
See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements
 
4
 
CATHAY GENERAL BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
 
   
Three months ended September 30,
  
Nine months ended September 30,
  
   
2007
  
2006
  
2007
  
2006
  
   
(In thousands, except share and per share data)
  
INTEREST AND DIVIDEND INCOME
                          
Loan receivable, including loan fees
  
$
123,925
  
$
110,321
  
$
356,841
  
$
304,566
  
Investment securities- taxable
    
25,127
   
17,779
   
71,381
   
46,305
 
Investment securities- nontaxable
    
443
   
687
   
1,625
   
2,116
 
Federal Home Loan Bank stock
    
639
   
383
   
1,689
   
1,100
 
Agency preferred stock
    
174
   
295
   
512
   
799
 
Federal funds sold and securities purchased under agreements to resell
    
7,615
   
30
   
15,382
   
160
 
Deposits with banks
    
1,248
   
105
   
3,288
   
259
 
 
                          
Total interest and dividend income
    
159,171
   
129,600
   
450,718
   
355,305
 
 
                          
INTEREST EXPENSE
                          
Time deposits of $100,000 or more
    
34,475
   
27,983
   
97,527
   
73,810
 
Other deposits
    
20,068
   
15,376
   
56,739
   
37,983
 
Securities sold under agreements to repurchase
    
9,865
   
4,658
   
23,126
   
11,183
 
Advances from Federal Home Loan Bank
    
11,472
   
8,621
   
34,930
   
19,315
 
Long-term debt
    
3,182
   
1,207
   
8,057
   
3,359
 
Short-term borrowings
    
282
   
1,072
   
1,263
   
2,780
 
 
                          
Total interest expense
    
79,344
   
58,917
   
221,642
   
148,430
 
 
                          
Net interest income before provision for loan losses
    
79,827
   
70,683
   
229,076
   
206,875
 
Provision/(Reversal) for loan losses
    
2,200
   
(1,000
)
  
5,300
   
2,000
 
 
                          
Net interest income after provision for loan losses
    
77,627
   
71,683
   
223,776
   
204,875
 
                           
NON-INTEREST INCOME
                          
Securities gains, net
    
88
   
206
   
268
   
236
 
Letters of credit commissions
    
1,622
   
1,441
   
4,349
   
4,046
 
Depository service fees
    
1,146
   
1,138
   
3,529
   
3,630
 
Gains from sale of premises and equipment
    
2,705
   
-
   
2,714
   
-
 
Other operating income
    
3,298
   
2,619
   
10,045
   
8,317
 
 
                          
Total non-interest income
    
8,859
   
5,404
   
20,905
   
16,229
 
 
                          
NON-INTEREST EXPENSE
                          
Salaries and employee benefits
    
16,893
   
15,949
   
50,756
   
46,060
 
Occupancy expense
    
3,159
   
2,637
   
9,035
   
7,444
 
Computer and equipment expense
    
2,432
   
1,876
   
7,209
   
5,544
 
Professional services expense
    
2,388
   
2,176
   
6,659
   
5,396
 
FDIC and State assessments
    
284
   
259
   
804
   
761
 
Marketing expense
    
608
   
723
   
2,413
   
2,328
 
Other real estate owned expense
    
23
   
16
   
284
   
513
 
Operations of affordable housing investments
   
2,540
   
1,429
   
4,928
   
4,027
 
Amortization of core deposit intangibles
    
1,767
   
1,801
   
5,298
   
4,778
 
Other operating expense
    
3,128
   
2,517
   
8,350
   
6,928
 
 
                          
Total non-interest expense
    
33,222
    
29,383
    
95,736
    
83,779
  
 
                          
Income before income tax expense
    
53,264
   
47,704
   
148,945
   
137,325
 
Income tax expense
    
19,258
   
17,046
   
54,392
   
50,279
 
Net income
    
34,006
   
30,658
   
94,553
   
87,046
  
Other comprehensive income, net of tax
                      
Unrealized holding gains arising during the period
    
5,968
   
12,181
   
2,358
   
1,040
 
Less: reclassification adjustments included in net income
    
(10
)
  
133
   
(210
)
  
109
 
Total other comprehensive income, net of tax
    
5,978
   
12,048
   
2,568
   
931
 
Total comprehensive income
  
$
39,984
  
$
42,706
  
$
97,121
  
$
87,977
  
 
                          
Net income per common share:
                          
Basic
 
$
0.68
  
$
0.60
  
$
1.87
  
$
1.71
  
Diluted
  
$
0.67
  
$
0.59
  
$
1.84
  
$
1.69
  
 
                          
Cash dividends paid per common share
  
$
0.105
  
$
0.090
  
$
0.300
  
$
0.270
  
Basic average common shares outstanding
    
49,828,379
   
51,507,434
   
50,683,650
   
51,046,270
 
Diluted average common shares outstanding
    
50,417,332
   
52,111,032
   
51,283,317
   
51,637,975
 
 
See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements
 
5
 
CATHAY GENERAL BANCORP AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
   
Nine Months Ended September 30
  
   
2007
  
2006
  
   
(In thousands)
  
Cash Flows from Operating Activities
              
Net income
 
$
94,553
  
$
87,046
  
Adjustments to reconcile net income to net cash provided by operating activities:
              
Provision for loan losses
   
5,300
   
2,000
 
Provision for losses on other real estate owned
   
210
   
283
 
Deferred tax benefit
   
(3,162
)
  
(1,938
)
Depreciation
    
3,183
   
2,698
 
Net gains on sale of other real estate owned
   
(29
)
  
-
 
Net gains on sale of loans held for sale
    
(125
)
  
(213
)
Proceeds from sale of loans held for sale
   
2,532
   
4,232
 
Originations of loans held for sale
   
(2,375
)
  
(3,934
)
Purchase of trading securities
    
(5,000
)
  
-
 
Write-downs on venture capital investments
   
630
   
876
 
Gain on sales and calls of securities
   
(268
)
  
(236
)
Decrease / (increase) in fair value of warrants
   
90
   
(909
)
Other non-cash interest
   
190
   
860
 
Amortization of security premiums, net
   
1,310
   
2,806
 
Amortization of intangibles
    
5,474
   
4,865
 
Excess tax benefit from stock options
    
(503
)
  
(411
)
Stock based compensation expense
    
5,694
   
6,016
 
Gain on sale of premises and equipment
   
(2,714
)
  
-
 
Increase in accrued interest receivable
   
(14,775
)
  
(8,074
)
Decrease in other assets, net
   
2,238
   
3,618
 
Increase in other liabilities
   
10,447
   
7,504
 
 
              
Net cash provided by operating activities
   
102,900
   
107,089
 
 
              
Cash Flows from Investing Activities
              
Increase in short-term investments
   
(773
)
  
-
 
Increase in long-term certificates of deposit
    
(50,000
)
  
-
 
Increase in securities purchased under agreements to resell
    
(360,000
)
  
-
 
Purchase of investment securities available-for-sale
    
(944,144
)
  
(388,101
)
Proceeds from maturity and call of investment securities available-for-sale
    
231,465
   
78,175
 
Proceeds from sale of investment securities available-for-sale
   
101,169
   
5,408
 
Proceeds from repayment and sale of mortgage-backed securities available-for-sale
    
107,909
   
124,167
 
Exercise of warrants to acquire common stock
   
-
   
(2,209
)
Proceeds from sale of common stock acquired from exercise of warrants
    
-
   
3,679
 
Purchase of Federal Home Loan Bank stock
    
(15,248
)
  
(5,312
)
Redemption of Federal Home Loan Bank stock
   
1,093
   
1,295
 
Net increase in loans
   
(654,072
)
  
(660,002
)
Purchase of premises and equipment
   
(6,907
)
  
(17,208
)
Proceeds from sales of premises and equipment
    
6,948
   
-
 
Proceeds from sale of other real estate owned
   
1,717
   
-
 
Net increase in investment in affordable housing
   
(10,873
)
  
(5,668
)
Acquisitions, net of cash acquired
   
(3,655
)
  
(25,810
)
 
              
Net cash used in investing activities
   
(1,595,371
)
  
(891,586
)
 
              
Cash Flows from Financing Activities
             
Net decrease in demand deposits, NOW accounts, money market and saving deposits
   
(10,769
)
  
(64,210
)
Net increase in time deposits
   
352,103
   
321,401
 
Net increase in federal funds purchased and securities sold under agreement to repurchase
   
756,710
   
91,000
 
Advances from Federal Home Loan Bank
   
2,668,000
   
2,097,230
 
Repayment of Federal Home Loan Bank borrowings
   
(2,293,000
)
  
(1,717,050
)
Cash dividends
   
(15,294
)
  
(13,786
)
Proceeds from other borrowings
    
22,351
   
15,000
 
Repayment of other borrowings
   
(29,000
)
  
-
 
Issuance of long term debt
    
65,000
   
50,000
 
Proceeds from shares issued to Dividend Reinvestment Plan
   
1,837
   
2,002
 
Proceeds from exercise of stock options
    
1,416
   
1,873
 
Excess tax benefits from share-based payment arrangements
    
503
   
411
 
Purchases of treasury stock
    
(76,908
)
  
-
 
 
              
Net cash provided by financing activities
   
1,442,949
   
783,871
 
 
              
Decrease in cash and cash equivalents
   
(49,522
)
  
(626
)
Cash and cash equivalents, beginning of the period
   
132,798
   
109,275
 
 
              
Cash and cash equivalents, end of the year
 
$
83,276
  
$
108,649
  
 
              
 
              
Supplemental disclosure of cash flow information
              
Cash paid during the period:
              
Interest
 
$
217,353
  
$
138,921
  
Income taxes
 
$
51,679
  
$
53,134
  
Non-cash investing and financing activities:
              
Net change in unrealized holding loss on securities available-for-sale, net of tax
 
$
2,568
  
$
931
  
Cumulative effect adjustment as result of adoption of FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes
  
$
(8,524
)
$
-
  
Transfers to other real estate owned
 
$
373
  
$
3,087
  
Loans to facilitate the sale of other real estate owned
 
$
3,360
  
$
-
  
Loans to facilitate the sale of fixed assets
  
$
1,940
  
$
-
  
 
See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
 
6
 
CATHAY GENERAL BANCORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Business

Cathay General Bancorp (the “Bancorp”) is the holding company for Cathay Bank (the “Bank”), six limited partnerships investing in affordable housing investments in which the Bank is the sole limited partner, and GBC Venture Capital, Inc., (together the “Company” or “we”, “us,” or “our”). The Bancorp also owns 100% of the common stock of five statutory business trusts created for the purpose of issuing capital securities. The Bank was founded in 1962 and offers a wide range of financial services. As of October 31, 2007, the Bank operates twenty one branches in Southern California, ten branches in Northern California, three branches in Washington State, nine branches in New York State, one branch in Massachusetts, two branches in Texas, three branches in Illinois, one branch in New Jersey, one branch in Hong Kong, and representative offices in Taipei and Shanghai.

2. Acquisitions and Investments
 
We continue to look for opportunities to expand the Bank’s branch network by seeking new branch locations and/or by acquiring other financial institutions to diversify our customer base in order to compete for new deposits and loans, and to be able to serve our customers more effectively. At the close of business on March 30, 2007, the Company completed the acquisition of New Jersey-based United Heritage Bank (“UHB”) for cash of $9.4 million. As of March 30, 2007, UHB had $58.9 million in assets and $4.3 million in stockholders’ equity.
 
The acquisition was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” The assets acquired and liabilities assumed were recorded by the Company at their fair values as of March 31, 2007:
 
   
United Heritage Bank
 
Assets acquired:
  
 
  
Cash and cash equivalents
 
$
5,745
  
Securities available-for-sale
   
14,305
 
Loans, net
   
37,681
 
Premises and equipment, net
   
432
 
Goodwill
   
3,878
 
Core deposit intangible
   
341
 
Other assets
   
2,371
 
 
        
Total assets acquired
   
64,753
 
       
Liabilities assumed:
       
Deposits
   
54,166
 
Accrued interest payable
   
9
 
Other liabilities
   
1,178
 
Total liabilities assumed
   
55,353
 
Net assets acquired and cash paid
 
$
9,400
  
 
No loans acquired as part of the acquisition of UHB were determined to be impaired and therefore no loans were within the scope of Statement of Position (SOP) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”. In addition, the estimated other costs related to the acquisition were recorded as a liability at closing when allocating the related purchase price. The purchase price allocation is still subject to final determination and valuation of the fair value of assets acquired and liabilities assumed.
 
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For each acquisition, we developed an integration plan for the consolidated company that addressed, among other things, requirements for staffing, systems platforms, branch locations and other facilities. The established plans are evaluated regularly during the integration process and modified as required. Merger and integration expenses are summarized in the following primary categories: (i) severance and employee-related charges; (ii) system conversion and integration costs, including contract termination charges; (iii) asset write-downs, lease termination costs for abandoned space and other facilities-related costs; and (iv) other charges. Other charges include investment banking fees, legal fees, other professional fees relating to due diligence activities and expenses associated with preparation of securities filings, as appropriate. Costs associated with exiting activities and without future economic benefit were included in the allocation of the purchase price at the acquisition date based on our formal integration plans. Goodwill increased by $3.1 million to $319.9 million at September 30, 2007 from $316.8 million at December 30, 2006, primarily due to the UHB acquisition.
 
The following table presents the activity in the merger-related liability account that was allocated to the purchase price as of September 30, 2007:

 
  
Severance and
 
Asset
  
Legal and
 
Lease
      
(Dollar in thousands)
  
Employee-related
  
Write-downs
  
Professional Fees
  
Liability
  
Total
  
Balance at December 31, 2006
  
$
37
  
$
-
  
$
5
  
$
778
  
$
820
  
United Heritage Bank acquisition
    
300
   
17
   
421
   
-
   
738
 
Non-cash write-downs and other
    
-
   
(17
)
  
-
   
-
   
(17
)
Cash outlays
    
(49
)
  
-
   
(426
)
  
(118
)
  
(593
)
Balance at September 30, 2007
  
$
288
  
$
-
  
$
-
  
$
660
  
$
948
  
 
3. 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 notes 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, 2007. 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, 2006.
 
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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.

4. Recent Accounting Pronouncements
 
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140." (“SFAS 155”) amends SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS 155 (i) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (ii) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133, (iii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (iv) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (v) amends SFAS 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for the Company on January 1, 2007. There was no material impact on the Company's financial statements from adoption of this standard.
 
SFAS No. 156, "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140" (“SFAS 156”) amends SFAS 140. "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125," by requiring, in certain situations, an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include the amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing income or net servicing loss or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the period in which they occur. If the amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each reporting date. SFAS 156 is effective for the Company on January 1, 2007. There was no material impact on the Company’s consolidated financial statements from adoption of this standard.
 
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, together with a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and requires a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. Market participant assumptions include assumptions about the risk, the effect of a restriction on the sale or use of an asset, and the effect of a nonperformance risk for a liability. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not completed its analysis to determine the impact on the Company’s consolidated financial statements from adoption of SFAS 157.
 
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In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits a business entity to choose to measure financial instruments and certain other items at fair value to mitigate volatility in reported earnings caused by measuring financial instruments differently without having to apply complex hedge accounting provisions. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments. Following the initial fair value measurement date, a business entity shall report unrealized gains and losses on financial instruments for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not completed its analysis to elect the fair value option on the Company’s consolidated financial statements at the date of adoption of SFAS 159.
 
5. 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.
 
Outstanding stock options with anti-dilutive effect were not included in the computation of diluted earnings per share. The following table sets forth the basic and diluted earnings per share calculations and the average shares of stock options with anti-dilutive effect:
 
   
For the three months ended September 30,
  
For the nine months ended September 30,
  
(Dollars in thousands, except share and per share data)
  
2007
  
2006
  
2007
  
2006
  
Net income
  
$
34,006
  
$
30,658
  
$
94,553
  
$
87,046
  
                           
Weighted-average shares:
                          
Basic weighted-average number of common shares outstanding
    
49,828,379
    
51,507,434
    
50,683,650
    
51,046,270
  
Dilutive effect of weighted-average outstanding common shares equivalents
                          
Stock Options
    
580,602
    
597,959
    
593,503
    
586,044
  
Restricted Stock
    
8,351
    
5,639
    
6,164
    
5,661
  
Diluted weighted-average number of common shares outstanding
    
50,417,332
    
52,111,032
    
51,283,317
    
51,637,975
  
                           
Average shares of stock options with anti-dilutive effect
    
1,438,436
    
1,481,394
    
1,446,152
    
1,526,181
  
Earnings per share:
                          
Basic
  
$
0.68
  
$
0.60
  
$
1.87
  
$
1.71
  
Diluted
  
$
0.67
  
$
0.59
  
$
1.84
  
$
1.69
  
 
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6. Stock-Based Compensation
 
In 1998, the Board adopted the Cathay Bancorp, Inc. Equity Incentive Plan. Under the Equity Incentive Plan, as amended in September, 2003, directors and eligible employees may be granted incentive or non-statutory stock options, or awarded non-vested stock, for up to 7,000,000 shares of the Company’s common stock on a split adjusted basis. In May 2005, the stockholders of the Company approved the 2005 Incentive Plan which provides that 3,131,854 shares of the Company’s common stock may be granted as incentive or non-statutory stock options, or as non-vested stock. In conjunction with the approval of the 2005 Incentive Plan, Bancorp agreed to cease granting awards under the Equity Incentive Plan. As of September 30, 2007, the only options granted by the Company under the 2005 Incentive Plan were non-statutory stock options to selected bank officers and non-employee directors at exercise prices equal to the fair market value of a share of the Company’s common stock on the date of grant. Such options have a maximum ten-year term and vest in 20% annual increments (subject to early termination in certain events) except for 245,060 shares granted to the Company’s Chief Executive Officer on March 22, 2005 of which 30% vested immediately, 10% vested on November 20, 2005 and an additional 20% would vest on November 20, 2006, 2007 and 2008, respectively, and 264,694 shares granted to the Company’s Chief Executive Officer on May 22, 2005 of which 40% vested on November 20, 2005 and an additional 20% would vest on November 20, 2006, 2007, and 2008, respectively. If such options expire or terminate without having been exercised, any shares not purchased will again be available for future grants or awards. Stock options are typically granted in the first quarter of the year. The Company has not yet awarded stock options in 2007 because it is considering changes to its stock option program. The Company expects to issue new shares to satisfy stock option exercises.
 
Stock-based compensation expense for stock options is calculated based on the fair value of the award at the grant date for those options expected to vest, 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. The Company estimates the expected volatility based on the Company’s historical stock prices for the period corresponding to the expected life of the stock options. Option compensation expense totaled $5.2 million for the nine months ended September 30, 2007 and $5.8 million for the nine months ended September 30, 2006. For the three months ended September 30, option compensation expense totaled $1.7 million for 2007 and $2.0 million for 2006. Stock-based compensation is recognized ratably over the requisite service period for all awards. Unrecognized stock-based compensation expense related to stock options totaled $14.8 million at September 30, 2007 and is expected to be recognized over the next 2.6 years.
 
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The weighted average per share fair value on the date of grant of the options granted was $13.46 during the first nine months of 2006. There were no options granted during the first nine months of 2007 and during the third quarter of 2006. The Company estimated the expected life of the options based on the average of the contractual period and the vesting period. The fair value of stock options has been determined using the Black-Scholes option pricing model with the following assumptions:
 
   
Nine months ended
  
   
September 30, 2006
  
Expected life- number of years
    
6.50
  
Risk-free interest rate
    
4.39
%
Volatility
    
33.17
%
Dividend yield
    
1.20
%
 
During the nine months period, exercised option shares were 84,236 shares in 2007 and 89,776 shares in 2006. Exercised options shares were 6,000 shares for the third quarter of 2007 and 18,694 shares for the third quarter of 2006. The table below summarizes cash received and aggregate intrinsic value from options exercised:
 
   
For the three months ended September 30,
  
For the nine months ended September 30,
  
(In thousands, except shares)
  
2007
  
2006
  
2007
  
2006
  
Shares of option exercised
   
6,000
   
18,694
   
84,236
   
89,776
 
Cash received from option exercised
  
$
75
  
$
377
  
$
1,416
  
$
1,873
  
Aggregate intrinsic value for option exercised
  
$
132
  
$
315
  
$
1,420
  
$
1,442
  
 
The following table presents the fair value of stock options vested for the period indicated:
 
   
2007
  
2006
  
(In thousands, except shares)
  
Vested Shares
  
Fair Value
  
Vested Shares
  
Fair Value
  
1st Quarter
    
504,539
 
$
5,079
    
514,398
 
$
4,393
  
2nd Quarter
    
11,000
 
$
108
    
9,200
 
$
73
  
3rd Quarter
    
-
 
$
-
    
-
 
$
-
  
 
The table below summarizes stock option activity for the periods indicated:

       
 
  
Weighted-Average
  
Aggregate
  
       
Weighted-Average
  
Remaining Contractual
  
Intrinsic
  
   
Shares
  
Exercise Price
  
Life (in years)
 
Value (in thousands)
  
Balance at December 31, 2006
   
4,783,027
 
$
28.09
    
7.0
 
$
34,011
  
 
                          
Granted
   
-
   
-
             
Forfeited
   
(9,706
)
  
36.19
             
Exercised
   
(63,522
)
  
16.22
             
 
                          
Balance at March 31, 2007
   
4,709,799
 
$
28.24
    
6.8
 
$
31,114
  
 
                          
Granted
   
-
   
-
             
Forfeited
   
(17,642
)
  
32.67
             
Exercised
   
(14,714
)
  
21.06
             
 
                          
Balance at June 30, 2007
   
4,677,443
 
$
28.24
    
6.5
 
$
30,869
  
 
                          
Granted
   
-
   
-
             
Forfeited
   
(11,026
)
  
36.42
             
Exercised
   
(6,000
)
  
12.56
             
 
                          
Balance at September 30, 2007
   
4,660,417
 
$
28.24
    
6.3
 
$
29,160
  
 
                          
Exercisable at September 30, 2007
    
2,761,629
  
$
25.42
    
5.6
 
$
20,978
  
 
At September 30, 2007, 2,247,433 shares were available under the Company’s 2005 Incentive Plan for future grants.
 
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The Company has granted non-vested stock to its Chairman of the Board, President, and Chief Executive Officer. The shares vest ratably over certain years if certain annual performance criteria are met. The following table presents information relating to the non-vested stock grants as of September 30, 2007:
 
   
Grant date
  
Grant date
  
   
January 25, 2006
  
January 31, 2007
  
Grant shares
    
30,000
   
20,000
 
Vested ratably over
    
3 years
    
2 years
  
Price per share at grant
  
$
36.24
  
$
34.66
  
Vested shares
    
10,000
   
-
 
Unvested shares
   
20,000
   
20,000
 
 
The stock compensation expense recorded related to non-vested stock above was $503,000 for the nine months ended September 30, 2007, and $242,000 for the nine months ended September 30, 2006. For the three months ended September 30, non-vested stock compensation expense was $177,000 for 2007 and $91,000 for 2006. Unrecognized stock-based compensation expense related to non-vested stock awards was $945,000 at September 30, 2007, and is expected to be recognized over the next 1.3 years.
 
Prior to 2006, the Company presented the entire amount of the tax benefit on options exercised as operating activities in the consolidated statements of cash flows. After adoption of SFAS No. 123R in January 2006, the Company reports only the benefits of tax deductions in excess of grant-date fair value as cash flows from financing activity. The following table summarizes the tax benefit from options exercised:
 
   
For the three months ended September 30,
  
For the nine months ended September 30,
  
(Dollars in thousands)
  
2007
  
2006
  
2007
  
2006
  
 
                          
Benefit of tax deductions in excess of grant-date fair value
  
$
53
  
$
48
  
$
503
  
$
411
  
Benefit of tax deductions on
                         
grant-date fair value
    
3
   
84
   
94
   
195
 
Total benefit of tax deductions
  
$
56
  
$
132
  
$
597
  
$
606
  
 
7. Securities Purchased Under Agreements to Resell
 
For the first nine months in 2007, the Company entered into seven long-term resale agreements totaling $350.0 million. The agreements have terms of ten years with interest rates ranging from 8.10%, to 9.12%. The counterparty has the right to a quarterly call. Among these agreements, $150.0 million are callable after the first year and $200.0 million are callable after the first three months anniversary. When the callable term starts if certain conditions are met, there may be no interest earned for those days when the certain conditions are met. The collateral for these resale agreements consists of U.S. Government agency securities. In addition to long-term agreements, in July 2007, the Company entered into a $10 million 180-day short term resale agreement at a rate of 5.20%.
 
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As of September 30, 2007, securities purchased under agreements to resell totaled $360.0 million at a weighted average interest rate of 8.43%. In October 2007, $150.0 million of these securities purchased under agreements to resell were called. 
 
8. 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, and financial guarantees. Those instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying condensed consolidated balance sheets. 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. The following table summarizes the outstanding commitments as of the dates indicated:
 
(In thousands)
  
At September 30, 2007
  
At December 31, 2006
  
Commitments to extend credit
  
$
2,330,514
  
$
2,178,640
  
Standby letters of credit
    
69,085
   
81,292
 
Other letters of credit
    
86,017
   
79,803
 
Bill of lading guarantees
    
646
   
223
 
Total
  
$
2,486,262
  
$
2,339,958
  
 
As of September 30, 2007, $23.7 million unfunded commitments for affordable housing limited partnerships were recorded under other liabilities.

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 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, including standby 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 these types of instrument is essentially the same as that involved in making loans to customers.
 
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9. Securities Sold Under Agreements to Repurchase
 
The Company has entered into long-term transactions involving the sale of securities under repurchase agreements which total $1.1 billion at September 30, 2007, and $400.0 million at December 31, 2006. Seventeen agreements totaling $900.0 million are with initial floating rates for a period of time ranging from six months to one year, with the floating rates ranging from the three-month LIBOR minus 100 basis points to the three-month LIBOR minus 340 basis points. Thereafter, the rates are fixed for the remainder of the term, with interest rates ranging from 4.29% to 5.07%. After the initial floating rate term, the counterparties have the right to terminate the transaction at par at the fixed rate reset date and quarterly thereafter. Two agreements of $50.0 million each are with initial fixed rates of 3.33% and 3.50%, respectively, for six months. For the remainder of the seven year term, the rates float at 8% minus the three-month LIBOR rate with a maximum rate of 3.75% and minimum rate of 0.0%. After the initial fixed rate term, the counterparties have the right to terminate the transaction at par at the floating rate reset date and quarterly thereafter. The Company may be required to provide additional collateral for the repurchase agreements. In addition, there were three short term repurchase agreements totaling $108.7 million which will mature in the fourth quarter of 2007 with a weighted average interest rate of 5.45% at September 30, 2007.
 
Securities sold under agreements to repurchase total $1.1 billion at a weighted average interest rate of 3.74% at September 30, 2007 compared to $400.0 million at a weighted average interest rate of 4.40% at December 31, 2006. 
 
At September 30, 2007, seven repurchase agreements totaling $350.0 million were callable but had not been called. Two repurchase agreements for $50.0 million each bear fixed interest rates of 4.75% and 4.79%, respectively, until their final maturities in March 2011. Five repurchase agreements of $50.0 million each bear fixed interest rates ranging from 4.29% to 4.61%, until their final maturities in the first half of 2014.
 
10. Line of Credit and Subordinated Note
 
On May 31, 2005, the Bancorp entered into a $30.0 million 364-day unsecured revolving loan agreement with a commercial bank bearing an interest rate of LIBOR plus 90 basis points and a commitment fee of 12.5 basis points on unused commitments. This loan was paid off in April 2007.
 
On September 29, 2006, the Bank issued $50.0 million in subordinated debt in a private placement transaction. This instrument matures on September 29, 2016 and bears interest at a per annum rate based on the three month LIBOR plus 110 basis points, payable on a quarterly basis. At September 30, 2007, the per annum interest rate on the subordinated debt was 6.30%. The subordinated debt was issued through the Bank and qualifies as Tier 2 capital for regulatory reporting purposes and is included in long-term debt in the accompanying condensed consolidated statement of financial condition.
 
11. Junior Subordinated Debt
 
The Bancorp issued junior subordinated debt securities of $46.4 million on March 30, 2007, and $20.6 million on May 31, 2007, in connection with pooled offerings of trust preferred securities by two newly formed and wholly-owned subsidiaries, Cathay Capital Trust III and Cathay Capital Trust IV, both of which are Delaware statutory business trusts.
 
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On March 30, 2007, Cathay Capital Trust III issued and sold $45.0 million of trust preferred securities in a private placement to institutional investors and $1.4 million of common securities to the Bancorp. Similarly, on May 31, 2007, Cathay Capital Trust IV issued and sold $20.0 million of trust preferred securities in a private placement to institutional investors and $619,000 of common securities to the Bancorp.
 
The trust preferred securities issued by Cathay Capital Trust III have a scheduled maturity of June 15, 2037, and bear interest at a per annum rate based on the three-month LIBOR plus 148 basis points, payable on a quarterly basis. The trust preferred securities issued by Cathay Capital Trust IV have a scheduled maturity of September 6, 2037, and bear interest at a per annum rate based on the three-month LIBOR plus 140 basis points, payable on a quarterly basis. The Bancorp acts as a guarantor on the payment of certain obligations associated with these trust preferred securities.
 
Cathay Capital Trust III and Cathay Capital Trust IV used the proceeds from the sale of these trust preferred and common securities to purchase junior subordinated debt securities of the Bancorp that have identical maturity and payment terms as the respective trust preferred securities issued by these trusts.
 
Interest on the Bancorp's junior subordinated debt securities may be deferred at any time or from time-to-time for a period not exceeding 20 consecutive quarterly payments, provided there is no event of default and the deferral does not extend beyond maturity. If the Bancorp elects to defer interest on the junior subordinated debt securities, or if a default occurs, the Bancorp will generally not be able to declare or pay any dividends or distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to, any of the Bancorp's common stock. The entire principal of the junior subordinated debt securities may become due and payable immediately if an event of default occurs.
 
At September 30, 2007, junior subordinated debt securities totaled $121.1 million with a weighted average interest rate of 7.73%. The junior subordinated debt issued qualifies as Tier 1 capital for regulatory reporting purposes.
 
12. Implementation of FASB Interpretation No. 48
 
As previously disclosed, on December 31, 2003, the California Franchise Tax Board (FTB) announced its intent to list certain transactions that in its view constitute potentially abusive tax shelters. Included in the transactions subject to this listing were transactions utilizing regulated investment companies (RICs) and real estate investment trusts (REITs). While the Company continues to believe that the tax benefits recorded in 2000, 2001, and 2002 with respect to its regulated investment company were appropriate and fully defensible under California law, the Company participated in Option 2 of the Voluntary Compliance Initiative of the Franchise Tax Board, and paid all California taxes and interest on these disputed 2000 through 2002 tax benefits, and at the same time filed a claim for refund for these years while avoiding certain potential penalties. The Company retains potential exposure for assertion of an accuracy-related penalty should the FTB prevail in its position in addition to the risk of not being successful in its refund claims.
 
The FASB issued Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”) which requires that the amount of recognized tax benefit should be the maximum amount which is more-likely-than-not to be realized and that amounts previously recorded that do not meet the requirements of FIN 48 be charged as a cumulative effect adjustment to retained earnings. As of December 31, 2006, the Company reflected a $12.1 million net state tax receivable related to payments it made in April 2004 under the Voluntary Compliance Initiative program for the years 2000, 2001, and 2002, after giving effect to reserves for loss contingencies on the refund claims. The Company has determined that its refund claim related to its regulated investment company is not more-likely-than-not to be realized and consequently, charged a total of $8.5 million, comprised of the $7.9 million after tax amount related to its refund claims as well as a $0.6 million after tax amount related to California Net Operating Losses generated in 2001 as a result of its regulated investment company, to the balance of retained earnings as of the January 1, 2007, effective date of FIN 48.
 
16
 
At the January 1, 2007 adoption date of FIN 48, the total amount of the Company’s unrecognized tax benefits was $5.5 million, of which $1.7 million, if recognized, would affect the effective tax rate. The Company recognized interest and penalties accrued related to unrecognized tax benefits in income tax expense. At January 1, 2007, the adoption date of FIN 48, the total amount of accrued interest and penalties was $1.7 million.
 
The Company’s tax returns are open for audits by the Internal Revenue Service back to 2003 and by the Franchise Tax Board of the State of California back to 2000. The Company is currently under audit by the California Franchise Tax Board for the years 2000 to 2002. During the second quarter of 2007, the Internal Revenue Service completed an examination of the Company’s 2004 and 2005 tax returns and did not propose any adjustments deemed to be material.
 
13. Stock Repurchase Program

During the third quarter of 2007, the Company repurchased 175,500 shares of its common stock for $5.4 million, or $30.77 average cost per share. For the nine months ended September 30, 2007, the Company repurchased 2,279,553 shares of its common stock for $76.9 million, or $33.74 average cost per share. At September 30, 2007, 172,150 shares remain under the Company’s May 8, 2007, repurchase program.
 
From October 30, 2007 to November 2, 2007, the Company repurchased 172,150 shares of its common stock for $5.1 million, or $29.66 average cost per share and thereby completed its May 2007 repurchase program. From January 1, 2007 to November 2, 2007, the Company repurchased 2,451,703 shares of its common stock for $82.0 million, or $33.45 average cost per share.
 
14. Premises and Equipment

On September 27, 2007, the Company sold the $3.6 million bank owned property that formerly housed a Bank branch and recognized a gain on sale of $2.7 million. This property was transferred from premises and equipment when management decided to sell this property.
 
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, 2006, of Cathay General Bancorp (“Bancorp”) and its wholly-owned subsidiary Cathay Bank (the “Bank” and, together, the “Company” or “we”, “us,” or “our”).
 
17
 
Critical Accounting Policies

The discussion and analysis of the Company’s unaudited condensed consolidated balance sheets and results of operations are based upon its unaudited condensed 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 have 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 “Accounting for the allowance for loan losses” under Item 7 to Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Accounting for investment securities involves significant judgments and assumptions by management, which have a material impact on the carrying value of securities and the recognition of any “other-than-temporary” impairment to our investment securities. The judgments and assumptions used by management are described under the heading “Investment Securities” under Item 7 to Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Accounting for income taxes involves significant judgments and assumptions by management, which have a material impact on the amount of taxes currently payable and the income tax expense recorded in the financial statements. The judgments and assumptions used by management are described under the heading “Income Taxes” under Item 7 to Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

HIGHLIGHTS

·
Third quarter earnings increased $3.3 million, or 10.9%, compared to the same quarter a year ago.
·
Third quarter diluted earnings per share reached $0.67, increasing 13.6%, compared to $0.59 per share the same quarter a year ago.
·
Return on average assets was 1.46% for the quarter ended September 30, 2007, compared to 1.40% for the quarter ended June 30, 2007 and compared to 1.60% for the same quarter a year ago.
·
Return on average stockholders’ equity was 14.45% for the quarter ended September 30, 2007, compared to 13.13% for the quarter ended June 30, 2007, and compared to 13.76% for the same quarter a year ago.
·
Gross loans increased by $264.6 million, or 4.3%, from $6.2 billion at June 30, 2007, to $6.4 billion at September 30, 2007.
·
Deposits totaled $6.1 billion at September 30, 2007, which increased by $228.8 million, or 3.9%, from $5.8 billion at June 30.
 
18
 
Income Statement Review

Net Income
 
Net income was $34.0 million, or $0.67, per diluted share for the third quarter of 2007, a $3.3 million, or 10.9%, increase compared with net income of $30.7 million, or $0.59, per diluted share for the same quarter a year ago. Return on average assets was 1.46% and return on average stockholders’ equity was 14.45% for the third quarter of 2007 compared with a return on average assets of 1.60% and a return on average stockholders’ equity of 13.76% for the three months ended September 30, 2006.
 
Financial Performance

   
Third Quarter 2007
  
Third Quarter 2006
  
           
Net income
  
$
34.0 million
  
$
30.7 million
  
Basic earnings per share
  
$
0.68
  
$
0.60
  
Diluted earnings per share
  
$
0.67
  
$
0.59
  
Return on average assets
    
1.46
%
  
1.60
%
Return on average stockholders’ equity
    
14.45
%
  
13.76
%
Efficiency ratio
    
37.46
%
  
38.62
%

Net Interest Income Before Provision for Loan Losses
 
The comparability of financial information is affected by our acquisitions. Operating results included the operations of acquired entities from the date of acquisition.
 
Net interest income before provision for loan losses increased $9.1 million, or 12.9%, to $79.8 million during the third quarter of 2007 from $70.7 million during the same quarter a year ago. The increase was due primarily to the strong growth in loans and securities.
 
The net interest margin, on a fully taxable-equivalent basis, was 3.69% for the third quarter of 2007. The net interest margin decreased 9 basis points from 3.78% in the second quarter of 2007 and decreased 37 basis points from 4.06% in the third quarter of 2006. The decrease in the net interest margin from the same quarter a year ago was primarily a result of the repricing of time deposits to reflect higher market interest rates, and increased reliance on more expensive wholesale deposits and borrowings.
 
For the third quarter of 2007, the yield on average interest-earning assets was 7.34% on a fully taxable-equivalent basis, and the cost of funds on average interest-bearing liabilities equaled 4.24%. In comparison, for the third quarter of 2006, the yield on average interest-earning assets was 7.42% and cost of funds on average interest-bearing liabilities equaled 4.01%. The interest spread, defined as the difference between the yield on average interest-earning assets and the cost of funds on average interest-bearing liabilities, decreased to 3.10% for the quarter ended September 30, 2007 from 3.41% for the same quarter a year ago primarily due to the reasons discussed above.
 
19
 
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 for the periods indicated are as follows:
 
Interest-Earning Assets and Interest-Bearing Liabilities
 
Three months ended September 30,
  
2007
  
2006
  
   
 
  
Interest
  
Average
      
Interest
  
Average
  
Taxable-equivalent basis
  
Average
  
Income/
  
Yield/
  
Average
  
Income/
  
Yield/
  
(Dollars in thousands)
  
Balance
  
Expense
  
Rate (1)(2)
  
Balance
  
Expense
  
Rate (1)(2)
  
Interest Earning Assets
                                      
 Commercial loans
  
$
1,320,611
  
$
27,110
    
8.14
%
$
1,126,348
  
$
23,755
    
8.37
%
 Residential mortgage
    
622,793
   
9,769
   
6.27
   
499,690
   
7,454
   
5.97
 
 Commercial mortgage
    
3,560,243
   
68,869
   
7.67
   
3,165,728
   
62,608
   
7.85
 
 Real estate construction loans
    
768,117
   
17,801
   
9.19
   
656,995
   
16,242
   
9.81
 
 Other loans and leases
    
26,688
   
376
   
5.59
   
30,195
   
262
   
3.44
 
Total loans and leases (1) 
    
6,298,452
   
123,925
   
7.81
   
5,478,956
   
110,321
   
7.99
 
Taxable securities 
    
1,769,245
   
25,127
   
5.63
   
1,345,854
   
17,779
   
5.24
 
Tax-exempt securities (3) 
    
55,217
   
921
   
6.62
   
83,368
   
1,463
   
6.96
 
FHLB & FRB Stock 
    
50,297
   
639
   
5.04
   
34,974
   
383
   
4.34
 
Interest bearing deposits 
    
71,843
   
1,248
   
6.89
   
10,837
   
105
   
3.84
 
Federal funds sold & securities purchased 
                                      
 under agreements to resell
    
371,413
   
7,615
   
8.13
   
2,293
   
30
   
5.19
 
 Total interest-earning assets
    
8,616,467
   
159,475
   
7.34
   
6,956,282
   
130,081
   
7.42
 
Non-interest earning assets
                                      
Cash and due from banks 
    
84,176
               
100,869
             
Other non-earning assets 
    
639,999
               
601,042
             
 Total non-interest earning assets
    
724,175
               
701,911
             
Less: Allowance for loan losses 
    
(65,902
)
              
(65,743
)
            
Deferred loan fees 
    
(11,584
)
              
(13,385
)
            
 Total assets
  
$
9,263,156
              
$
7,579,065
              
                                       
Interest bearing liabilities:
                                      
Interest bearing demand accounts 
  
$
233,116
  
$
755
    
1.28
 
$
228,854
  
$
726
    
1.26
 
Money market accounts 
    
699,679
   
5,610
   
3.18
   
606,914
   
4,352
   
2.84
 
Savings accounts 
    
342,971
   
873
   
1.01
   
375,043
   
904
   
0.96
 
Time deposits 
    
3,935,125
   
47,305
   
4.77
   
3,409,894
   
37,377
   
4.35
 
 Total interest-bearing deposits
    
5,210,891
   
54,543
   
4.15
   
4,620,705
   
43,359
   
3.72
 
                                       
Federal funds purchased 
    
22,863
   
279
   
4.84
   
39,359
   
531
   
5.35
 
Securities sold under agreement to repurchase 
    
1,041,577
   
9,865
   
3.76
   
415,652
   
4,658
   
4.45
 
Other borrowings 
    
978,759
   
11,475
   
4.65
   
695,321
   
9,162
   
5.23
 
Long-term debt 
    
171,136
   
3,182
   
7.38
   
55,101
   
1,207
   
8.69
 
 Total interest-bearing liabilities
    
7,425,226
   
79,344
   
4.24
   
5,826,138
   
58,917
   
4.01
 
Non-interest bearing liabilities
                                      
Demand deposits 
    
774,513
               
767,217
             
Other liabilities 
    
129,855
               
101,888
             
Stockholders' equity
    
933,562
               
883,822
             
 Total liabilities and stockholders' equity
  
$
9,263,156
              
$
7,579,065
              
Net interest spread (4)
                
3.10
%
              
3.41
%
Net interest income (4)
        
$
80,131
              
$
71,164
        
Net interest margin (4)
                
3.69
%
              
4.06
%
 
(1)
Yields and amounts of interest earned include loan fees. Non-accrual loans are included in the average balance.
(2)
Calculated by dividing net interest income by average outstanding interest-earning assets.
(3)
The average yield has been adjusted to a fully taxable-equivalent basis for certain securities of states and political subdivisions and other securities held using a statutory Federal income tax rate of 35%.
(4)
Net interest income, net interest spread, and net interest margin on interest-earning assets have been adjusted to a fully taxable-equivalent basis using a statutory Federal income tax rate of 35%.
 
20
 
The following table summarizes the changes in interest income and interest expense attributable to changes in volume and changes in interest rates for the periods indicated:

Taxable-Equivalent Net Interest Income — Changes Due to Rate and Volume(1)
 
   
Three months ended September 30,
  
 
  
2007-2006
  
   
Increase (Decrease) in
  
   
Net Interest Income Due to:
  
(Dollars in thousands)
  
Changes in Volume
  
Changes in Rate
  
Total Change
  
               
Interest-Earning Assets:
                    
Loans and leases
    
16,138
   
(2,534
)
  
13,604
 
Taxable securities
    
5,932
   
1,416
   
7,348
 
Tax-exempt securities (2)
    
(473
)
  
(69
)
  
(542
)
FHLB and FRB stocks
    
187
   
69
   
256
 
Deposits with other banks
   
1,002
   
141
   
1,143
 
Federal funds sold and securities purchased
                    
under agreements to resell
    
7,558
   
27
   
7,585
 
                     
Total increase in interest income
   
30,344
   
(950
)
  
29,394
 
                     
Interest-Bearing Liabilities:
                    
Interest bearing demand accounts
    
14
   
15
   
29
 
Money market accounts
    
710
   
548
   
1,258
 
Savings accounts
    
(79
)
  
48
   
(31
)
Time deposits
   
6,099
   
3,829
   
9,928
 
Federal funds purchased
    
(205
)
  
(47
)
  
(252
)
Securities sold under agreement to repurchase
    
6,019
   
(812
)
  
5,207
 
Other borrowed funds
   
3,398
   
(1,085
)
  
2,313
 
Long-term debt
    
2,180
   
(205
)
  
1,975
 
Total increase in interest expense
    
18,136
   
2,291
   
20,427
 
Changes in net interest income 
  
$
12,208
  
$
(3,241
)
$
8,967
  

(1)
Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated proportionately to changes due to volume and changes due to rate.
(2)
The amount of interest earned on certain securities of states and political subdivisions and other securities held has been adjusted to a fully taxable-equivalent basis, using a statutory federal income tax rate of 35%.

Provision for Loan Losses
 
The provision for loan losses was $2.2 million for the third quarter of 2007 compared to negative $1.0 million provision for loan losses for the third quarter of 2006 and a $2.1 million provision for loan losses for the second quarter of 2007. The provision for loan losses was $5.3 million for the first nine months of 2007 and $2.0 million for same period of 2006. The provision for loan losses was based on the review of the adequacy of the allowance for loan losses at September 30, 2007. The provision for loan losses represents the charge or credit against current earnings that is determined by management, through a credit review process, as the amount needed to establish an allowance that management believes to be sufficient to absorb loan losses inherent in the Company’s loan portfolio. The following table summarizes the charge-offs and recoveries for the periods as indicated:
 
   
For the three months ended September 30,
  
For the nine months ended September 30,
  
(Dollars in thousands)
  
2007
  
2006
  
2007
  
2006
  
                   
Charge-offs:
                          
Commercial loans
  
$
511
  
$
33
  
$
6,253
  
$
838
  
Construction loans
    
-
   
-
   
190
   
-
 
Real estate loans
    
912
   
3
   
1,030
   
3
 
Installment and other loans
    
-
   
-
   
1
   
4
 
Total charge-offs
    
1,423
   
36
   
7,474
   
845
 
Recoveries:
                          
Commercial loans
    
138
   
300
   
2,911
   
944
 
Construction loans
          
-
   
190
   
-
 
Real estate loans
    
-
   
1
   
202
   
4
 
Installment and other loans
    
2
   
9
   
27
   
25
 
Total recoveries
    
140
   
310
   
3,330
   
973
 
Net Charge-offs / (Recoveries)
  
$
1,283
  
$
(274
)
$
4,144
  
$
(128
)
 
21
 
Non-Interest Income
 
Non-interest income, which includes revenues from depository service fees, letters of credit commissions, securities gains (losses), gains (losses) on loan sales, wire transfer fees, gains from sales of premises and equipment and other sources of fee income, was $8.9 million for the third quarter of 2007, an increase of $3.5 million, or 63.9%, compared to the non-interest income of $5.4 million for the third quarter of 2006.
 
In the third quarter of 2007, the Company recorded a gain of $2.7 million from sale of a property housing a former branch. In the third quarter of 2007, wealth management commissions increased $356,000, or 110%, to $681,000, venture capital income increased $319,000 as a result of partnership distributions, and letter of credit commissions increased by $181,000, or 12.6%, compared to the same quarter a year ago.
 
Non-Interest Expense
 
Non-interest expense increased $3.8 million, or 13.1%, to $33.2 million in the third quarter of 2007 compared to $29.4 million in the same quarter a year ago. The efficiency ratio was 37.46% for the third quarter of 2007 compared to 38.62% in the year ago quarter and 39.06% for the second quarter of 2007.
 
The increase of non-interest expense in the third quarter of 2007 compared to the same period a year ago was primarily due to the following:
 
 
·
Salaries and employee benefits increased $944,000, or 5.9%, due primarily to the Company’s acquisitions and the hiring of additional staff.