| CATHAY GENERAL BANCORP Item 1A Risk Factors |
| The allowance for loan losses is an estimate of probable loan losses |
| Actual loan losses in excess of the estimate could adversely affect our net income and capital |
| The allowance for loan losses is based on management’s estimate of the probable losses from our loan portfolio |
| If actual losses exceed the estimate, the excess losses could adversely affect our net income and capital |
| Such excess could also lead to larger allowances for loan losses in future periods, which could in turn adversely affect net income and capital in those periods |
| If economic conditions differ substantially from the assumptions used in the estimate or adverse developments arise with respect to our loans, future losses may occur, and increases in the allowance may be necessary |
| In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of our allowance |
| These agencies may require us to establish additional allowances based on their judgment of the information available at the time of their examinations |
| No assurance can be given that we will not sustain loan losses in excess of present or future levels of the allowance for loan losses |
| 19 ______________________________________________________________________ [55]Table of Contents Fluctuations in interest rates could reduce our net interest income and adversely affect our business |
| The interest rate risk inherent in our lending, investing, and deposit taking activities is a significant market risk to us and our business |
| Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by fluctuations in interest rates |
| The magnitude and duration of changes in interest rates, events over which we have no control, may have an adverse effect on net interest income |
| Prepayment and early withdrawal levels, which are also impacted by changes in interest rates, can significantly affect our assets and liabilities |
| Increases in interest rates may adversely affect the ability of our floating rate borrowers to meet their higher payment obligations, which could in turn lead to an increase in non-performing assets and net charge-offs |
| Generally, the interest rates on interest-earning assets and interest-bearing liabilities of the Company do not change at the same rate, to the same extent, or on the same basis |
| Even assets and liabilities with similar maturities or periods of repricing may react in different degrees to changes in market interest rates |
| Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in general market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates |
| Certain assets, such as fixed and adjustable rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the asset |
| We seek to minimize the adverse effects of changes in interest rates by structuring our asset-liability composition to obtain the maximum spread |
| We use interest rate sensitivity analysis and a simulation model to assist us in estimating the optimal asset-liability composition |
| However, such management tools have inherent limitations that impair their effectiveness |
| There can be no assurance that we will be successful in minimizing the adverse effects of changes in interest rates |
| See also the sections entitled “Risks Elements of the Loan Portfolio” under Item 7 and “Market Risk” under Item 7A of this Annual Report on the Form 10-K We have engaged in and may continue to engage in further expansion through mergers and acquisitions, which could negatively affect our business and earnings |
| We have engaged in and may continue to engage in expansion through mergers and acquisitions |
| There are risks associated with such expansion |
| These risks include, among others, incorrectly assessing the asset quality of a bank acquired in a particular transaction, encountering greater than anticipated costs in integrating acquired businesses, facing resistance from customers or employees, and being unable to profitably deploy assets acquired in the transaction |
| Additional country- and region-specific risks are associated with transactions outside the United States, including in China |
| To the extent we issue capital stock in connection with additional transactions, these transactions and related stock issuances may have a dilutive effect on earnings per share and share ownership |
| Our earnings, financial condition, and prospects after a merger or acquisition depend in part on our ability to successfully integrate the operations of the acquired company |
| We may be unable to integrate operations successfully or to achieve expected cost savings |
| Any cost savings which are realized may be offset by losses in revenues or other charges to earnings |
| Inflation and deflation may adversely affect our financial performance |
| The consolidated financial statements and related financial data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States |
| These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation or deflation |
| The primary impact of inflation on the operations of the Company is reflected in increased operating costs |
| Conversely, deflation will tend to erode collateral values and diminish loan quality |
| Virtually all of our assets and liabilities are monetary in nature |
| As a result, interest rates have a more significant impact on our performance than the general levels of 20 ______________________________________________________________________ [56]Table of Contents inflation or deflation |
| Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services |
| As we expand our business outside of California markets, we will encounter risks that could adversely affect us |
| We primarily operate in California markets with a concentration of Chinese-American individuals and businesses; however, one of our strategies is to expand beyond California into other domestic markets that have concentrations of Chinese-American individuals and businesses |
| In the course of this expansion, we will encounter significant risks and uncertainties that could have a material adverse effect on our operations |
| These risks and uncertainties include increased operational difficulties arising from, among other things, our ability to attract sufficient business in new markets, to manage operations in noncontiguous market areas, and to anticipate events or differences in markets in which we have no current experience |
| To the extent that we expand through acquisitions, such acquisitions may also adversely harm our business, if we fail to adequately address the financial and operational risks associated with such acquisitions |
| For example, risks can include difficulties in assimilating the operations, technology, and personnel of the acquired company; diversion of management’s attention from other business concerns; inability to maintain uniform standards, controls, procedures and policies; potentially dilutive issuances of equity securities; incurrence of additional debt and contingent liabilities; use of cash resources; large write-offs; and amortization expenses related to other intangible assets with finite lives |
| Our financial results could be adversely affected by changes in California tax law and changes in its interpretation relating to registered investment companies and real estate investment trusts |
| Our effective income tax rate was lower in 2002 and 2001 than in subsequent years due in large part to income tax benefits derived from a registered investment company subsidiary of the Bank |
| We had relied on the California tax law related to registered investment companies and on an outside tax opinion in creating this subsidiary |
| In the fourth quarter of 2003, a change in that law was enacted by the California Legislature, which would deny such tax benefits from and after January 1, 2003 |
| On December 31, 2003, the California Franchise Tax Board (FTB) announced its position that certain tax deductions related to regulated investment companies as well as real estate investment trusts prior to January 1, 2003 would also be disallowed |
| In December, 2002, we decided to deregister the registered investment company and, in February, 2003, we completed such deregistration |
| In addition, in the fourth quarter of 2003, the Company reversed the net state tax benefits recorded in the first three quarters of 2003 relating to the real estate investment trust (REIT) that it formed as a subsidiary of the Bank during 2003 |
| The Company did not record any tax benefits relating to the REIT in the fourth quarter of 2003 and did not record any such benefits in 2004 or 2005 |
| 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) |
| As part of the notification indicating the listed transactions, the FTB also indicated its position that it intends to disallow tax benefits associated with these transactions |
| While the Company continues to believe that the tax benefits recorded in three prior years with respect to its regulated investment company were appropriate and fully defensible under California law, the Company has deemed it prudent to participate in Voluntary Compliance Initiative – Option 2, requiring payment of all California taxes and interest on these disputed 2000 through 2002 tax benefits, and permitting the Company to claim a 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 |
| As of December 31, 2005, the Company reflected a dlra12dtta1 million net state tax receivable for the years 2000, 2001, and 2002 after giving effect to reserves for loss contingencies on the refund claims, or an 21 ______________________________________________________________________ [57]Table of Contents equivalent of dlra7dtta9 million after giving effect to Federal tax benefits |
| Although the Company believes its tax deductions related to the regulated investment company were appropriate and fully defensible, there can be no assurance of the outcome of its refund claims, and an adverse outcome on the refund claims could result in a loss of all or a portion of the dlra7dtta9 million net state tax receivable after giving effect to Federal tax benefits |
| Adverse economic conditions in California and other regions where the Bank has operations could cause us to incur losses |
| Our banking operations are concentrated primarily in Southern and Northern California, and secondarily in New York, Texas, Massachusetts, and Washington |
| Adverse economic conditions in these regions, such as the current California budget deficit and its impact could impair borrowers’ ability to service their loans, decrease the level and duration of deposits by customers, and erode the value of loan collateral |
| These events could increase the amount of our non-performing assets and have an adverse effect on our efforts to collect our non-performing loans or otherwise liquidate our non-performing assets (including other real estate owned) on terms favorable to us |
| Real estate securing our lending activities is also principally located in Southern and Northern California, and to a lesser extent, in New York, Texas, Massachusetts, and Washington |
| The value of such collateral depends upon conditions in the relevant real estate markets |
| These include general or local economic conditions and neighborhood characteristics, real estate tax rates, the cost of operating the properties, governmental regulations and fiscal policies, acts of nature including earthquakes, flood and hurricanes (which may result in uninsured losses), and other factors beyond our control |
| The risks inherent in construction lending may adversely affect our net income |
| As a result of the merger with GBC Bancorp, the Company has a higher proportion of real estate construction loans than it did before the merger |
| The risks inherent in construction lending may adversely affect our net income |
| Such risks include, among other things, the possibility that contractors may fail to complete, or complete on a timely basis, construction of the relevant properties; substantial cost overruns in excess of original estimates and financing; market deterioration during construction; and lack of permanent take-out financing |
| Loans secured by such properties also involve additional risk because such properties have no operating history |
| In these loans, loan funds are advanced upon the security of the project under construction, which is of uncertain value prior to completion of construction, and the estimated operating cash flow to be generated by the completed project |
| There is no assurance that such properties will be sold or leased so as to generate the cash flow anticipated by the borrower |
| Such consideration can affect the borrowers’ ability to repay their obligations to us and the value of our security interest in collateral |
| Our use of appraisals in deciding whether to make a loan on or secured by real property does not insure the value of the real property collateral |
| In considering whether to make a loan on or secured by real property, we generally require an appraisal of such property |
| However, the appraisal is only an estimate of the value of the property at the time the appraisal is made |
| If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property |
| We face substantial competition from larger competitors |
| We face substantial competition for deposits and loans, as well as other banking services, throughout our market area from the major banks and financial institutions that dominate the commercial banking industry |
| This may cause our cost of funds to exceed that of our competitors |
| Such banks and financial institutions have greater 22 ______________________________________________________________________ [58]Table of Contents resources than us, including the ability to finance advertising campaigns and allocate their investment assets to regions of higher yield and demand |
| By virtue of their larger capital bases, such institutions have substantially greater lending limits than us and perform certain functions, including trust services, which are not presently offered by us |
| We also compete for loans and deposits, as well as other banking services, with savings and loan associations, finance companies, money market funds, brokerage houses, credit unions and non-financial institutions |
| Adverse effects of banking regulations or changes in banking regulations could adversely affect our business |
| We are regulated by significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers or which serve other public policies and not for the benefit of our stockholders |
| In the past, our business has been materially affected by such regulation and supervision |
| Laws, regulations, or policies currently affecting us may change at any time |
| Regulatory authorities may also change their interpretation of existing laws and regulations |
| It is impossible to predict the competitive impact that any such changes would have on commercial banking in general or on our business in particular |
| Such changes may, among other things, increase the cost of doing business, limit permissible activities, or affect the competitive balance between banks and other financial institutions |
| Adverse economic conditions in Asia could adversely affect our business |
| It is difficult to predict the behavior of the Asian economy |
| US economic policies, military tensions, and an unfavorable global economic condition may adversely impact the Asian economy |
| If the Asian economic conditions deteriorate, we could be exposed to economic and transfer risk, and could experience an outflow of deposits by our Asian-American customers |
| Transfer risk may result when an entity is unable to obtain the foreign exchange needed to meet its obligations or to provide liquidity |
| This may adversely impact the recoverability of investments with or loans made to such entities |
| Adverse economic conditions may also negatively impact asset values and the profitability and liquidity of companies operating in this region |
| Statutory restrictions on dividends and other distributions from the Bank may adversely impact us |
| A substantial portion of the Bancorp’s cash flow comes from dividends that the Bank pays to us |
| Various statutory provisions restrict the amount of dividends that the Bank can pay without regulatory approval |
| In addition, if the Bank were to liquidate, the Bank’s creditors would be entitled to receive distributions from the assets of the Bank to satisfy their claims against the Bank before we, as a holder of an equity interest in the Bank, would be entitled to receive any of the assets of the Bank |
| Our need to continue to adapt to our information technology systems to allow us to provide new and expanded services could present operational issues and require significant capital spending |
| As we continue to offer internet banking and other on-line services to our customers, and continue to expand our existing conventional banking services, we will need to adapt our information technology systems to handle these changes in a way that meets constantly changing industry and regulatory standards |
| This can be very expensive and may require significant capital expenditures |
| In addition, our success will depend, among other things, on our ability to provide secure and reliable services, anticipate changes in technology, and efficiently develop and introduce services that are accepted by our customers and cost effective for us to provide |
| Systems failures, delays, breaches of confidentiality and other problems could harm our reputation and business |
| Certain provisions of our charter, bylaws, and rights agreement could make the acquisition of our Company more difficult |
| Certain provisions of our Charter, Bylaws, and Rights Agreement between us and American Stock Transfer and Trust Company, as Rights Agent, could make the acquisition of our company more difficult |
| These 23 ______________________________________________________________________ [59]Table of Contents provisions include authorized but unissued shares of preferred and common stock that may be issued without stockholder approval; three classes of directors serving staggered terms; preferred share purchase rights that generally become exercisable if a person or group acquires 15prca or more of our common stock or announces a tender offer for 15prca or more of our common stock; special requirements for stockholder proposals and nominations for director; and super-majority voting requirements in certain situations including certain types of business combinations |
| Terrorist attacks could adversely affect us |
| Any terrorist attacks and responses to such activities could adversely affect the Company in a number of ways, including, among others, an increase in delinquencies, bankruptcies or defaults that could result in a higher level of non-performing assets, net charge-offs, and provision for loan losses |