East West Bancorp, Inc. — 2019 Q2 Form 10-Q Summary
Business Context and Reporting Period
East West Bancorp, Inc. is a bank holding company whose principal subsidiary, East West Bank, provides consumer and commercial banking services through more than 130 locations in the United States and Greater China, with a focus on the Chinese-American community. The filing covers the unaudited quarter and six months ended June 30, 2019, compared primarily with the periods ended June 30, 2018 and December 31, 2018.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Net interest income before provision | $367.3 million | $341.7 million | $729.8 million | $668.4 million |
| Provision for credit losses | $19.2 million | $15.5 million | $41.8 million | $35.8 million |
| Noninterest income | $52.8 million | $48.3 million | $94.9 million | $122.7 million |
| Noninterest expense | $177.7 million | $177.4 million | $364.6 million | $346.6 million |
| Income before taxes | $223.2 million | $197.0 million | $418.3 million | $408.8 million |
| Net income | $150.4 million | $172.3 million | $314.4 million | $359.4 million |
| Diluted EPS | $1.03 | $1.18 | $2.15 | $2.46 |
| Net interest margin | 3.73% | 3.83% | 3.76% | 3.78% |
| ROA | 1.45% | 1.84% | 1.54% | 1.93% |
| ROE | 12.88% | 17.02% | 13.75% | 18.15% |
At June 30, 2019, total assets were $42.89 billion, loans held for investment were $33.73 billion gross, total deposits were $36.48 billion, stockholders’ equity was $4.73 billion, and cash and cash equivalents were $3.62 billion. The loan-to-deposit ratio was approximately 92%.
- Loan growth was 4% from December 31, 2018, led by single-family residential, commercial real estate, and commercial and industrial loans.
- Deposits increased 3% from year-end, primarily from a $1.53 billion increase in time deposits; noninterest-bearing demand deposits declined $777.9 million.
- FHLB advances increased to $745.1 million from $326.2 million at year-end. Long-term debt and finance lease liabilities totaled $152.5 million.
- Allowance for loan losses was $330.6 million, or 0.98% of loans held for investment. Annualized second-quarter net charge-offs were 0.09% of average loans.
- Non-PCI nonperforming assets were $119.3 million, or 0.28% of total assets, up from $93.0 million at December 31, 2018.
- Six-month operating cash flow was $290.0 million; investing cash flow was negative $997.2 million, primarily reflecting loan growth; financing cash flow was $1.33 billion. Cash and cash equivalents increased $620.2 million.
- Company regulatory capital ratios remained well above minimum requirements: CET1 and Tier 1 ratios were 12.5%, total risk-based capital was 13.9%, and Tier 1 leverage was 10.4%.
Material Changes Versus Comparable Periods
- Second-quarter net interest income increased 8%, and first-half net interest income increased 9%, primarily because of loan growth and higher loan yields. Higher deposit funding costs reduced the net interest margin.
- Second-quarter pre-tax income increased 13%, but net income declined 13% because of higher income taxes. First-half pre-tax income increased 2%, while net income declined 13%.
- Second-quarter income tax expense increased to $72.8 million from $24.6 million. The effective tax rate rose to 32.6% from 12.5%, primarily because of a $30.1 million tax expense related to reversal of previously claimed DC Solar tax credits.
- First-half noninterest income declined 23%, mainly because the prior-year period included a $31.5 million pre-tax gain from the sale of eight Desert Community Bank branches. Loan-sale gains also declined materially.
- Noninterest expense was essentially flat year over year in the second quarter but increased 5% for the first half, reflecting higher compensation, operating, software, and tax-credit investment expenses.
- Nonaccrual loans increased 38% from year-end to $118.0 million, driven primarily by higher C&I nonaccrual loans. The allowance for impaired loans increased substantially as newly impaired C&I loans were identified.
- The company adopted the new lease standard prospectively on January 1, 2019, recognizing $109.1 million of operating lease right-of-use assets, $117.7 million of related liabilities, and a $14.7 million increase to beginning retained earnings.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal earnings or revenue guidance. Management states that its strategy remains focused on organic loan, deposit, and revenue growth, profitability improvement, technology investment, and risk and capital management. Management also states that current liquidity sources are sufficient for reasonably foreseeable short-term needs over the next 12 months.
- DC Solar: The company fully wrote off $7.0 million of related tax-credit investments in the first quarter and recorded a further $2.9 million of other-than-temporary impairment in the second quarter related to a historic tax credit and a CRA investment. In the second quarter, it recorded $30.1 million of additional income tax expense after concluding that a portion of previously claimed DC Solar tax credits would be recaptured. The company continues to investigate and warns that additional tax expense or reversal of remaining credits may result.
- CECL adoption: The company expects to adopt the current expected credit loss standard on January 1, 2020. It expects the allowance for credit losses may increase, but the ultimate effect remains under evaluation.
- Interest-rate risk: The company describes itself as asset sensitive because of its substantial variable-rate loan portfolio. A modeled instantaneous 100-basis-point decline in rates was estimated to reduce 12-month net interest income by 8.2%; a 100-basis-point increase was estimated to increase it by 7.2%.
- LIBOR transition: Approximately $7.34 billion of loans and $4.39 billion of derivative notional amounts indexed to LIBOR mature after 2021. The transition creates financial, operational, legal, compliance, and reputational risks.
- Geographic and portfolio concentration: Approximately 78% of CRE loans and 84% of multifamily loans were concentrated in California. Adverse California economic or real estate conditions could affect credit quality.
- Off-balance-sheet commitments: Loan commitments totaled $5.39 billion and commercial letters of credit and standby letters of credit totaled $1.83 billion. The allowance for unfunded credit exposures was $12.9 million.
- Capital return: The quarterly common dividend increased to $0.275 per share. A third-quarter dividend of $0.275 per share was declared on July 18, 2019, payable August 15, 2019.
Most Important Facts for Investors to Verify
- Whether the DC Solar tax-credit investigation or IRS position results in additional tax expense, tax-credit reversals, penalties, or litigation.
- The trajectory of nonaccrual C&I loans, impaired loans, TDRs, charge-offs, and the allowance as the loan portfolio continues to grow.
- The effect of deposit mix changes and funding costs on net interest margin and profitability, particularly if interest rates decline.
- The magnitude of the allowance and retained earnings adjustment when CECL is adopted in 2020.
- Progress and contractual remediation related to the LIBOR-to-SOFR transition.
- Exposure to California commercial real estate, multifamily housing, construction, and other concentrated markets.
- The sustainability of reported earnings excluding the $30.1 million DC Solar tax item and other unusual items, including the prior-year DCB branch-sale gain.
- Liquidity and funding capacity, including reliance on time deposits and increased FHLB advances.