East West Bancorp, Inc. 2019 Q1 Form 10-Q Summary
Business context and reporting period
East West Bancorp, Inc. is a bank holding company operating primarily through East West Bank, serving consumer and commercial customers in the United States and Greater China. The company has a strong focus on the Chinese-American community and operates through Consumer and Business Banking, Commercial Banking, and Other segments. This unaudited filing covers the three months ended March 31, 2019, with comparisons to the three months ended March 31, 2018 and the balance sheet at December 31, 2018.
Financial performance and condition
| Metric | Q1 2019 | Comparable period or prior period |
|---|---|---|
| Net income | $164.0 million | $187.0 million in Q1 2018 |
| Diluted EPS | $1.12 | $1.28 in Q1 2018 |
| Net interest income before provision | $362.5 million | $326.7 million in Q1 2018 |
| Net interest margin | 3.79% | 3.73% in Q1 2018 |
| Provision for credit losses | $22.6 million | $20.2 million in Q1 2018 |
| Noninterest income | $42.1 million | $74.4 million in Q1 2018 |
| Noninterest expense | $186.9 million | $169.1 million in Q1 2018 |
| Return on average assets | 1.63% | 2.03% in Q1 2018 |
| Return on average equity | 14.66% | 19.34% in Q1 2018 |
| Total assets | $42.09 billion | $41.04 billion at December 31, 2018 |
| Total loans, net | $32.55 billion | $32.07 billion at December 31, 2018 |
| Total deposits | $36.27 billion | $35.44 billion at December 31, 2018 |
| Stockholders’ equity | $4.59 billion | $4.42 billion at December 31, 2018 |
Average loans increased 11% year over year to $32.41 billion, while average loan yield increased 61 basis points to 5.30%. The higher loan yield and loan growth drove the 11% increase in net interest income, but funding costs also rose materially as the deposit mix shifted toward interest-bearing checking and time deposits.
Cash provided by operating activities was $139.2 million. Investing activities used $118.7 million, primarily reflecting loan growth and investments in affordable housing and tax-credit projects. Financing activities provided $749.4 million, principally from an $800.1 million increase in deposits. Cash and cash equivalents increased to $3.79 billion from $3.00 billion at December 31, 2018.
Long-term debt and finance lease liabilities were $152.4 million, FHLB advances were $344.7 million, and net repurchase agreements were $50.0 million. The company reported $6.49 billion of liquid assets, or approximately 15% of total assets, and stated that available liquidity was sufficient for reasonably foreseeable needs over the next 12 months.
Regulatory capital remained strong: the company reported a 12.4% CET1 ratio, 13.9% total risk-based capital ratio, and 10.2% Tier 1 leverage ratio at March 31, 2019. The company and bank were considered well-capitalized.
Material changes versus comparable periods
- GAAP net income declined 12% year over year, primarily because Q1 2018 included a $31.5 million pretax gain from the sale of eight Desert Community Bank branches.
- Excluding the Q1 2019 tax-credit impairment and the Q1 2018 branch-sale gain, management reported non-GAAP net income of $168.9 million versus $164.9 million, and non-GAAP diluted EPS of $1.16 versus $1.13.
- Noninterest income declined 43% to $42.1 million, principally because the prior-year branch-sale gain did not recur. Foreign exchange income increased substantially, while derivative income and loan-sale gains declined.
- Noninterest expense increased 11% to $186.9 million. Compensation, operating expenses, software costs, and tax-credit investment amortization increased; deposit insurance expense declined following the expiration of a temporary FDIC surcharge.
- Loans increased 1% sequentially, led by single-family residential, CRE, and construction and land loans. Deposits increased 2%, led by interest-bearing checking and time deposits, while noninterest-bearing demand deposits declined 12%.
- Non-PCI nonperforming assets increased to $138.0 million, or 0.33% of total assets, from $93.0 million, or 0.23%, at December 31, 2018. Nonaccrual loans increased to $136.7 million from $85.7 million.
- The allowance for loan losses increased to $317.9 million, or 0.97% of loans held for investment. Annualized quarterly net charge-offs were 0.18% of average loans, compared with 0.14% in Q1 2018.
- The company adopted the new lease standard prospectively on January 1, 2019, recognizing $104.3 million of operating lease right-of-use assets, $112.8 million of operating lease liabilities, and a $14.7 million increase to opening retained earnings.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide formal earnings or revenue guidance. Management’s stated strategy is to grow loans, deposits, and revenue, improve profitability, invest in technology, and manage risk, expenses, and capital. Management expects its relationship-focused banking model to support organic growth, but notes that quarterly results are not necessarily indicative of full-year results.
The most significant unusual item was a $7.0 million pretax impairment charge related to investments in DC Solar, which had entered bankruptcy after allegations that it operated a fraudulent “Ponzi-like scheme.” The company had claimed approximately $53.9 million of related tax credits from 2014 through 2018. Management stated that an uncertain tax position liability had not yet been recognized as of March 31, 2019, but that a liability could become necessary for some or all of those credits, potentially adversely affecting taxes, earnings, and financial condition.
Key risks include rising nonaccrual loans, concentration of commercial real estate and multifamily exposure in California, interest-rate and funding-cost sensitivity, exposure to China and Hong Kong, counterparty and derivative risk, litigation, regulatory changes, cybersecurity and operational risks, and changes in tax-credit availability or tax law. The company is asset sensitive: modeled net interest income would increase in rising-rate scenarios and decrease in falling-rate scenarios, subject to management’s assumptions.
The company expects to adopt the current expected credit loss standard on January 1, 2020. Management expects the standard may increase the allowance for credit losses, but the filing does not provide a quantified expected impact.
The board declared a second-quarter 2019 common dividend of $0.275 per share, payable May 15, 2019, representing an increase from the $0.23 per-share dividend paid for Q1 2019.
Investor verification checklist
- Verify whether nonaccrual loans and non-PCI nonperforming assets continue to increase, particularly within C&I lending.
- Assess whether loan growth remains supported by stable credit quality and whether the allowance ratio adequately reflects portfolio risk.
- Monitor deposit pricing, the shift from noninterest-bearing to interest-bearing deposits, funding costs, and net interest margin.
- Review subsequent disclosures regarding the DC Solar investment, tax-credit recapture risk, and any uncertain tax position liability.
- Evaluate the eventual quantitative impact of CECL adoption on retained earnings, capital, and the allowance for credit losses.
- Review California commercial real estate, multifamily, construction, and residential loan concentrations against regional economic and property-market conditions.
- Confirm liquidity availability, pledged collateral, borrowing capacity, and compliance with well-capitalized regulatory requirements.
- Reconcile non-GAAP results with GAAP results and consider the recurring nature of tax-credit amortization and impairment-related charges.