EAST WEST BANCORP INC quarterly report, Q3 FY2018

Business Context and Reporting Period

East West Bancorp, Inc. is a bank holding company whose principal subsidiary, East West Bank, provides commercial and retail banking services in the U.S. and Greater China, with a focus on Chinese-American and cross-border customers. The filing covers the unaudited quarter and nine months ended September 30, 2018. The Company reported approximately $39.1 billion of assets and about 3,000 full-time equivalent employees, operating through more than 130 locations.

Key Financial Metrics

Metric	Three Months Ended September 30, 2018	Nine Months Ended September 30, 2018	Change Versus 2017
Revenue	$395.2 million	$1.19 billion	+12%; +10%
Net interest income before provision	$348.7 million	$1.02 billion	+15%; +18%
Net income	$171.3 million	$530.7 million	+29%; +26%
Diluted EPS	$1.17	$3.63	+29%; +26%
Net interest margin	3.76%	3.77%	+24 bps; +32 bps
Return on average assets	1.76%	1.87%	+30 bps; +28 bps
Return on average equity	16.19%	17.47%	+218 bps; +197 bps
Efficiency ratio	45.50%	44.37%	Improved from 46.61%; 45.10%

Interest expense increased 100% in the quarter and 77% year to date, reflecting higher deposit and borrowing costs.
Provision for credit losses was $10.5 million for the quarter, down 19%, and $46.3 million year to date, up 51%.
Noninterest income was $46.5 million for the quarter and $169.2 million year to date, down 6% and 20%, respectively. Noninterest expense increased 9% and 8% to $179.8 million and $526.4 million.
The effective tax rate declined to 16.4% for the quarter and 13.5% year to date, primarily due to the Tax Cuts and Jobs Act.

Balance Sheet, Credit and Liquidity

Total assets increased 5% from December 31, 2017 to $39.07 billion. Gross loans held for investment increased 8% to $31.21 billion, led by single-family residential and commercial and industrial loans.
Total deposits increased 6% to $33.63 billion. Time deposits increased 54% to $8.70 billion, while core deposits declined 4% to $24.93 billion; core deposits represented 74% of total deposits.
Loans-to-deposits increased to 93% from 90%. The allowance for loan losses was $310.0 million, or 0.99% of loans. Nonaccrual loans were $113.9 million, or 0.36% of loans held for investment, and nonperforming assets were $114.6 million, or 0.29% of total assets.
Cash and cash equivalents were $2.22 billion. Management identified $5.24 billion of liquidity sources, including cash, interest-bearing deposits, resale agreements and unpledged securities. Available borrowing capacity with the FHLB and Federal Reserve was $6.15 billion and $3.07 billion, respectively.
Long-term debt declined 9% to $156.8 million. FHLB advances were $325.6 million, net repurchase agreements were $50.0 million, and short-term borrowings were $56.4 million.
Operating cash flow was $693.3 million, compared with $669.5 million in the prior-year period. Investing activities used $2.65 billion, primarily for loan growth and the DCB branch transaction, while financing activities provided $2.03 billion, principally from deposit growth. Cash and cash equivalents increased $44.2 million.
Capital remained strong: CET1 and Tier 1 risk-based capital ratios were 12.3%, total risk-based capital was 13.8%, and Tier 1 leverage was 10.0%. The Company and Bank were considered well-capitalized.

Material Changes Versus the Prior Comparable Period

Higher loan balances, higher loan yields and rising interest rates drove net interest income and expanded net interest margin, although deposit costs increased materially.
Loan growth shifted the portfolio mix modestly toward consumer lending: consumer loans represented 25% of loans versus 23% at December 31, 2017, while commercial lending declined to 75% from 77%.
Noninterest income was affected by unusual gains in both periods. The first nine months of 2018 included a $31.5 million pretax gain from the sale of eight Desert Community Bank branches. The first nine months of 2017 included a $71.7 million gain on a commercial property sale and a $3.8 million gain on the sale of the EWIS insurance brokerage business.
The March 2018 DCB transaction involved a $499.9 million net cash payment to Flagstar Bank and reduced deposits by $613.7 million at the transaction date. Management reported a $0.15 after-tax diluted EPS impact for the first nine months of 2018.
Stockholders’ equity increased 10% to $4.24 billion, and book value per common share increased 10% to $29.29. The quarterly dividend increased from $0.20 to $0.23 per share beginning in the third quarter; a $0.23 fourth-quarter dividend was declared in October 2018.
The Company adopted several accounting standards in 2018 without material effects on the financial statements. It expects to adopt the leases standard in the first quarter of 2019 and estimates right-of-use assets and liabilities of approximately $95 million to $105 million. The Company is also evaluating the CECL standard, which it expects may increase the allowance for credit losses upon adoption.

Guidance, Outlook, Commentary and Risks

The filing does not provide specific quantitative earnings or revenue guidance. Management stated that it intends to continue pursuing organic loan, deposit and revenue growth, investing in technology, customer experience and risk infrastructure, while managing expenses, liquidity, credit risk and capital.

The Company is asset-sensitive: management expects net interest income to benefit from rising rates and decline if rates fall, but higher deposit betas and migration from noninterest-bearing deposits could pressure margins.
Management cited California real estate concentration as a material credit risk. California represented 78% of CRE loans, 85% of multifamily loans and 59% of construction and land loans. California also represented 64% of single-family residential loans and 71% of HELOCs.
Available-for-sale securities had $112.99 million of gross unrealized losses at September 30, 2018, compared with $58.33 million at year-end 2017. Management considered the losses temporary and recorded no other-than-temporary impairment.
Off-balance-sheet exposure included $5.10 billion of loan commitments and $1.71 billion of commercial letters of credit and standby letters of credit. The allowance for unfunded credit exposures was $11.9 million.
Risks include credit deterioration, interest-rate and deposit-mix changes, liquidity and funding conditions, cybersecurity and operational failures, regulatory and compliance requirements, litigation, foreign exchange and Greater China economic or regulatory developments.
The Federal Reserve and California regulator terminated the Bank’s prior BSA/AML-related Written Agreement and Memorandum of Understanding in July 2018. Management cautioned that continued deficiencies could lead to adverse examinations, penalties, increased expenses or operating restrictions.
Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing states that there were no material changes to the risk factors previously disclosed in the 2017 Form 10-K.

Important Facts for Investors to Verify

Whether loan growth and the 93% loans-to-deposits ratio remain manageable as core deposits decline and time-deposit funding increases.
Whether higher deposit costs, deposit migration and future rate movements erode the 3.76% quarterly net interest margin.
Credit performance in California commercial real estate, multifamily, construction, C&I, residential and HELOC portfolios, including trends in nonaccrual loans, charge-offs and the allowance ratio.
The eventual first-quarter 2019 balance-sheet impact of lease accounting and the expected allowance and capital impact of CECL adoption.
Whether recurring earnings growth remains strong after excluding the DCB gain and prior-period property and EWIS disposal gains.
Trends in unrealized securities losses, liquidity capacity, collateral availability and interest-rate sensitivity under changing market conditions.
Continued compliance performance following termination of the BSA/AML and OFAC regulatory agreements.