East West Bancorp, Inc. — 2018 Q1 Form 10-Q Summary
Business context and reporting period
East West Bancorp is a bank holding company operating through East West Bank, serving customers in the United States and Greater China through more than 130 locations. The filing covers the unaudited three months ended March 31, 2018, compared primarily with the three months ended March 31, 2017 and, for balance-sheet measures, December 31, 2017.
Key financial metrics
| Metric | Q1 2018 | Comparable period | Change |
|---|---|---|---|
| Revenue | $401.1 million | $388.0 million | 3% |
| Net interest income before provision | $326.7 million | $272.1 million | 20% |
| Provision for credit losses | $20.2 million | $7.1 million | 186% |
| Noninterest income | $74.4 million | $115.8 million | (36%) |
| Noninterest expense | $169.1 million | $152.9 million | 11% |
| Net income | $187.0 million | $169.7 million | 10% |
| Diluted EPS | $1.28 | $1.16 | 10% |
| Net interest margin | 3.73% | 3.33% | +40 basis points |
| Return on average assets | 2.03% | 1.97% | +6 basis points |
| Return on average equity | 19.34% | 19.71% | (37) basis points |
Loan yield increased to 4.69% from 4.23%, while the reported cost of deposits increased to 0.49% from 0.32%. The cost of interest-bearing deposits increased to 0.76% from 0.49%. Management attributed the higher net interest income and margin primarily to loan growth and rising interest rates on the company’s asset-sensitive balance sheet.
- Total assets were $37.69 billion, up 1% from December 31, 2017.
- Loans held for investment were $29.56 billion gross, up 2% from year-end; the allowance for loan losses was $297.7 million, or 1.01% of loans.
- Total deposits were $32.61 billion, up 3%; core deposits represented 81% of total deposits, and noninterest-bearing demand deposits represented 36%.
- Cash and cash equivalents were $2.31 billion. Reported liquidity assets, including cash, interest-bearing deposits, resale agreements and unpledged investment securities, totaled approximately $5.56 billion, or 15% of assets.
- Long-term debt was $166.6 million, FHLB advances were $324.5 million, and net repurchase agreements were $50.0 million. The company also had $30.3 million of short-term borrowings.
- Stockholders’ equity was $3.98 billion, up 4% from year-end. Book value per common share was $27.46.
- Regulatory capital remained strong: company CET1, total risk-based and Tier 1 leverage ratios were 11.9%, 13.4% and 9.6%, respectively. The company and bank were reported as well-capitalized.
- Operating cash flow was $217.9 million. Investing activities used $1.04 billion, primarily reflecting loan growth and the $503.7 million net cash payment for the DCB branch sale. Financing activities provided $944.4 million, primarily from deposit growth.
Material changes versus prior comparable periods
- Net interest income increased $54.6 million, supported by a 12% increase in average loans and a 46-basis-point increase in average loan yield.
- Noninterest income declined because Q1 2017 included a $71.7 million gain from a California commercial-property sale. Q1 2018 included a $31.5 million pretax gain from the sale of eight Desert Community Bank branches.
- The DCB transaction closed March 17, 2018. The company transferred approximately $613.7 million of deposits and $59.1 million of loans and paid Flagstar Bank approximately $499.9 million net cash after related adjustments. Management estimated a $0.15 after-tax diluted EPS benefit.
- Excluding the respective property and DCB sale gains, non-GAAP diluted EPS was $1.13 in Q1 2018 versus $0.88 in Q1 2017.
- The effective tax rate declined to 11.7% from 25.6%, primarily due to the Tax Cuts and Jobs Act, a $3.9 million state tax payable reversal and tax benefits from stock compensation.
- Provision for credit losses increased materially to $20.2 million. Net charge-offs increased to $9.4 million from $5.4 million, while annualized net charge-offs to average loans increased to 0.13% from 0.08%.
- Nonaccrual loans increased to $130.2 million from $114.3 million at year-end, and nonperforming assets increased to $131.0 million from $115.1 million. Management attributed the increase primarily to two C&I loans placed on nonaccrual status.
- The company adopted several accounting standards, including revenue recognition, financial instruments, cash-flow classification, hedging and stranded tax-effect guidance. Management reported no material impact from most adoptions; ASU 2018-02 increased retained earnings and reduced AOCI by approximately $6.7 million.
Guidance, outlook, commentary, risks and unusual items
Management did not provide specific quantitative earnings guidance in the filing. It stated that the strategy remains focused on organic growth in loans, deposits and revenue; technology and human-capital investment; expense management; cross-border banking; and prudent risk management.
- The company remains asset-sensitive: modeled 12-month net interest income would increase 9.1% for a 100-basis-point rate increase and 20.2% for a 200-basis-point increase, but decline 8.1% and 15.0% under corresponding rate decreases. Actual results may differ because of deposit migration, deposit betas, prepayments and other modeling assumptions.
- Credit risk is concentrated in commercial lending and California real estate. California represented 77% of CRE loans, 85% of multifamily residential loans and 60% of construction and land loans at March 31, 2018.
- The company remains subject to a 2015 Federal Reserve Written Agreement and related California regulatory memorandum concerning BSA, AML and OFAC compliance. Management reported progress but stated that regulators may determine that additional actions are necessary, potentially resulting in fines, higher expenses, operating restrictions or adverse regulatory ratings.
- Off-balance-sheet exposure included $4.82 billion of loan commitments and $1.63 billion of commercial letters of credit and standby letters of credit. The allowance for unfunded credit exposures was $13.6 million.
- Loans sold or securitized with recourse had an unpaid principal balance of $108.7 million and maximum potential repurchase exposure of $37.8 million.
- The available-for-sale securities portfolio had $79.5 million of net unrealized losses, which management considered temporary; no other-than-temporary impairment loss was recorded.
- The company expects future adoption of CECL to potentially increase the allowance for credit losses, but had not yet quantified the impact.
- The board declared a $0.20 per-share second-quarter dividend payable May 15, 2018.
Most important facts for investors to verify
- Whether loan growth and the 3.73% net interest margin can continue as deposit costs rise and customers migrate toward higher-yielding products.
- Whether the higher provision expense, C&I nonaccrual loans and California real-estate concentration signal further credit-cost increases.
- The recurring earnings impact after removing the $31.5 million DCB sale gain and comparing against the unusually large Q1 2017 property-sale gain.
- The company’s continued compliance with the Federal Reserve Written Agreement and California MOU, including any subsequent regulatory findings or enforcement actions.
- The eventual balance-sheet and capital impact of CECL adoption and the timing of implementation.
- Liquidity and funding capacity, including the $5.56 billion of reported liquidity assets, $6.32 billion of FHLB/FRB secured borrowing capacity and deposit stability.
- Interest-rate sensitivity assumptions, particularly deposit beta, deposit migration and loan or securities prepayment behavior.