East West Bancorp, Inc. — 2Q 2015 Form 10-Q Summary
Business Context and Reporting Period
East West Bancorp, Inc. is the holding company for East West Bank, serving customers in the United States and Greater China through more than 130 branches. The unaudited filing covers the quarter and six months ended June 30, 2015, with comparisons to the periods ended June 30, 2014 and the December 31, 2014 balance sheet. Prior periods were retrospectively restated for adoption of ASU 2014-01 concerning qualified affordable housing investments.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Revenue, defined as net interest income plus noninterest income | $268.1 million | $547.9 million |
| Net income | $98.7 million | $198.8 million |
| Diluted EPS | $0.68 | $1.38 |
| Net interest income | $227.5 million | $463.2 million |
| Net interest margin | 3.31% | 3.41% |
| Noninterest income | $40.6 million | $84.7 million |
| Provision for loan losses | $3.5 million | $8.5 million |
| Noninterest expense | $120.2 million | $248.2 million |
| Return on average assets | 1.34% | 1.37% |
| Return on average equity | 13.25% | 13.58% |
At June 30, 2015, total assets were $30.06 billion, total loans held for investment were $21.96 billion, net loans including loans held for sale were $21.89 billion, total deposits were $25.53 billion, and stockholders’ equity was $3.00 billion. Cash and cash equivalents were $1.88 billion, while liquid assets consisting of cash, short-term investments and available-for-sale securities totaled $5.13 billion, or 17% of total assets.
Loans increased modestly despite approximately $998.6 million of loan sales. Growth was concentrated in commercial real estate, commercial and industrial, and consumer loans, partially offset by lower residential loans. The allowance for loan losses was $261.2 million, or 1.19% of loans held for investment. Nonaccrual loans were $87.2 million, nonperforming assets were $112.9 million, and OREO was $25.8 million.
Six-month operating cash flow was $289.5 million, compared with $47.5 million in the prior-year period. Investing activities used $798.6 million, primarily for securities, loans and resale agreements. Financing activities provided $1.35 billion, principally from a $1.52 billion increase in deposits. Cash and cash equivalents increased $838.0 million to $1.88 billion.
Debt and secured funding included $318.3 million of FHLB advances, $400.0 million of repurchase agreements, $216.0 million of long-term debt and $3.3 million of short-term borrowings. The Company paid down $10.0 million of long-term debt and extinguished $100.0 million of repurchase agreements, incurring $6.6 million of extinguishment costs.
Material Changes Versus Prior Comparable Period
- Quarterly net income increased 17% and six-month net income increased 25%, primarily because of significantly improved noninterest income and lower loan-loss provisions.
- Noninterest income improved from a $14.9 million loss to $40.6 million of income for the quarter, and from a $29.9 million loss to $84.7 million for the six-month period. The principal driver was the substantially smaller loss associated with the FDIC indemnification asset and related receivable/payable.
- Net interest income declined 15% for the quarter and 12% for the six-month period. Net interest margin decreased 91 basis points to 3.31% for the quarter and 83 basis points to 3.41% for the six-month period, primarily because of lower accretion income from purchased credit-impaired loans and lower securities yields.
- Noninterest expense was broadly flat for the quarter but increased 3% for the six-month period. Higher compensation, tax-credit investment amortization and $6.6 million of repurchase-agreement extinguishment costs offset lower legal, data-processing and OREO expenses.
- Credit trends improved: nonaccrual loans decreased 13%, nonperforming assets decreased 15%, and quarterly net recoveries were $4.1 million versus $8.0 million of net charge-offs in the prior-year quarter.
- Deposits increased 6% from year-end, including a 5% increase in core deposits. Repurchase agreements declined 50% because of extinguishment activity and additional netting-eligible resale agreements.
- Basel III capital ratios remained above well-capitalized thresholds: company CET1, Tier 1, total risk-based and Tier 1 leverage ratios were 10.9%, 11.0%, 12.7% and 8.8%, respectively.
Outlook, Commentary, Risks and Unusual Items
Management described results as supported by loan and core-deposit growth, stable credit quality and diversified fee income. No quantified earnings, revenue or margin guidance was provided. Management stated that liquidity sources were sufficient for reasonably foreseeable short- and intermediate-term needs and that it was not aware of material liquidity trends or foreseeable capital-expenditure commitments.
- FDIC shared-loss coverage for UCB commercial loans ended after December 31, 2014, and coverage for WFIB commercial loans ended after June 30, 2015. Residential coverage continues through November 2019 and June 2020, respectively. The net payable to the FDIC was $105.1 million at June 30, 2015.
- Liquidity included $5.32 billion of available FHLB borrowing capacity, $2.92 billion from the Federal Reserve Bank and $683.0 million of unsecured correspondent-bank lines.
- Interest-rate risk is material. The balance sheet was asset-sensitive; management projected higher net interest income in rising-rate scenarios and lower net interest income in declining-rate scenarios.
- Loan commitments were $3.28 billion and commercial and standby letters of credit were $1.50 billion. The allowance for unfunded commitments, off-balance-sheet exposures and recourse provisions was $19.7 million.
- Maximum potential future payments under loan-sale and securitization recourse arrangements were $224.2 million; the related reserve was $619 thousand.
- The Company recorded a $33.5 million litigation accrual related to a case involving East West Bank. Management stated that pending legal matters were not expected to have a material adverse effect, although outcomes are inherently difficult to predict and the case was under appeal.
- Available-for-sale securities had $10.95 million of gross unrealized losses, but management considered the impairments temporary and recorded no other-than-temporary credit losses.
- The Board declared a third-quarter dividend of $0.20 per share, payable August 17, 2015.
Important Facts for Investors to Verify
- Whether the lower purchased-loan accretion and expiration of FDIC commercial shared-loss coverage will continue to pressure net interest income, margins and credit costs.
- The sustainability of noninterest income, particularly gains on securities and loans and changes in the FDIC indemnification obligation, which materially benefited 2015 comparisons.
- Credit performance in commercial real estate, commercial and industrial and China-related lending, including the increase in performing TDR loans to $88.2 million and impaired loans to $174.6 million.
- The adequacy of the $261.2 million loan-loss allowance and $19.7 million off-balance-sheet exposure allowance under changing economic, real-estate and interest-rate conditions.
- The effect of Basel III risk-weighting changes and the continued growth of risk-weighted assets on future capital ratios.
- The outcome and potential financial impact of the appealed litigation matter and other legal or regulatory contingencies.
- The impact of the ASU 2014-01 restatement and the Company’s future accounting assessments for revenue recognition, consolidation, debt issuance costs and cloud-computing arrangements.