East West Bancorp, Inc. — 2019 Form 10-K Summary
Business context and reporting period
East West Bancorp, Inc. is a California-based bank holding company whose principal subsidiary, East West Bank, provides consumer and commercial banking services in the United States and Greater China. The filing covers the fiscal year ended December 31, 2019, with comparative annual data for 2018 and 2017. The company operated through Consumer and Business Banking, Commercial Banking, and Other segments, with more than 125 locations and approximately 3,300 full-time equivalent employees.
At December 31, 2019, the company reported $44.20 billion of assets, $34.42 billion of net loans, $37.32 billion of deposits, and $5.02 billion of stockholders’ equity.
Financial results and key metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net interest income before provision | $1.468 billion | $1.387 billion | Up 6% |
| Provision for credit losses | $98.7 million | $64.3 million | Up 54% |
| Noninterest income | $209.4 million | $210.9 million | Down 1% |
| Noninterest expense | $734.6 million | $714.5 million | Up 3% |
| Net income | $674.0 million | $703.7 million | Down 4% |
| Diluted EPS | $4.61 | $4.81 | Down 4% |
| Net interest margin | 3.64% | 3.78% | Down 14 bps |
| ROA | 1.59% | 1.83% | Down 24 bps |
| ROE | 14.16% | 17.04% | Down 288 bps |
| Efficiency ratio | 43.80% | 44.73% | Improved 93 bps |
Revenue, defined by management as net interest income before provision plus noninterest income, was $1.68 billion, up 5%. Loan growth and higher loan yields increased net interest income, but funding costs rose materially. Average interest-bearing deposit cost increased to 1.47% from 1.06%, while average noninterest-bearing demand deposits declined 5%.
Cash flow from operating activities was $735.8 million, compared with $883.2 million in 2018. Investing activities used $2.57 billion, principally for loan growth and purchases of available-for-sale securities. Financing activities provided $2.12 billion, primarily from deposit growth and increased FHLB advances. Cash and cash equivalents ended at $3.26 billion.
Total loans increased 7% to $34.78 billion, led by an 18% increase in single-family residential loans and an 11% increase in commercial real estate loans. Deposits increased 5%, primarily due to a 13% increase in time deposits. The loan-to-deposit ratio increased to 93.18% from 91.38%.
Debt and other funding at year-end included $745.9 million of FHLB advances, $200.0 million of net repurchase agreements, $152.3 million of long-term debt and finance lease liabilities, and $28.7 million of short-term borrowings. The company reported $6.70 billion of unencumbered liquid assets and available FHLB and Federal Reserve borrowing capacity of $6.83 billion and $2.97 billion, respectively.
Capital remained strong. The company reported a 12.9% CET1 ratio, 12.9% Tier 1 capital ratio, 14.4% total capital ratio, and 10.3% Tier 1 leverage ratio. Both the company and the bank were categorized as well capitalized.
Material changes versus the prior comparable period
- Net income declined despite loan-driven revenue growth because of higher credit-loss provisions, higher operating expenses, and substantially higher income taxes.
- The effective tax rate increased to 20.1% from 14.0%, primarily because of a $30.1 million tax expense related to reversal of previously claimed DC Solar tax credits and lower tax credits from other projects.
- The allowance for loan losses increased to $358.3 million, or 1.03% of loans held for investment, from $311.3 million, or 0.96%.
- Net charge-offs increased to $52.8 million, or 0.16% of average loans, from $40.1 million, or 0.13%.
- Non-PCI nonperforming assets increased to $121.5 million, or 0.27% of total assets, from $93.0 million, or 0.23%. The increase was driven primarily by three energy-related C&I loans totaling $33.0 million.
- Noninterest income was broadly stable, but the prior-year amount included a $31.5 million pretax gain from the sale of eight Desert Community Bank branches. Interest-rate contract and derivative income increased 110% to $39.9 million, while foreign exchange income increased 24% to $26.4 million.
- Stockholders’ equity increased 13% to $5.02 billion. The annual common dividend increased 23% to $1.055 per share. No shares were repurchased under the existing $100 million authorization.
- The company adopted the new lease standard in 2019, recognizing approximately $109.1 million of operating lease right-of-use assets and $117.7 million of related lease liabilities at adoption.
Guidance, outlook, management commentary, risks and unusual items
Management did not provide explicit quantitative earnings or revenue guidance in the filing. Its stated strategy is to grow loans, deposits, and revenue; improve profitability; invest in technology and infrastructure; and manage risk, expenses, and capital.
- DC Solar: The company wrote off its DC Solar tax-credit investments, recorded a $7.0 million pretax impairment charge, later recorded a $1.6 million pretax recovery, and recognized $30.1 million of additional income tax expense. Management stated that its investigation remained ongoing.
- Credit risk: Risks include increased C&I charge-offs, migration of loan risk ratings, rising nonperforming assets, and the company’s concentration in California commercial real estate and residential lending.
- Interest-rate risk: The company is asset sensitive because of its variable-rate loan portfolio. Its modeled 12-month net interest income sensitivity was positive 6.7% for an immediate 100-basis-point increase and negative 5.5% for an immediate 100-basis-point decrease in rates.
- LIBOR transition: A significant volume of loans, derivatives, deposits, securities, FHLB advances, repurchase agreements, and junior subordinated debt referenced LIBOR. The company established a cross-functional transition team, developed a product inventory, and began using fallback language for new loans.
- International and geopolitical exposure: Operations and customer relationships in Greater China expose the company to trade restrictions, tariffs, political and economic developments, currency movements, regulatory changes, and potential disease pandemics.
- Liquidity and funding: The company relies primarily on deposits and is also dependent on dividends from East West Bank for parent-company liquidity. Dividends from the bank are subject to statutory and regulatory restrictions.
- Accounting change after year-end: The company adopted CECL on January 1, 2020. The allowance for credit losses increased approximately 34% from the December 31, 2019 balance of $369.4 million, reducing retained earnings through a cumulative-effect adjustment. The company remained well capitalized and did not elect the three-year regulatory capital phase-in.
- Subsequent dividend: The board declared a first-quarter 2020 dividend of $0.275 per share, paid February 14, 2020.
Most important facts for an investor to verify
- Whether the higher 2019 credit-loss provision, charge-offs, nonperforming assets, and C&I risk migration represent a sustained deterioration or primarily portfolio-growth effects.
- The size and composition of the CECL adoption adjustment and its continuing effect on credit reserves, earnings, and capital.
- The remaining tax, legal, and recovery implications of the DC Solar investments and the company’s ongoing investigation.
- The effect of deposit repricing, higher time-deposit reliance, and the 93% loan-to-deposit ratio on future net interest margin and liquidity.
- Concentration and stress exposure in California CRE, multifamily, residential lending, energy-related C&I loans, and Greater China activities.
- Progress and contractual outcomes of the LIBOR-to-SOFR transition, including effects on loans, derivatives, deposits, and junior subordinated debt.
- The amount and terms of unfunded loan commitments, standby letters of credit, guarantees, tax-credit investment commitments, and other off-balance-sheet exposures.
- Whether non-GAAP earnings of $707.9 million and non-GAAP diluted EPS of $4.84 provide a sustainable view of performance after excluding DC Solar and other unusual items.