East West Bancorp, Inc. — 2020 Q3 Form 10-Q Summary
Business Context and Reporting Period
East West Bancorp, Inc. is a bank holding company whose principal subsidiary, East West Bank, provides consumer and commercial banking services through more than 125 locations in the United States and Greater China, with a focus on the Asian-American community. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020. Results were materially affected by the COVID-19 pandemic, historically low interest rates, the Paycheck Protection Program (PPP), and adoption of the current expected credit loss (CECL) standard.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net income | $159.5 million | $171.4 million | $403.7 million | $485.8 million |
| Diluted EPS | $1.12 | $1.17 | $2.82 | $3.33 |
| Net interest income before provision | $324.1 million | $369.8 million | $1.03 billion | $1.10 billion |
| Provision for credit losses | $10.0 million | $38.3 million | $186.3 million | $80.1 million |
| Noninterest income | $49.6 million | $51.5 million | $162.3 million | $146.4 million |
| Noninterest expense | $167.7 million | $176.6 million | $534.2 million | $541.2 million |
| Net interest margin | 2.72% | 3.59% | 3.05% | 3.70% |
| ROA | 1.26% | 1.58% | 1.13% | 1.55% |
| ROE | 12.50% | 14.06% | 10.73% | 13.86% |
- Balance sheet: Total assets were $50.37 billion at September 30, 2020, up 14% from December 31, 2019. Loans held for investment were $37.44 billion before allowance, up 8%; total deposits were $41.68 billion, up 12%; and stockholders’ equity was $5.13 billion.
- Liquidity: Cash and cash equivalents were $4.51 billion. Unencumbered liquid assets totaled $9.69 billion, and available borrowing capacity was $17.46 billion. The loan-to-deposit ratio was 89.83%.
- Debt and funding: Long-term debt and finance lease liabilities were $1.58 billion, including $1.43 billion of PPPLF borrowings secured by PPP loans. The Company repaid the $1.43 billion PPPLF balance in full in October 2020. FHLB advances were $657.2 million.
- Cash flow: For the first nine months, operating activities provided $430.6 million, investing activities used $4.40 billion, and financing activities provided $5.26 billion. Cash and cash equivalents increased by $1.25 billion to $4.51 billion.
- Credit quality: The allowance for loan losses was $618.3 million, or 1.65% of loans held for investment, compared with 1.03% at December 31, 2019. Nonperforming assets were $259.9 million, or 0.52% of total assets, versus $121.5 million, or 0.27%, at year-end 2019. Nine-month net charge-offs were $44.3 million, or 0.16% of average loans.
- Capital: At September 30, 2020, Company CET1, total capital, and Tier 1 leverage ratios were 12.8%, 14.5%, and 9.8%, respectively. Management stated that the Company and Bank exceeded well-capitalized requirements.
Material Changes Versus Comparable Periods
- Third-quarter net income declined 7% and nine-month net income declined 17%, primarily because of lower net interest income and, for the nine-month period, significantly higher credit-loss provisions.
- Revenue declined 11% in the third quarter and 4% for the first nine months. Net interest margin compressed by 87 basis points in the quarter and 65 basis points year to date, reflecting substantially lower benchmark rates and loan yields.
- Funding costs declined sharply, supported by growth in low-cost noninterest-bearing deposits. Noninterest-bearing deposits increased 35% from year-end 2019 and represented 36% of total deposits at September 30, 2020.
- Noninterest income increased 11% year to date, helped by lending fees, deposit account fees, and gains on sales of available-for-sale securities, but declined 4% in the third quarter.
- The CECL adoption on January 1, 2020 increased the allowance for loan losses by $125.2 million, increased the allowance for unfunded commitments by $10.5 million, and reduced opening retained earnings by $98.0 million after tax.
- Commercial and industrial loans increased 9% from year-end, primarily due to $1.77 billion of PPP loans outstanding at September 30, 2020. Total CRE loans increased 7%, and single-family residential loans increased 10%.
- Nonaccrual loans nearly doubled to $236.5 million, driven primarily by oil and gas and CRE inflows. The Company increased oil and gas loan allowance coverage to 10% from 5% at year-end.
- The Company repurchased 4.47 million shares for $146.0 million during the first quarter. No repurchases occurred in the second or third quarters; $354.0 million remained authorized at September 30.
Guidance, Outlook, Commentary, and Risks
The filing does not provide formal quantitative earnings guidance. Management reported that the third-quarter macroeconomic forecast improved relative to June 30, 2020, supporting a reduction in the allowance and a $10.0 million third-quarter credit-loss provision versus $102.4 million in the second quarter. Management nevertheless emphasized that the trajectory and duration of the COVID-19 recovery remained uncertain.
- COVID-19 could cause additional borrower stress, higher charge-offs and provisions, lower demand, declining collateral values, and pressure on revenues, profitability, capital, and liquidity.
- At September 30, 2020, 1,029 loans totaling $1.57 billion were subject to COVID-19-related payment deferrals or forbearance, excluding certain other modifications not classified as TDRs.
- Commercial real estate and other loans are geographically concentrated, particularly in California. Oil and gas exposure was $1.18 billion, with $320.1 million of unfunded commitments.
- The Company’s securities portfolio had $25.4 million of gross unrealized losses, but management concluded these were primarily non-credit-related and recorded no credit-loss allowance for the securities.
- Loan commitments totaled $5.45 billion and commercial letters of credit and standby letters of credit totaled $2.12 billion. The allowance for unfunded credit commitments was $29.1 million.
- The Company remains exposed to interest-rate risk, with modeled net interest income increasing under rising-rate scenarios and declining under falling-rate scenarios. LIBOR transition, cybersecurity, regulatory changes, litigation, foreign operations, and capital-market volatility are additional risks.
- Management stated that liquidity sources were sufficient for reasonably foreseeable needs over the following 12 months, but this assessment remains subject to pandemic and market conditions.
Investor Verification Checklist
- Verify the performance and forgiveness timing of the $1.77 billion PPP portfolio and the effect of related deferred fees on future interest income.
- Monitor allowance coverage, nonaccrual loans, charge-offs, and criticized assets as COVID-19 payment accommodations expire.
- Assess sensitivity to continued low rates, deposit repricing, and the Company’s asset-sensitive interest-rate position.
- Review California CRE concentrations, hospitality and retail exposure, and oil and gas credit performance.
- Confirm the effect of the October 2020 PPPLF repayment on liquidity, funding mix, and balance-sheet growth.
- Evaluate whether CECL assumptions and macroeconomic forecasts remain adequate if unemployment, GDP, real estate values, or fiscal support deteriorate.
- Review the remaining $354.0 million share-repurchase authorization alongside capital requirements and dividend capacity.
- Track the transition of LIBOR-linked loans, derivatives, securities, and borrowings to successor reference rates.