Business Context and Reporting Period
East West Bancorp, Inc., through East West Bank, provides consumer and commercial banking services in the U.S. and Greater China, with a focus on the Chinese-American community. The unaudited Form 10-Q covers the quarter and six months ended June 30, 2020. Results were significantly affected by the COVID-19 pandemic, lower interest rates, the CARES Act and adoption of the current expected credit loss (CECL) standard.
Key Financial Metrics
| Metric | Q2 2020 | Q2 2019 | Six Months 2020 | Six Months 2019 |
|---|---|---|---|---|
| Net interest income before provision | $343.8 million | $367.3 million | $706.5 million | $729.8 million |
| Provision for credit losses | $102.4 million | $19.2 million | $176.3 million | $41.8 million |
| Net income | $99.4 million | $150.4 million | $244.2 million | $314.4 million |
| Diluted EPS | $0.70 | $1.03 | $1.70 | $2.15 |
| Net interest margin | 3.04% | 3.73% | 3.24% | 3.76% |
| ROA / ROE | 0.83% / 8.02% | 1.45% / 12.88% | 1.06% / 9.82% | 1.54% / 13.75% |
| Noninterest income | $58.6 million | $52.8 million | $112.7 million | $94.9 million |
| Noninterest expense | $187.7 million | $177.7 million | $366.6 million | $364.6 million |
Revenue, defined by the Company as net interest income before provision plus noninterest income, was $402.4 million in the second quarter and $819.2 million for the first half, down 4% and 1%, respectively, from the comparable periods.
- Total assets were $49.41 billion at June 30, 2020, up 12% from December 31, 2019.
- Total loans were $37.23 billion, up 7% from year-end 2019; net loans were $36.60 billion after the allowance.
- Total deposits were $40.67 billion, up 9%, led by noninterest-bearing demand deposits and money market accounts.
- Cash and cash equivalents were $4.53 billion, compared with $3.26 billion at December 31, 2019.
- Unencumbered liquid assets totaled $8.90 billion. Available borrowing capacity was $15.66 billion, including FHLB and Federal Reserve capacity.
- Long-term debt and finance lease liabilities were $1.58 billion, including $1.43 billion of Federal Reserve Paycheck Protection Program Liquidity Facility advances.
- Stockholders’ equity was $4.99 billion; book value was $35.25 per share and tangible common equity per share was $31.86.
- Cash flow from operations was $270.9 million; investing activities used $3.51 billion, principally for loan growth and securities purchases; financing activities provided $4.53 billion. Cash increased $1.27 billion.
Material Changes Versus Prior Periods
- Second-quarter net income declined 34% and first-half net income declined 22%, primarily because of higher credit-loss provisions and lower net interest income.
- The net interest margin contracted 69 basis points in the quarter and 52 basis points for the first half, reflecting the cumulative 225-basis-point reduction in the federal funds target rate and lower loan yields.
- Average loans grew 13% in the quarter and 11% for the first half, while average deposits grew 13% and 10%, respectively.
- The allowance for loan losses increased to $632.1 million, or 1.70% of loans held for investment, from $358.3 million, or 1.03%, at year-end 2019. CECL adoption increased the allowance by $125.2 million and reduced opening retained earnings by $98.0 million after tax.
- Nonperforming assets increased to $202.2 million, or 0.41% of assets, from $121.5 million, or 0.27%, at year-end. Nonaccrual loans increased 49% to $178.8 million, driven principally by oil and gas and commercial real estate exposures.
- Net charge-offs were $19.2 million in the quarter and $20.1 million for the first half, compared with $7.6 million and $22.1 million, respectively, in the prior-year periods.
- Noninterest income increased 11% in the quarter and 19% for the first half, helped by gains on available-for-sale securities and higher lending fees. Noninterest expense increased 6% in the quarter, including an $8.7 million repurchase-agreement extinguishment cost.
- The Company repurchased 4.47 million shares for $146.0 million during the first quarter; no shares were repurchased in the second quarter. $354.0 million remained available under the authorization at June 30, 2020.
- Regulatory capital remained strong: Company CET1, total capital and Tier 1 leverage ratios were 12.7%, 14.4% and 9.7%, respectively, and the Company and Bank remained above well-capitalized requirements.
Guidance, Outlook, Commentary and Risks
The filing does not provide formal earnings or financial guidance. Management stated that the duration and severity of COVID-19 remain uncertain and that the pandemic could cause material declines in revenue, profitability or cash flow during 2020. The Company expects to continue monitoring credit quality, liquidity, capital and customer assistance programs.
- The Company funded more than 7,200 PPP loans totaling $1.75 billion at June 30, 2020. The loans carry a 1% rate, are guaranteed by the SBA and had no recorded loan-loss allowance.
- COVID-19-related modifications not classified as TDRs totaled $2.82 billion across 3,183 loans. Management used CARES Act and interagency relief provisions that generally freeze delinquency status for qualifying modifications.
- Credit risk is concentrated in commercial lending, real estate and California. Oil and gas loans totaled $1.27 billion, with allowance coverage increased to 9% from 5% at year-end 2019.
- Approximately 77% of CRE loans and 82% of multifamily loans were concentrated in California. A deterioration in California real estate or broader economic conditions could increase losses.
- Key risks include a prolonged or renewed COVID-19 downturn, additional unemployment, borrower defaults, real estate declines, further margin compression, market and counterparty stress, cybersecurity risks from remote work, regulatory changes and the transition away from LIBOR.
- The Company remains asset-sensitive to interest rates; modeled 12-month net interest income would increase 6.7% under an instantaneous 100-basis-point increase and 14.6% under a 200-basis-point increase. Downside rate scenarios were not meaningful because rates were near zero.
- The filing states that disclosure controls were effective as of June 30, 2020 and that no material changes occurred in internal control over financial reporting.
Investor Verification Priorities
- Verify the performance and forgiveness or repayment status of the $1.75 billion PPP portfolio and the associated deferred fee income.
- Track COVID-19 loan modifications as deferrals expire, including potential migration into nonaccrual status or TDR classification.
- Assess whether the $632.1 million allowance adequately reflects deterioration in commercial, oil and gas, CRE and California exposures under updated economic forecasts.
- Monitor net interest margin, loan yields, deposit pricing and the effect of near-zero interest rates on future earnings.
- Review nonperforming assets, charge-offs, foreclosure activity and collateral values, particularly in commercial real estate and oil and gas.
- Confirm liquidity and funding capacity, including the $1.43 billion PPPLF balance, $15.66 billion of stated borrowing capacity and the maturity profile of borrowings.
- Evaluate the sustainability of dividends and any future stock repurchases against credit losses, capital requirements and regulatory expectations.
- Follow the Company’s LIBOR transition, unresolved reference-rate exposures and any effects on loans, derivatives, securities and borrowings.