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 130 locations in the United States and Greater China, with a focus on the Chinese-American community. Reported results cover the unaudited quarter and nine months ended September 30, 2019. The company reported approximately $43.27 billion of assets and 3,282 full-time-equivalent employees at quarter-end.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net interest income before provision | $369.8 million | $348.7 million | $1.10 billion | $1.02 billion |
| Provision for credit losses | $38.3 million | $10.5 million | $80.1 million | $46.3 million |
| Noninterest income | $51.5 million | $46.5 million | $146.4 million | $169.2 million |
| Noninterest expense | $176.6 million | $179.8 million | $541.2 million | $526.4 million |
| Net income | $171.4 million | $171.3 million | $485.8 million | $530.7 million |
| Diluted EPS | $1.17 | $1.17 | $3.33 | $3.63 |
| Net interest margin | 3.59% | 3.76% | 3.70% | 3.77% |
| ROA / ROE | 1.58% / 14.06% | 1.76% / 16.19% | 1.55% / 13.86% | 1.87% / 17.47% |
Third-quarter revenue, defined by management as net interest income before provision plus noninterest income, was $421.3 million, up 7% year over year. The efficiency ratio improved to 41.93% from 45.50%; the non-GAAP efficiency ratio was 37.66% versus 39.89%.
- Total assets increased 5% from December 31, 2018 to $43.27 billion.
- Total loans, including loans held for sale, increased 5% to approximately $34.03 billion. Growth was led by single-family residential loans, CRE, C&I, and construction and land loans.
- Total deposits increased 3% to $36.66 billion, primarily due to a 16% increase in time deposits. The loan-to-deposit ratio was 92.81%.
- Available-for-sale securities increased 20% to $3.28 billion; approximately 99% of the securities portfolio was rated AA-/Aa3 or higher.
- Cash and cash equivalents were $3.04 billion. Unencumbered liquid assets totaled $6.26 billion, and available FHLB and Federal Reserve borrowing capacity was $6.49 billion and $3.04 billion, respectively.
- FHLB advances increased to $745.5 million from $326.2 million at year-end 2018. Long-term debt and finance lease liabilities were $152.4 million.
- Stockholders’ equity increased 10% to $4.88 billion. Book value was $33.54 per share and tangible common equity per share was $30.22.
- Regulatory capital remained strong: company CET1, total risk-based capital, and Tier 1 leverage ratios were 12.8%, 14.2%, and 10.3%, respectively. The company and bank remained well-capitalized.
Material Changes Versus Comparable Periods
- Net interest income increased 6% in the quarter and 8% year to date, primarily from loan growth. However, the net interest margin contracted because funding costs rose faster than asset yields. Average interest-bearing deposit costs increased to 1.49% in the quarter from 1.14% and to 1.52% year to date from 0.96%.
- Credit costs increased materially. The provision for credit losses rose to $38.3 million in the quarter from $10.5 million and to $80.1 million year to date from $46.3 million. Management attributed the increase to loan growth, higher C&I charge-offs, and deterioration in C&I credit ratings.
- Net charge-offs increased to $22.5 million in the quarter and $44.5 million year to date, compared with $3.7 million and $24.1 million in the prior-year periods. The allowance for loan losses rose to $345.6 million, or 1.02% of loans held for investment, from $311.3 million at December 31, 2018.
- Nonaccrual loans increased 54% from year-end to $132.2 million, with C&I loans representing 69% of total nonaccrual loans. Total non-PCI nonperforming assets increased to $134.5 million, or 0.31% of total assets, from $93.0 million, or 0.23%.
- Nine-month net income declined 8% despite a 2% increase in pretax income. The primary reason was a $30.1 million income tax expense recorded in the second quarter to reverse certain previously claimed DC Solar tax credits.
- Nine-month noninterest income declined 14%, primarily because the 2018 period included a $31.5 million pretax gain on the sale of eight Desert Community Bank branches. Excluding specified unusual items, management reported nine-month 2019 non-GAAP net income of $520.8 million, or $3.57 diluted EPS, versus $508.5 million, or $3.48, in 2018.
- The quarterly dividend increased to $0.275 per share from $0.23. The board declared a fourth-quarter 2019 dividend of $0.275 per share, payable November 15, 2019.
Cash Flow, Liquidity, Outlook, and Risks
- For the first nine months, operating cash flow was $389.0 million, investing cash flow was negative $1.87 billion, and financing cash flow was $1.53 billion. Cash and cash equivalents increased by $40.9 million to $3.04 billion.
- Management stated that liquidity sources were sufficient for reasonably foreseeable short-term needs over the following 12 months and that no known trends or events were reasonably likely to have a material effect on liquidity at September 30, 2019.
- No formal earnings or revenue guidance was provided. Management’s stated strategy remains focused on loan, deposit, and revenue growth, profitability improvement, technology investment, expense management, and risk control.
- The company expected to adopt CECL on January 1, 2020. It had completed a parallel run but had not quantified the impact; management expected CECL could increase the allowance for credit losses, depending on portfolio composition, credit quality, and economic conditions.
- DC Solar remains a significant contingency. The company recorded a $7.0 million pretax write-off in the first quarter and $30.1 million of additional tax expense in the second quarter. Management stated that further tax expense or reversal of remaining credits remains possible as investigations, asset recovery efforts, and discussions with the Internal Revenue Service continue.
- Material risk exposures include C&I credit deterioration, California commercial and residential real estate concentration, rising deposit funding costs, interest-rate and yield-curve changes, the U.S.-China trade dispute, foreign operations in China and Hong Kong, cybersecurity and operational risk, litigation, regulatory changes, and the transition from LIBOR to alternative rates such as SOFR.
- The company reported that its disclosure controls were effective and that there had been no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether higher C&I charge-offs, nonaccrual loans, troubled debt restructurings, and credit provisions represent a temporary increase or a broader deterioration in portfolio credit quality.
- The ultimate tax and legal consequences of the DC Solar investments, including whether additional tax credits must be reversed.
- The size and timing of the CECL adoption adjustment and its effect on capital, earnings, and future provisions.
- Whether deposit costs continue to rise and compress the 3.59% net interest margin, particularly in a lower-rate or inverted-yield-curve environment.
- The sustainability of loan and deposit growth while maintaining liquidity, capital ratios, and the 92.81% loan-to-deposit ratio.
- The company’s exposure to California CRE, multifamily, construction, C&I, China/Hong Kong operations, and LIBOR-linked contracts.
- Potential obligations from $5.47 billion of loan commitments, $1.91 billion of commercial letters of credit and standby letters of credit, loan-sale recourse, litigation, and tax-credit investment commitments.