East West Bancorp, Inc. — Q3 2015 Form 10-Q Summary
Business context and reporting period
East West Bancorp is a bank holding company for East West Bank, operating more than 130 branches in the United States and Greater China. Its strategy is to serve as a financial bridge between the United States and Greater China through retail banking, commercial banking, trade finance, wealth management and cross-border services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2015. Prior-period amounts were retrospectively restated for ASU 2014-01 concerning qualified affordable housing investments.
Financial performance and condition
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net income | $94.1 million | $91.9 million | $292.9 million | $250.4 million |
| Diluted EPS | $0.65 | $0.64 | $2.03 | $1.74 |
| Net interest income | $240.3 million | $257.0 million | $703.5 million | $781.4 million |
| Provision for credit losses | $7.7 million | $15.2 million | $16.2 million | $30.2 million |
| Noninterest income | $54.2 million | $10.3 million | $138.9 million | $(19.5) million |
| Noninterest expense | $147.7 million | $166.8 million | $395.9 million | $407.3 million |
| Net interest margin | 3.32% | 3.89% | 3.38% | 4.12% |
| Return on average assets | 1.22% | 1.30% | 1.31% | 1.23% |
| Return on average equity | 12.23% | 13.26% | 13.12% | 12.53% |
- Total assets were $31.12 billion at September 30, 2015, up 8% from December 31, 2014.
- Total loans held for investment were $22.66 billion; total loans, including loans held for sale, were $22.73 billion, up 6% from year-end.
- Total deposits were $26.76 billion, up 11%; core deposits were $20.11 billion, up 12%.
- Cash and cash equivalents were $1.88 billion. Cash, short-term investments and available-for-sale securities totaled $5.09 billion, or 16% of assets.
- Stockholders’ equity was $3.07 billion, up 8% from year-end. The quarterly dividend was $0.20 per share.
- Long-term debt was $211.0 million, down from $225.8 million at year-end. FHLB advances were $318.9 million, and repurchase agreements were $150.0 million.
- The allowance for loan losses was $264.4 million, equal to 1.17% of loans held for investment. The allowance for credit losses, including unfunded commitments, was $283.5 million.
- Nonperforming assets were $129.8 million, or 0.42% of assets. Nonaccrual loans were $117.5 million, and net OREO was $12.3 million.
- Basel III capital ratios remained above well-capitalized thresholds: company CET1, Tier 1, total risk-based and Tier 1 leverage ratios were 10.8%, 10.9%, 12.6% and 8.7%, respectively; bank ratios were 11.1%, 11.1%, 12.2% and 8.8%.
Cash flow, liquidity and funding
- For the nine months, operating activities provided $421.6 million of cash, investing activities used $1.68 billion, and financing activities provided $2.10 billion.
- Net cash and cash equivalents increased $835.8 million to $1.88 billion, primarily supported by deposit growth.
- Available secured borrowing capacity was $4.92 billion at the Federal Home Loan Bank and $3.06 billion at the Federal Reserve, supplemented by $683.0 million of unsecured correspondent-bank lines.
- Management stated that liquidity sources were sufficient for reasonably foreseeable short- and intermediate-term needs. The Bank paid no dividends to the holding company during the first nine months of 2015, compared with $111.6 million in the prior-year period.
Material changes versus the prior comparable periods
- Net income increased 2% in Q3 and 17% for the nine months, despite lower net interest income. Growth was driven by substantially higher noninterest income, lower credit-loss provisions and lower noninterest expense.
- Net interest income declined 6% in Q3 and 10% for the nine months. Net interest margin contracted 57 basis points in Q3 and 74 basis points year to date, primarily because of lower accretion income from acquired PCI loans.
- Noninterest income increased $43.8 million in Q3 and $158.4 million year to date. The improvement reflected much smaller FDIC indemnification-related losses and higher gains on available-for-sale securities.
- Net gains on available-for-sale securities were $17.0 million in Q3 and $27.0 million year to date, versus $2.5 million and $6.6 million, respectively, in the prior periods.
- Noninterest expense declined 11% in Q3 and 3% year to date, helped by lower legal expense and lower tax-credit investment amortization. These benefits were partly offset by $15.2 million of Q3 and $21.8 million of year-to-date repurchase-agreement extinguishment costs and higher compensation expense.
- Loan growth was concentrated in commercial real estate, commercial and industrial, and consumer loans, while residential loans declined largely because of loan sales. Approximately $1.24 billion of loans were sold year to date.
- Credit metrics were mixed: nonperforming assets declined modestly, but nonaccrual loans rose 17% from year-end, primarily because three current commercial loans were placed on nonaccrual due to future cash-flow concerns.
- The Company adopted ASU 2014-01 retrospectively, moving qualifying affordable-housing investment amortization from noninterest expense to income tax expense and changing reported prior-period results.
Guidance, outlook, risks and unusual items
- No specific quantitative earnings or revenue guidance was provided. Management emphasized continued loan and core-deposit growth, stable credit quality and diversified fee income.
- The Company is asset-sensitive in modeled rising-rate scenarios. Estimated 12-month net interest income sensitivity was positive 9.6% for a 100-basis-point increase and 18.7% for a 200-basis-point increase; modeled declines were 1.7% and 1.8% for 100- and 200-basis-point decreases. Actual results may differ because of deposit migration, repricing, prepayment and other assumptions.
- On November 9, 2015, after the quarter-end, East West Bank entered into a written agreement with the Federal Reserve Bank of San Francisco concerning deficiencies in its Bank Secrecy Act and Office of Foreign Assets Control compliance program. The Bank must submit a revised compliance program and retain an independent firm to review certain higher-risk customers and transactions.
- The Company recorded a $101.5 million net payable to the FDIC related to shared-loss agreements. Coverage for certain UCB and WFIB commercial loans had expired, and WFIB shared-loss agreements were terminated early for a $7.0 million payment. Remaining recovery provisions extend through 2017 and 2019 for specified portfolios.
- A foreign subsidiary changed its functional currency from the U.S. dollar to the renminbi, producing a $6.8 million foreign-currency translation loss in other comprehensive income during Q3.
- The Company had a $34.4 million litigation accrual related to the F&F, LLC and 618 Investment, Inc. matter; the case was on appeal. Management believed pending legal matters were not expected to have a material adverse aggregate effect, but acknowledged litigation outcomes are difficult to predict.
- Key ongoing risks include interest-rate and yield-curve changes, credit losses, commercial and consumer real-estate conditions, California and China economic conditions, foreign-exchange volatility, regulatory and compliance matters, legal proceedings, capital requirements and changes in accounting or banking regulation.
Important facts for investors to verify
- Whether the Federal Reserve compliance agreement results in additional costs, restrictions, remediation requirements or regulatory penalties.
- Future trends in net interest margin as acquired-loan accretion declines and interest rates change.
- Whether the increase in nonaccrual commercial loans develops into higher charge-offs or allowance requirements.
- The sustainability of gains on securities sales and the reduced FDIC-related losses, which materially supported reported earnings.
- The remaining exposure, recovery obligations and timing of cash flows under FDIC shared-loss agreements.
- Capital and liquidity impacts from continued balance-sheet growth, expiration of shared-loss coverage and the planned limitation of trust-preferred securities to Tier II capital beginning in 2016.
- Potential outcomes of the appealed litigation and the adequacy of the recorded $34.4 million accrual.
- The effect of the ASU 2014-01 restatement and future accounting pronouncements on comparability and effective tax rates.