EAST WEST BANCORP INC annual report, FY2017

East West Bancorp, Inc. — 2017 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2017; filing dated February 27, 2018. The filing reports annual results, with unaudited fourth-quarter information also provided. East West Bancorp is a California-focused bank holding company whose principal subsidiary, East West Bank, serves customers in the United States and Greater China, with an emphasis on cross-border banking and the Chinese-American community.

Business Context and Reporting Period

East West operated more than 130 locations, including U.S. branches and five full-service branches plus representative offices in Greater China.
Operating segments were Retail Banking, Commercial Banking and Other.
At December 31, 2017, the Company reported approximately 3,000 employees, $37.15 billion of assets, $28.69 billion of net loans, $31.62 billion of deposits excluding held-for-sale deposits, and $3.84 billion of stockholders’ equity.

Key Financial Metrics

Metric	2017	2016	Change
Revenue	$1.44 billion	$1.22 billion	Up 19%
Net interest income before provision	$1.185 billion	$1.033 billion	Up 15%
Provision for credit losses	$46.3 million	$27.5 million	Up 68%
Noninterest income	$258.4 million	$182.9 million	Up 41%
Noninterest expense	$662.1 million	$615.9 million	Up 8%
Net income	$505.6 million	$431.7 million	Up 17%
Diluted EPS	$3.47	$2.97	Up 17%
Net interest margin	3.48%	3.30%	Up 18 basis points
Return on average assets	1.41%	1.30%	Up 11 basis points
Return on average equity	13.71%	13.06%	Up 65 basis points
Cash dividends declared per share	$0.80	$0.80	Unchanged

Balance Sheet, Credit, Cash Flow and Capital

Total assets increased 7% to $37.15 billion. Gross loans held for investment increased 14% to $28.98 billion, led by growth in single-family residential, commercial and industrial, commercial real estate, and multifamily loans.
Deposits excluding held-for-sale deposits increased 6% to $31.62 billion. Core deposits rose 7% to $25.97 billion and represented 82% of total deposits; noninterest-bearing demand deposits represented 34%.
Cash and cash equivalents increased to $2.17 billion from $1.88 billion. Reported liquidity sources, including cash, interest-bearing deposits, resale agreements and unpledged securities, totaled approximately $5.51 billion, or 15% of assets.
Net cash provided by operating activities was $696.9 million. Investing activities used $2.50 billion, primarily reflecting loan growth, while financing activities provided $2.07 billion, primarily from deposit growth. Cash increased $296.1 million during the year.
FHLB advances were $323.9 million, repurchase agreements were $50.0 million net of eligible offsets, and long-term debt was $171.6 million. No short-term borrowings were outstanding at year-end.
The allowance for loan losses increased to $287.1 million, or 0.99% of loans held for investment, from $260.5 million, or 1.02%. Net charge-offs declined to $22.5 million, or 0.08% of average loans, from $36.2 million, or 0.15%.
Non-PCI nonperforming assets declined 11% to $115.1 million, and nonaccrual loans declined to $114.3 million, or 0.39% of loans held for investment.
Stockholders’ equity increased 12% to $3.84 billion, and book value per share increased to $26.58 from $23.78.
The Company and Bank were categorized as well capitalized. Company ratios at year-end included CET1 of 11.4%, total risk-based capital of 12.9% and Tier 1 leverage of 9.2%.

Material Changes Versus the Prior Comparable Period

2017 was the Company’s eighth consecutive year of record earnings, with revenue growth exceeding expense growth.
Net interest income benefited from 14% loan growth, higher loan yields and Federal Reserve rate increases. The average loan yield increased to 4.40% from 4.27%, while the cost of deposits increased to 0.38% from 0.30%.
Noninterest income was elevated by a $71.7 million pretax gain recognized from the sale-and-leaseback of a San Francisco commercial property and a $3.8 million pretax gain from the sale of the EWIS insurance brokerage business.
Noninterest expense increased primarily because of higher compensation, legal expense, technology investment and tax-credit investment amortization. Consulting expense declined as the Company progressed on BSA/AML remediation.
The Company recorded $41.7 million of additional income tax expense in the fourth quarter related to the Tax Cuts and Jobs Act, primarily from remeasurement of deferred tax assets and liabilities and tax-credit-related items. The effective tax rate increased to 31.2% from 24.6%.
Retail Banking pretax segment income increased 55% to $323.8 million. Commercial Banking pretax segment income increased 1% to $426.3 million. The Other segment’s pretax loss narrowed to $15.0 million from $59.3 million, largely because of the property-sale gain.
Fourth-quarter net income was $84.9 million, or $0.58 diluted EPS, compared with $110.7 million, or $0.76 diluted EPS, in fourth-quarter 2016. The fourth quarter included the Tax Act charge.

Guidance, Outlook, Commentary and Unusual Items

Management emphasized continued organic growth in loans, deposits and revenue, expense management, technology and human-capital investment, and disciplined risk and capital management.
Management anticipated a significant reduction in the effective tax rate beginning in 2018 because of the federal corporate tax rate reduction to 21%, while noting that the longer-term tax impact remained subject to interpretation and further guidance.
The Bank entered into an agreement to sell all eight Desert Community Bank branches and related assets and liabilities to Flagstar Bank. At year-end, assets held for sale were $91.3 million, including $78.1 million of loans, and deposits held for sale were $605.1 million. Completion was expected in the first quarter of 2018.
The Bank remained subject to a 2015 Federal Reserve Written Agreement and related California DBO memorandum of understanding concerning BSA/AML and OFAC compliance. Management reported progress but could not assure that regulators would deem remediation satisfactory.
Loan commitments totaled $5.08 billion, and commercial letters of credit and standby letters of credit totaled $1.66 billion. These commitments may not result in equivalent future funding requirements.
The Company had $169.2 million of unfunded commitments related to affordable housing, tax-credit and other investments.
Management stated that available liquidity was sufficient for reasonably foreseeable short- and intermediate-term needs and identified no known material liquidity trends or capital-expenditure commitments.

Principal Risks and Contingencies

Continued regulatory, compliance and legal exposure, particularly relating to the BSA/AML Written Agreement and MOU, could increase expenses or result in penalties, restrictions or other enforcement actions.
The loan portfolio is concentrated in California and includes substantial commercial real estate, multifamily, construction and residential exposure. A downturn in California real estate or economic conditions could increase credit losses.
Higher interest rates may support asset yields but could increase deposit costs, cause deposit migration and compress net interest margin. The Company’s results are sensitive to interest-rate movements and deposit behavior.
Credit-loss estimates depend on subjective assumptions regarding economic conditions, collateral values, loan performance and expected losses. The future adoption of the CECL standard was expected to potentially increase the allowance for credit losses, although the amount was not yet clear.
International operations and customers connected to China expose the Company to foreign-exchange, political, regulatory, economic and cross-border risks.
Cybersecurity, operational-system failures, technology implementation risk, natural disasters and reputational damage could adversely affect operations, liquidity and financial results.
Unrealized losses on available-for-sale securities totaled $53.3 million at year-end. Management considered the losses temporary and recorded no other-than-temporary impairment.
The filing states that legal proceedings are accrued when probable and reasonably estimable, but ultimate losses could exceed recorded accruals. It does not provide a clear aggregate litigation exposure value.

Important Facts for Investors to Verify

Whether the DCB branch sale closed as expected in the first quarter of 2018 and the final effect on deposits, loans, earnings and capital.
Whether BSA/AML remediation satisfied the Federal Reserve and California DBO, and whether the Written Agreement or MOU was modified or terminated.
The magnitude of the 2018 effective tax-rate reduction and any subsequent adjustments to the provisional Tax Act accounting.
The effect of continued Federal Reserve rate increases on deposit pricing, deposit mix, net interest margin and loan demand.
Whether rapid loan growth, particularly in California commercial real estate and consumer portfolios, changes nonperforming assets, charge-offs or the allowance under CECL.
The eventual opening adjustment and ongoing allowance impact from adoption of CECL, which the filing states could increase credit-loss reserves but does not quantify.
Actual liquidity availability after considering pledged collateral, deposit concentrations, unfunded commitments and regulatory or market constraints.