East West Bancorp, Inc. — Q3 2016 Form 10-Q Summary
Business context and reporting period
East West Bancorp, Inc. is the parent of East West Bank and East West Insurance Services, serving customers across the United States and Greater China through more than 130 locations. The filing covers the unaudited three and nine months ended September 30, 2016, with comparisons to the corresponding 2015 periods and December 31, 2015 balance-sheet amounts.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net income | $110.1 million | $94.1 million | $320.9 million | $292.9 million |
| Diluted EPS | $0.76 | $0.65 | $2.21 | $2.03 |
| Net interest income | $254.1 million | $240.3 million | $759.9 million | $703.5 million |
| Noninterest income | $49.3 million | $54.2 million | $134.1 million | $138.9 million |
| Noninterest expense | $170.5 million | $147.7 million | $466.0 million | $395.9 million |
| Provision for credit losses | $9.5 million | $7.7 million | $17.0 million | $16.2 million |
| Net interest margin | 3.26% | 3.32% | 3.29% | 3.38% |
| Return on average assets | 1.33% | 1.22% | 1.31% | 1.31% |
| Return on average equity | 13.08% | 12.23% | 13.12% | 13.12% |
Revenue, defined by management as net interest income before provision for credit losses plus noninterest income, was $303.5 million in Q3 and $894.1 million for the first nine months, up 3% and 6%, respectively. The Q3 effective tax rate was 10.8%, versus 32.3% in the prior-year quarter; the nine-month rate was 21.9%, versus 31.9%. The lower rates primarily reflected increased tax-credit investments and a $3.0 million tax benefit related to a California tax settlement.
As of September 30, 2016, total assets were $33.26 billion, stockholders’ equity was $3.38 billion, and book value per common share was $23.44. Gross loans held for investment were $24.72 billion, net loans were $24.48 billion, and the allowance for loan losses was $255.8 million, or 1.03% of loans. Total deposits were $28.59 billion, including $22.99 billion of core deposits. Cash and cash equivalents were $1.67 billion.
Liquidity assets consisting of cash and cash equivalents, short-term investments, and available-for-sale securities totaled approximately $5.21 billion, or 16% of total assets. Available borrowing capacity was $5.45 billion from the FHLB and Federal Reserve Bank of San Francisco, and unsecured federal funds lines totaled $716.0 million.
Debt included $321.1 million of FHLB advances, $200.0 million of net repurchase agreements, $37.0 million of short-term borrowings, and $191.3 million of long-term debt. The company and bank were described as well capitalized. Company ratios at September 30, 2016 were 10.9% CET1, 12.5% total risk-based capital, and 8.9% Tier 1 leverage.
Material changes versus comparable periods
- Net income increased 17% in Q3 and 10% for the first nine months; diluted EPS increased 17% and 9%, respectively.
- Net interest income grew 6% in Q3 and 8% year to date, principally from loan growth and, year to date, lower repurchase-agreement interest expense.
- Net interest margin declined 6 basis points in Q3 and 9 basis points year to date, primarily because of lower loan yields, the low-rate environment, and lower accretion income from purchased credit-impaired loans.
- Noninterest income declined 9% in Q3 and 3% year to date, mainly because of lower gains on sales of investment securities and loans. Letters of credit fees and foreign-exchange income increased 45% in Q3 and 26% year to date.
- Noninterest expense increased 15% in Q3 and 18% year to date. Major increases included tax-credit investment amortization, compensation, regulatory costs, legal expense, and year-to-date consulting expense related to BSA/AML remediation. No repurchase-agreement extinguishment costs were recorded in 2016, compared with $15.2 million in Q3 2015 and $21.8 million for the first nine months of 2015.
- Loans held for investment increased 5% from year-end 2015, led by commercial real estate, commercial and industrial, residential, and consumer loans. Core deposits increased 10%, while time deposits declined 15%.
- Net charge-offs increased to $22.5 million in Q3 and $28.2 million year to date, compared with $5.2 million and $7.1 million in the prior-year periods. The increase was primarily attributable to three unrelated C&I loans totaling approximately $21.0 million.
- Nonaccrual loans were $121.9 million and total nonperforming assets were $130.5 million at September 30, 2016, broadly consistent with year-end levels. Nonperforming assets were 0.39% of total assets.
- Operating cash flow was $417.6 million for the first nine months. Investing activities used $473.3 million and financing activities provided $365.6 million, producing a $305.9 million increase in cash.
Guidance, outlook, management commentary, risks and unusual items
No formal financial guidance or quantitative earnings outlook is provided in the filing. Management stated that it remained focused on prudent growth, risk-management infrastructure, regulatory compliance, BSA/AML programs, and continued support of its United States–Greater China banking strategy. Management believed liquidity sources were sufficient for foreseeable short- and intermediate-term needs.
- The Bank remained subject to a November 2015 Federal Reserve Written Agreement and related California Department of Business Oversight memorandum concerning BSA/AML programs. Management reported progress but stated that regulators might not find the remediation satisfactory. Additional compliance costs, operating restrictions, or regulatory actions could materially affect results.
- Interest-rate risk is material. The company is asset sensitive; modeled Q3 2016 net interest income volatility was positive 10.8% under a 100-basis-point rate increase and positive 21.2% under a 200-basis-point increase, but negative 4.6% and 5.1% under 100- and 200-basis-point declines.
- Credit risks include commercial real estate exposure, California concentration, C&I charge-offs, changing economic conditions, and potential increases or decreases in future allowance requirements.
- Off-balance-sheet commitments included $4.69 billion of loan commitments and $1.53 billion of commercial letters of credit and standby letters of credit. The allowance for unfunded credit reserves was $18.3 million.
- The company reported a $38.1 million litigation accrual related to the appealed F&F, LLC and 618 Investment, Inc. matter. Management stated that pending legal matters were not expected to have a material adverse effect based on currently available information, but acknowledged that outcomes are difficult to predict.
- The company recognized no other-than-temporary impairment on investment securities during the 2016 periods. It had $11.8 million of net unrealized gains in available-for-sale securities at September 30, 2016.
- The board declared a fourth-quarter cash dividend of $0.20 per common share, payable November 15, 2016 to holders of record November 1, 2016.
Important facts for investors to verify
- Whether BSA/AML remediation satisfies the Federal Reserve and California regulators and whether additional restrictions, costs, or enforcement actions arise.
- The sustainability of loan and core-deposit growth while net interest margin remains under pressure.
- Whether elevated C&I charge-offs and net charge-offs represent an isolated event or a broader deterioration in credit quality.
- The adequacy of the $255.8 million loan-loss allowance and $18.3 million unfunded-commitment reserve as the portfolio expands.
- The effect of tax-credit investment amortization and related tax benefits on reported earnings and effective tax rates.
- Exposure to California commercial real estate, C&I lending, interest-rate movements, deposit migration, and Greater China economic and currency conditions.
- The potential financial impact of the appealed litigation and other contingencies, including loan-sale recourse and unfunded tax-credit commitments.