East West Bancorp, Inc. — 2016 First-Quarter Form 10-Q
Business context and reporting period
East West Bancorp, Inc. is a bank holding company serving customers in the United States and Greater China through East West Bank and related subsidiaries. The filing covers the three months ended March 31, 2016, with comparative results for the three months ended March 31, 2015, and balance-sheet comparisons to December 31, 2015. The financial statements are unaudited and presented under U.S. GAAP.
Key financial metrics
| Metric | Q1 2016 | Comparable period or date |
|---|---|---|
| Net interest income | $252.2 million | $235.7 million in Q1 2015 |
| Revenue before provision | $292.7 million | $279.8 million in Q1 2015 |
| Provision for credit losses | $1.4 million | $5.0 million in Q1 2015 |
| Noninterest income | $40.5 million | $44.1 million in Q1 2015 |
| Noninterest expense | $146.6 million | $128.0 million in Q1 2015 |
| Income before taxes | $144.7 million | $146.8 million in Q1 2015 |
| Net income | $107.5 million | $100.0 million in Q1 2015 |
| Diluted EPS | $0.74 | $0.69 in Q1 2015 |
| Net interest margin | 3.32% | 3.51% in Q1 2015 |
| Return on average assets | 1.33% | 1.39% in Q1 2015 |
| Return on average equity | 13.59% | 13.93% in Q1 2015 |
| Total assets | $33.11 billion | $32.35 billion at December 31, 2015 |
| Total deposits | $28.60 billion | $27.48 billion at December 31, 2015 |
| Loans held for investment, gross | $23.77 billion | $23.66 billion at December 31, 2015 |
| Cash and cash equivalents | $2.27 billion | $1.36 billion at December 31, 2015 |
| Long-term debt | $201.1 million | $206.1 million at December 31, 2015 |
| CET1 capital ratio | 10.7% | 10.5% at December 31, 2015 |
Material changes versus prior comparable periods
- Net income rose 7% to $107.5 million, and diluted EPS increased 7% to $0.74.
- Net interest income increased 7%, primarily from loan growth, higher average interest-earning assets and lower repurchase-agreement interest expense. Average loans increased 10% year over year to $23.82 billion.
- Net interest margin declined 19 basis points to 3.32%, reflecting lower loan yields and reduced accretion income from purchased credit-impaired loans. Loan yield declined to 4.28% from 4.51%.
- Noninterest income declined 8%, principally because net gains on loan sales fell to $1.9 million from $9.6 million, while wealth-management and derivative commission income also decreased.
- Noninterest expense increased 15%. Compensation rose 12%, tax-credit investment amortization increased 125% to $14.2 million, and consulting expense increased to $8.5 million, primarily for Bank Secrecy Act and anti-money-laundering compliance efforts.
- The effective tax rate decreased to 25.7% from 31.9%, mainly because of increased tax credits from affordable-housing and other tax-credit investments.
- Total assets increased 2% from year-end. Deposits increased 4% to a record $28.60 billion, driven by an 8% increase in core deposits; time deposits declined 8%.
- FHLB advances declined $699.5 million to $320.0 million after repayment of $700.0 million of short-term advances. Reported repurchase-agreement borrowings increased to $200.0 million because of balance-sheet netting changes.
- Available-for-sale securities declined $568.0 million, primarily from the sale of $558.2 million of U.S. Treasury securities. The Company also securitized $201.7 million of multifamily loans and retained a $160.1 million senior tranche.
Credit quality, liquidity and capital
- Nonaccrual loans increased 34% from year-end to $162.6 million, and total nonperforming assets increased to $168.7 million from $128.4 million. Management attributed the increase mainly to a fully secured commercial real estate loan becoming seriously delinquent and additional loans placed on nonaccrual status because of cash-flow concerns.
- The allowance for loan losses was $260.2 million, or 1.09% of loans held for investment, compared with 1.12% at year-end and 1.21% in Q1 2015. Annualized net charge-offs were 0.09% of average loans.
- Cash, short-term investments and available-for-sale securities totaled approximately $5.78 billion, or 17% of assets. Available borrowing capacity with the FHLB and Federal Reserve Bank was $5.34 billion and $3.11 billion, respectively; unsecured federal-funds lines totaled $683.0 million.
- Operating, investing and financing activities generated net cash inflows of $183.6 million, $330.5 million and $389.8 million, respectively. Cash and cash equivalents increased $904.4 million during the quarter.
- The Company and Bank met Basel III capital requirements and were considered well capitalized. The Company’s CET1, total risk-based capital and Tier 1 leverage ratios were 10.7%, 12.4% and 8.5%, respectively.
Guidance, outlook, commentary and risks
The filing does not provide formal earnings or revenue guidance. Management described the quarter as having strong earnings, loan and deposit growth, and continued opportunities under its strategy of serving as a financial bridge between the United States and Greater China. Management expects continued investment in risk management, compliance and BSA/AML programs.
- The Bank remains subject to a Federal Reserve written agreement and a related California Department of Business Oversight memorandum of understanding concerning BSA/AML deficiencies. Management stated that compliance efforts require significant internal and third-party resources and are expected to adversely affect results and may impose operating restrictions.
- Material risks include interest-rate and net-interest-margin pressure, deposit migration and funding costs, credit quality deterioration, commercial and consumer real-estate conditions, U.S. and China economic conditions, foreign-exchange movements, regulatory changes, litigation, cybersecurity and operational failures, and the ability to maintain adequate capital and liquidity.
- The Company reported $3.86 billion of loan commitments and $1.25 billion of commercial letters of credit and standby letters of credit. Loans sold or securitized with recourse had $178.4 million of unpaid principal; maximum potential future payments were $28.3 million for full-recourse obligations and $5.4 million for limited-recourse obligations.
- A litigation accrual of $36.3 million related to the F&F, LLC and 618 Investment, Inc. matter was recorded at March 31, 2016; the case was on appeal. Management did not expect pending legal matters to have a material adverse effect, but acknowledged that outcomes are difficult to predict.
- The Company declared a quarterly dividend of $0.20 per common share payable May 16, 2016. Disclosure controls were deemed effective, and management reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the increase in nonaccrual loans and troubled debt restructurings persists and requires higher provisions or charge-offs.
- Whether lower loan yields, reduced PCI accretion and interest-rate sensitivity continue to pressure net interest margin.
- The ongoing cost, progress and regulatory consequences of the BSA/AML written agreement and memorandum of understanding.
- The sustainability and composition of deposit growth, including the reported withdrawal of approximately $696 million of short-term deposits during April 2016.
- The performance and valuation of the retained $160.1 million multifamily securitization tranche and the available-for-sale securities portfolio.
- The effect of elevated compliance, consulting, compensation and tax-credit investment costs on future operating leverage and returns.
- The status and potential exposure of the pending litigation, loan-sale recourse obligations, off-balance-sheet commitments and derivative-related contingent features.