Business Context and Reporting Period
East West Bancorp, Inc. filed its Form 10-K for the fiscal year ended December 31, 2015. The company is a bank holding company whose principal subsidiary, East West Bank, serves individuals and small-to-medium-sized businesses in the United States and Greater China, with emphasis on cross-border U.S.-China banking. The company operated more than 130 locations and had approximately 2,833 employees at year-end.
The filing presents annual 2015 results, with unaudited fourth-quarter information also included. Prior-period amounts were retrospectively restated for ASU 2014-01 concerning investments in qualified affordable housing projects.
Key Financial Metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Net income | $384.7 million | $345.9 million | Up 11% |
| Diluted EPS | $2.66 | $2.41 | Up 10% |
| Revenue before provision for credit losses | $1.13 billion | Approximately $1.03 billion | Up 10% |
| Net interest income | $950.4 million | $1.04 billion | Down 9% |
| Net interest margin | 3.35% | 4.03% | Down 68 bps |
| Provision for credit losses | $14.2 million | $49.2 million | Down $34.9 million |
| Noninterest income | $183.4 million | $(11.7) million | Improved materially |
| Noninterest expense | $540.9 million | $533.0 million | Up 1% |
| Return on average assets | 1.27% | 1.25% | Up 2 bps |
| Return on average equity | 12.74% | 12.72% | Up 2 bps |
- Total assets reached $32.35 billion, up 13%.
- Total loans, net of allowance, reached $23.41 billion, up 9%; commercial real estate loans increased 19%, commercial and industrial loans increased 11%, and consumer loans increased 29.
- Total deposits reached $27.48 billion, up 14%; core deposits increased 17% to $20.86 billion.
- Stockholders’ equity increased 9% to $3.12 billion.
- Cash and cash equivalents were $1.36 billion. Cash, short-term investments, and available-for-sale securities totaled $5.43 billion, or 17% of assets.
- Net cash provided by operating activities was $469.6 million, compared with $392.9 million in 2014. Investing activities used $3.63 billion, while financing activities provided $3.49 billion.
- Long-term debt declined to $206.1 million from $225.8 million. FHLB advances increased to $1.02 billion, including $700 million of short-term advances obtained in December 2015 and maturing in February 2016.
- The company paid quarterly common dividends of $0.20 per share during 2015, compared with $0.18 per share in 2014.
Material Changes Versus the Prior Comparable Period
- Profitability improved despite lower net interest income, primarily because noninterest income shifted from a $11.7 million loss to $183.4 million of income and credit-loss provision declined sharply.
- The net interest margin contracted because of lower loan yields and reduced accretion income from acquired FDIC-assisted loan portfolios. Lower-cost funding and the payoff of higher-cost repurchase agreements partly offset the pressure.
- Noninterest income benefited from a substantially smaller FDIC indemnification charge, higher securities-sale gains, and growth in fee-based activities. The company recorded $40.4 million of gains on available-for-sale securities, including $21.7 million related to securities with previously recognized other-than-temporary impairment.
- The company terminated the remaining UCB and WFIB shared-loss agreements with the FDIC, making a total payment of $125.5 million. No FDIC indemnification asset or net payable remained at year-end.
- Noninterest expense was broadly stable. Higher compensation, consulting costs, and $21.8 million of repurchase-agreement extinguishment costs were largely offset by lower legal expense; 2014 included a $31.6 million litigation accrual.
- Credit quality remained generally strong. Nonperforming assets declined 3% to $128.4 million, or 0.40% of assets, while net charge-offs to average loans improved to 0.01% from 0.18%. However, nonaccrual loans increased to $121.4 million from $100.3 million.
- The allowance for loan losses increased modestly to $265.0 million, but declined to 1.12% of loans held for investment from 1.20%.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide quantified earnings or revenue guidance in the filing. Management stated that the company remained focused on continued loan and deposit growth and its strategy of serving as a financial bridge between the United States and Greater China.
- Regulatory matter: On November 9, 2015, East West Bank entered into a Written Agreement with the Federal Reserve Bank of San Francisco and a related memorandum of understanding with the California Department of Business Oversight concerning deficiencies in its BSA/AML compliance program. Required actions include enhanced board oversight, customer due diligence, transaction monitoring, suspicious-activity reporting, and OFAC controls. Management expects significant incremental compliance and consulting costs and operational restrictions.
- Capital: At December 31, 2015, the company reported CET1, Tier 1, total risk-based, and Tier 1 leverage ratios of 10.5%, 10.7%, 12.2%, and 8.5%, respectively. Both the company and bank exceeded fully phased-in Basel III minimums and were categorized as well capitalized.
- Interest-rate risk: The company is asset-sensitive in rising-rate scenarios. A 100-basis-point increase was modeled to increase 12-month net interest income by 9.6%, while a 100-basis-point decrease was modeled to reduce it by 4.0%, subject to model assumptions.
- Concentration risk: A substantial portion of the loan portfolio and collateral is concentrated in California commercial real estate and commercial lending. The company also has meaningful exposure to customers and operations connected to China and Greater China.
- Liquidity: Management stated that liquidity sources were sufficient for reasonably foreseeable needs. Available borrowing capacity was $4.45 billion from the FHLB, $2.91 billion from the Federal Reserve Bank, and $683 million in unsecured federal funds lines.
- Contingencies: The company reported $3.37 billion of unfunded loan commitments and $1.29 billion of commercial and standby letters of credit. Maximum potential future payments on loans sold or securitized with recourse were $191.3 million.
- Litigation: The company accrued $35.4 million for the F&F, LLC and 618 Investments litigation, which was under appeal. Management did not expect pending legal matters to have a material aggregate effect, although it noted that outcomes are difficult to predict.
- Accounting and unusual items: ASU 2014-01 was adopted retrospectively. The company also recorded a $261.2 million deferred tax expense in 2015, contributing to a 33.5% effective tax rate versus 22.6% in 2014.
Investor Verification Items
- Verify the status, remediation milestones, costs, and potential consequences of the Federal Reserve Written Agreement and DBO memorandum of understanding.
- Assess whether loan growth, particularly in California CRE and C&I lending, is being matched by adequate underwriting, reserves, and capital.
- Monitor the sustainability of 2015 noninterest income, including securities-sale gains and the reduced FDIC-related charge, rather than treating all of the improvement as recurring.
- Track net interest margin, deposit pricing, deposit migration, and the effect of rising or falling interest rates on earnings.
- Review the increase in nonaccrual loans and nonperforming TDRs despite the decline in total nonperforming assets.
- Confirm liquidity following the February 2016 maturity of the $700 million short-term FHLB advances and evaluate reliance on wholesale funding.
- Review litigation reserves, recourse obligations, unfunded commitments, and tax-credit investment commitments for potential cash or capital effects.
- Confirm that the reported capital ratios remain above Basel III distribution constraints as the capital conservation buffer phases in.