East West Bancorp, Inc. — Q1 2015 Form 10-Q Summary
Business context and reporting period
East West Bancorp, Inc. is the bank holding company for East West Bank, serving customers in the United States and Greater China through retail, commercial, international finance, trade finance and wealth management businesses. The filing covers the unaudited three months ended March 31, 2015, with comparisons to March 31, 2014 and, for balance-sheet items, December 31, 2014.
The Company operates three reportable segments: Retail Banking, Commercial Banking and Other. Management describes its strategy as serving as a financial bridge between the United States and Greater China. Prior periods were retrospectively restated for adoption of ASU 2014-01 concerning investments in qualified affordable housing projects.
Financial performance and key metrics
| Metric | Q1 2015 | Comparable period or date |
|---|---|---|
| Net income | $100.0 million | $74.2 million in Q1 2014 |
| Diluted EPS | $0.69 | $0.52 in Q1 2014 |
| Revenue: net interest income plus noninterest income | $279.8 million | $243.1 million in Q1 2014 |
| Net interest income | $235.7 million | $258.0 million in Q1 2014 |
| Net interest margin | 3.51% | 4.26% in Q1 2014 |
| Noninterest income | $44.1 million | $(14.9) million in Q1 2014 |
| Noninterest expense | $128.0 million | $120.0 million in Q1 2014 |
| Provision for loan losses | $5.0 million | $6.9 million in Q1 2014 |
| Annualized return on average assets | 1.39% | 1.14% in Q1 2014 |
| Annualized return on average equity | 13.93% | 11.64% in Q1 2014 |
- Net income increased 35%, or $25.9 million, year over year. Management attributed the improvement mainly to the swing in FDIC indemnification-related results, higher loan-sale gains, derivative commission income, wealth management fees and other operating income.
- Net interest income declined 9%, primarily because of substantially lower discount accretion from purchased credit-impaired loans. Loan yield decreased to 4.51% from 5.49%.
- Noninterest expense rose 7%, reflecting higher compensation, tax-credit investment amortization and legal expense. Lower data-processing expense partly offset these increases.
- The effective tax rate was 32%, compared with 36% in Q1 2014, primarily due to additional affordable-housing and other tax-credit investments.
Financial condition, cash flow, debt and liquidity
| Balance-sheet item | March 31, 2015 | December 31, 2014 |
|---|---|---|
| Total assets | $29.91 billion | $28.74 billion |
| Total loans, net, including loans held for sale | $21.31 billion | $21.51 billion |
| Customer deposits | $25.16 billion | $24.01 billion |
| Core deposits | $18.79 billion | $17.90 billion |
| Cash and cash equivalents | $1.89 billion | $1.04 billion |
| Available-for-sale securities | $2.84 billion | $2.63 billion |
| Stockholders’ equity | $2.94 billion | $2.86 billion |
| Federal Home Loan Bank advances | $317.8 million | $317.2 million |
| Repurchase agreements | $695.0 million | $795.0 million |
| Long-term debt | $220.9 million | $225.8 million |
- Loan balances declined because the Company sold approximately $668.8 million of loans, partly offset by $467.3 million of organic growth. Loans held for sale increased to $196.1 million from $46.0 million.
- Deposits increased 5%; noninterest-bearing demand deposits increased 10% to $8.12 billion. Time deposits increased 4% to $6.38 billion.
- Operating activities provided $125.5 million of cash, investing activities used $397.3 million, and financing activities provided $1.12 billion. Cash and cash equivalents increased $846.3 million during the quarter.
- Management reported $5.05 billion of liquid assets, equal to 17% of total assets, and $5.41 billion of available FHLB borrowing capacity plus $2.92 billion at the Federal Reserve discount window. Federal funds lines totaled $683.0 million.
- Capital remained above well-capitalized thresholds. Company CET1, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 10.6%, 10.7%, 12.4% and 8.6%, respectively.
Credit quality and material changes
- Nonaccrual loans decreased 12% to $87.8 million from $100.3 million at year-end 2014. Nonperforming assets decreased to $120.5 million, or 0.40% of assets, from $132.4 million, or 0.46%.
- The allowance for loan losses was $257.7 million, or 1.21% of loans held for investment, compared with $261.7 million, or 1.20%, at December 31, 2014. First-quarter net charge-offs were $6.0 million, compared with $4.3 million in Q1 2014.
- Purchased credit-impaired loans declined to $1.24 billion from $1.32 billion. FDIC shared-loss coverage for UCB commercial loans ended after December 31, 2014; remaining coverage is scheduled to expire at various dates through 2020.
- The Company recorded a $101.4 million net payable to the FDIC at March 31, 2015, compared with a $27.6 million FDIC indemnification asset at March 31, 2014. This change materially affected noninterest income and reflects improved credit performance and lower expected FDIC reimbursements.
- The Company adopted ASU 2014-01 using retrospective application. Affordable-housing investment amortization is now recognized in income tax expense rather than noninterest expense.
- Basel III became effective January 1, 2015. Risk-weighted assets increased to $23.1 billion from $21.9 billion at year-end 2014, partly because UCB commercial loans no longer received shared-loss coverage and because of the new capital rules.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide quantitative earnings or revenue guidance. Management expressed confidence in continued loan-volume and core-deposit growth, stable credit quality, diversified fee income and sufficient liquidity to meet foreseeable needs. The Company stated that it expects to meet Basel III requirements on a fully phased-in basis based on its current interpretation.
- Interest-rate risk is material: management reported that the balance sheet is more asset-sensitive. A 200-basis-point increase was modeled to increase annualized net interest income by 14.0%, while a 200-basis-point decrease was modeled to reduce it by 1.6%.
- Key risks include borrower performance, commercial and consumer real estate markets, U.S. and China economic conditions, interest-rate policy, regulatory and capital changes, credit losses, liquidity and funding, competition, litigation and market volatility.
- The Company has $3.71 billion of undisbursed loan commitments and $1.44 billion of commercial and standby letters of credit. It also has $237.7 million of maximum potential future payments under loan-sale recourse arrangements.
- A litigation matter involving East West Bank resulted in a $36.6 million adjusted verdict; the case is under appeal and the Company had recorded a $32.6 million accrual at March 31, 2015.
- Unrealized losses on available-for-sale securities totaled $6.6 million. Management considered the declines temporary and recorded no other-than-temporary credit impairment in the quarter.
- The Board declared a second-quarter cash dividend of $0.20 per share, payable in May 2015.
Investor verification checklist
- Verify the sustainability of earnings given the large year-over-year improvement in FDIC indemnification-related results and loan-sale gains.
- Assess the effect of reduced PCI loan accretion on future net interest income, loan yield and net interest margin.
- Review credit performance after the end of UCB commercial-loan FDIC coverage, including nonaccrual trends, charge-offs and allowance adequacy.
- Reconcile reported liquidity and capital ratios with the effects of Basel III risk-weighting changes and balance-sheet growth.
- Evaluate exposure to California commercial real estate, C&I lending, China-related activity, interest-rate movements and off-balance-sheet commitments.
- Monitor the appealed litigation matter, the $32.6 million accrual and any subsequent developments.
- Consider the retrospective ASU 2014-01 restatement when comparing 2014 results and expense or tax trends.