EAST WEST BANCORP INC quarterly report, Q2 FY2014

East West Bancorp, Inc. — Q2 2014 Form 10-Q Summary

Business context and reporting period

East West Bancorp, Inc. is the holding company for East West Bank and related subsidiaries, serving retail, commercial, real estate, trade finance and consumer banking customers. This unaudited Form 10-Q covers the three and six months ended June 30, 2014, with comparisons to the same periods in 2013 and balance-sheet comparisons to December 31, 2013.

The January 17, 2014 acquisition of MetroCorp Bancshares expanded the company’s presence in Texas and California and materially affected reported balances, expenses and goodwill.

Financial performance and key metrics

Metric	Q2 2014	Q2 2013	Change
Net interest income	$266.5 million	$227.6 million	Up 17%
Net interest margin	4.22%	4.29%	Down 7 basis points
Net income	$84.0 million	$74.0 million	Up 13%
Diluted EPS	$0.58	$0.52	Up 12%
Provision for non-covered loan losses	$8.9 million	$8.3 million	Higher
Noninterest loss	$14.9 million	$12.4 million	Greater loss
Noninterest expense	$127.9 million	$94.4 million	Up 35%
Effective tax rate	27.3%	33.8%	Lower

• For the six months ended June 30, 2014, net interest income was $524.4 million versus $436.9 million, and net income was $160.7 million versus $146.1 million.
• Annualized return on average assets was 1.24% and return on average common equity was 12.56% in Q2 2014.
• Average earning assets increased 3% sequentially, driven primarily by higher average non-covered loans. Covered-loan interest income remained significant at $78.7 million in the quarter, with a 16.84% yield, including accretion from purchased credit-impaired loans.
• Total assets were $27.56 billion at June 30, 2014, up 11% from year-end 2013. Net total loans were $20.54 billion, including $18.48 billion of non-covered loans and loans held for sale and $1.80 billion of covered loans.
• Total deposits were $22.88 billion, including $16.64 billion of core deposits. Cash and cash equivalents were $1.25 billion.
• Debt and secured funding included $316.2 million of FHLB advances, $1.01 billion of repurchase agreements and $235.7 million of long-term debt.
• Regulatory capital remained above stated minimums: Bancorp total risk-based capital was 12.8%, Tier 1 risk-based capital was 11.0% and Tier 1 leverage capital was 10.7%. East West Bank reported total risk-based capital of 11.7% and Tier 1 leverage capital of 10.5%.
• Six-month cash flow from operations was $47.5 million; investing activities used $741.0 million, while financing activities provided $1.04 billion. Cash increased by $350.2 million to $1.25 billion.

Material changes versus prior comparable periods

• Loan growth and the MetroCorp acquisition increased non-covered loans by $2.61 billion from December 31, 2013, while covered loans declined $384.8 million because of paydowns and payoffs.
• Deposits increased $2.46 billion from year-end, including approximately $1.32 billion acquired from MetroCorp and additional organic growth. Management emphasized growth in lower-cost commercial and core deposits.
• Noninterest expense increased substantially, primarily because of MetroCorp-related severance, retention costs, additional headcount, integration expenses, higher affordable-housing investment amortization, legal costs and data-processing costs.
• Noninterest loss increased largely because reductions in the FDIC indemnification asset and related receivable/payable were greater as covered-loan loss assumptions improved. The company reported a net payable to the FDIC of $24.3 million at June 30, 2014, compared with a $74.7 million indemnification asset at year-end 2013.
• Non-covered net charge-offs rose to $7.3 million in Q2 2014 from $4.0 million in Q2 2013. The allowance for non-covered loan losses was $246.5 million, or 1.35% of non-covered loans, versus 1.73% a year earlier.
• Non-covered nonperforming assets increased to $161.4 million, or 0.59% of assets, from $130.6 million at year-end 2013. Nonaccrual loans were $118.9 million, and non-covered OREO increased to $42.5 million.
• Accumulated other comprehensive loss improved to $2.5 million from $30.5 million at year-end 2013, principally because of gains in available-for-sale securities.
• Goodwill increased by $121.0 million to $458.5 million from the MetroCorp acquisition. No shares were repurchased under the $100 million repurchase authorization during the quarter.

Guidance, outlook, commentary, risks and unusual items

• The filing provides no formal earnings or revenue guidance. Management expects covered-loan balances and related accretion income to decline over time as loans pay off, reducing their contribution to net interest margin.
• Management stated that covered-loan performance was better than expected and that the expiration of commercial FDIC shared-loss agreements in November 2014 and June 2015 was not expected to have a material impact based on portfolio performance. Future losses on remaining uncovered balances would, however, belong to the company.
• The company expects liquidity sources to remain stable and adequate, supported by deposits, FHLB advances, Federal Reserve facilities, federal funds lines and repurchase agreements. Bancorp liquidity depends materially on dividends from East West Bank, which are subject to regulatory and capital limitations.
• Key risks include California real-estate concentration, borrower performance, interest-rate changes, economic and regulatory conditions, China-related economic and monetary developments, competitive pressures, acquisition integration and achievement of MetroCorp synergies.
• Interest-rate sensitivity analysis indicated that a modeled 200-basis-point increase could increase annual net interest income by 13.5%, while a 200-basis-point decrease could reduce it by 1.0%. The modeled effect on net portfolio value was a 13.2% increase and a 5.3% decrease, respectively.
• Unfunded loan commitments were $4.40 billion and letters of credit were $1.13 billion at June 30, 2014. Affordable-housing and other investment commitments were $86.6 million.
• Litigation matters arose in the ordinary course of business. Management stated that no material legal proceeding was pending, but acknowledged that adverse litigation or regulatory outcomes could materially affect liquidity, financial position or results.
• The company declared a subsequent quarterly common-stock dividend of $0.18 per share, payable in August 2014.

Important facts for investors to verify

• Whether MetroCorp integration costs, elevated compensation and legal expenses decline as expected and whether projected acquisition synergies are realized.
• The sustainability of loan growth, deposit growth and the 4.22% net interest margin as covered-loan balances and accretion income decline.
• Trends in nonaccrual loans, OREO, troubled debt restructurings, charge-offs and the allowance for loan losses, particularly in California commercial real estate and commercial business loans.
• The timing and ultimate liability associated with FDIC shared-loss agreements, including the transition from the former indemnification asset to a net payable.
• Capital and liquidity levels after continued balance-sheet growth, dividend payments and any future acquisitions or share repurchases.
• The impact of interest-rate movements, deposit pricing, repurchase funding and the company’s reliance on dividends from its bank subsidiary.
• The effect of pending or future litigation, regulatory changes, tax-credit investments and accounting changes on reported earnings and capital.