Business Context and Reporting Period
East West Bancorp, Inc. is a California-focused bank holding company whose principal subsidiary, East West Bank, provides consumer, commercial and cross-border banking services in the United States and Greater China. The filing is the Form 10-K for the fiscal year ended December 31, 2018; fourth-quarter results are included in the annual report. The company operated through Consumer and Business Banking, Commercial Banking and Other segments, with more than 130 locations and approximately 3,200 full-time equivalent employees.
Financial Performance and Position
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total revenue | $1.60 billion | $1.44 billion | 11% |
| Net interest income before provision | $1.39 billion | $1.19 billion | 17% |
| Provision for credit losses | $64.3 million | $46.3 million | 39% |
| Noninterest income | $210.9 million | $257.7 million | (18%) |
| Noninterest expense | $714.5 million | $661.5 million | 8% |
| Net income | $703.7 million | $505.6 million | 39% |
| Diluted EPS | $4.81 | $3.47 | 39% |
| Net interest margin | 3.78% | 3.48% | +30 bps |
| Efficiency ratio | 44.73% | 45.84% | Improved 111 bps |
| Return on average assets | 1.83% | 1.41% | +42 bps |
| Return on average equity | 17.04% | 13.71% | +333 bps |
- Balance sheet: Total assets increased 11% to $41.04 billion. Total loans increased 11% to $32.39 billion, led by single-family residential and commercial and industrial lending. Deposits increased 12% to $35.44 billion, primarily because time deposits increased 61% to $9.07 billion.
- Liquidity: Cash and cash equivalents were $3.00 billion. Primary liquidity sources, including cash, interest-bearing deposits, resale agreements and qualifying securities, totaled approximately $6.05 billion, or 15% of assets. Available borrowing capacity was $6.11 billion from the FHLB, $2.84 billion from the Federal Reserve and $663.5 million through correspondent-bank federal funds lines.
- Capital and debt: Stockholders’ equity increased 15% to $4.42 billion. The company’s CET1 ratio was 12.2%, total risk-based capital ratio was 13.7% and Tier 1 leverage ratio was 9.9%; the Bank was also well capitalized. Long-term debt declined 14% to $146.8 million after repayment of the remaining $25.0 million term-loan balance. FHLB advances were $326.2 million and short-term borrowings were $57.6 million.
- Credit quality: The allowance for loan losses was $311.3 million, or 0.96% of loans held for investment, versus 0.99% in 2017. Net charge-offs rose to 0.13% of average loans from 0.08%. Non-PCI nonperforming assets declined 19% to $93.0 million, or 0.23% of total assets.
- Cash flow: Operating activities provided $883.2 million. Investing activities used $3.83 billion, principally reflecting $3.43 billion of loan growth and $503.7 million paid in the Desert Community Bank branch sale. Financing activities provided $3.80 billion, primarily from a $3.90 billion increase in deposits. Cash and cash equivalents increased $826.8 million.
Material Changes Versus the Prior Comparable Period
- Profit growth was driven by loan growth, higher loan yields and a 30-basis-point expansion in net interest margin. Average loan yield increased to 4.97% from 4.40%, although funding costs rose to 0.78% from 0.44%.
- Noninterest income declined because 2017 included a $71.7 million gain from a commercial property sale. The 2018 results included a $31.5 million pretax gain from the sale of eight Desert Community Bank branches, completed March 17, 2018.
- Reported earnings benefited from the Tax Cuts and Jobs Act. The effective tax rate decreased to 14.0% from 31.2%; 2017 included $41.7 million of one-time tax expense related to the Act. Excluding specified tax and asset-sale items, 2018 non-GAAP diluted EPS was $4.66 versus $3.46 in 2017.
- Noninterest expense increased primarily from compensation, staffing, executive severance and technology investments. The filing states that BSA and AML-related consulting costs declined as compliance programs improved.
- The company raised its quarterly common dividend from $0.20 to $0.23 per share beginning in the third quarter of 2018. Total dividends declared were $126.0 million, and no shares were repurchased under the existing $100 million authorization.
- Fourth-quarter 2018 net income was $173.0 million, or $1.18 diluted EPS, compared with $84.9 million, or $0.58 diluted EPS, in fourth-quarter 2017. Fourth-quarter 2017 income tax expense included the principal impact of the Tax Act.
Guidance, Outlook, Risks and Unusual Items
- Management emphasizes continued organic growth in loans, deposits and revenue, investment in technology and process efficiency, and disciplined risk and capital management. The filing does not provide explicit numerical earnings or revenue guidance.
- The company is asset sensitive: management estimates that net interest income would increase with higher rates and decrease with lower rates. A gradual 200-basis-point rate increase was modeled to increase 12-month net interest income by 6.3%; a gradual 200-basis-point decrease was modeled to reduce it by 6.3%.
- Key risks include interest-rate and funding-cost pressure, LIBOR transition to SOFR, California commercial and residential real-estate concentration, U.S.-China trade and economic conditions, foreign-exchange exposure, credit-loss volatility, liquidity stress, cybersecurity, regulatory compliance and legal proceedings.
- The Bank’s 2015 Federal Reserve Written Agreement and related California DBO memorandum concerning BSA and AML controls were terminated in July 2018. Management cautions that continued deficiencies could still result in regulatory scrutiny, penalties, higher expenses or operating restrictions.
- A significant subsequent-event contingency involves DC Solar. Its assets were frozen in December 2018 and it filed for bankruptcy in February 2019 after an FBI affidavit alleged a “Ponzi-like scheme.” East West had claimed approximately $53.9 million of related tax credits from 2014 through 2018 and was evaluating whether some or all could be disallowed in 2019. No uncertain tax liability had been recorded as of the filing date because the more-likely-than-not threshold was not then met.
- The company expects adoption of CECL on January 1, 2020 and stated that the new methodology may increase the allowance for credit losses. It expected 2019 adoption of the new lease standard to add approximately $114.6 million of right-of-use assets and $120.4 million of lease liabilities, with an estimated $14.7 million increase to retained earnings related to deferred sale-and-leaseback gains.
- Available-for-sale securities had $65.1 million of net unrealized losses at year-end, but no OTTI losses were recognized. The company stated that it did not intend, and was not expected, to sell the affected securities before recovery.
Most Important Facts for Investors to Verify
- Whether loan and deposit growth can continue without materially increasing funding costs, provisions or net charge-offs.
- The sustainability of the 3.78% net interest margin and the effect of future Federal Reserve rate changes and LIBOR-to-SOFR transition.
- Exposure to California CRE, multifamily, residential real estate and C&I borrowers, particularly under weaker property values or a U.S.-China trade slowdown.
- The ultimate tax and earnings impact of the DC Solar investment, including any 2019 uncertain tax position, tax-credit disallowance or charge-offs.
- Progress in maintaining BSA, AML and OFAC controls after termination of the 2015 regulatory agreements.
- The expected increase in reserves and capital effects when CECL is adopted in 2020.
- The quality and stability of deposit growth, given that time deposits increased sharply and core deposits declined as a percentage of total deposits from 82% to 74%.