East West Bancorp, Inc. — Q3 2014 Form 10-Q Summary
Business context and reporting period
East West Bancorp, Inc. is the bank holding company for East West Bank and related subsidiaries, serving retail, commercial, real estate, trade finance and consumer customers in the United States and selected international markets. This unaudited quarterly report covers the three and nine months ended September 30, 2014, with comparisons to the corresponding 2013 periods and December 31, 2013 balances.
The January 17, 2014 acquisition of MetroCorp Bancshares expanded the company primarily in Houston, Dallas and San Diego. Consideration was approximately $291.4 million, including $190.8 million of East West common stock and $89.4 million of cash; the transaction added approximately $1.19 billion of loans, $1.32 billion of deposits and $121.0 million of goodwill.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Change |
|---|---|---|---|
| Net income | $88.8 million | $73.2 million | 21% increase |
| Diluted EPS | $0.62 | $0.53 | 17% increase |
| Net interest income | $257.0 million | $254.3 million | 1% increase |
| Net interest margin | 3.89% | 4.54% | Down 65 basis points |
| Provision for loan losses | $15.2 million | $3.6 million | Increase |
| Noninterest income | $10.3 million | $(41.4) million | $51.7 million improvement |
| Noninterest expense | $177.0 million | $100.4 million | 76% increase |
| Return on average assets | 1.25% | 1.22% | Improved |
| Return on average common equity | 12.80% | 12.65% | Improved |
For the nine months ended September 30, 2014, net income was $249.5 million versus $219.3 million, diluted EPS was $1.74 versus $1.56, and net interest income was $781.4 million versus $691.2 million. The nine-month net interest margin was 4.12%, compared with 4.32% in 2013. The effective tax rate was 17.5%, compared with 33.0%, primarily because of increased affordable housing and other tax credit investments.
Balance sheet, credit quality and liquidity
- Total assets were $28.48 billion, up 15% from $24.73 billion at December 31, 2013.
- Total loans receivable were $21.23 billion, including $19.10 billion of non-covered loans and $1.64 billion of covered loans. Non-covered loans increased substantially, partly from the MetroCorp acquisition; covered loans declined because of payoffs and paydowns.
- Total deposits were $23.81 billion, up 17% from $20.41 billion. Core deposits increased to $17.68 billion from $14.59 billion, reflecting growth in noninterest-bearing demand, checking, money market and savings accounts.
- Cash and cash equivalents were $1.12 billion. Nine-month cash flow from operating activities was $243.2 million; investing activities used $1.97 billion, primarily for loan growth and securities purchases; financing activities provided $1.95 billion, primarily from deposit growth.
- Long-term debt was $230.8 million, FHLB advances were $316.7 million and repurchase agreements were $805.1 million. The company stated that its liquidity sources were stable and adequate for day-to-day requirements.
- Non-covered nonperforming assets were $159.1 million, or 0.56% of total assets, versus $130.6 million, or 0.53%, at year-end 2013. Nonaccrual loans were $125.7 million.
- The allowance for non-covered loan losses was $249.3 million, or 1.29% of non-covered loans. Nine-month net charge-offs on non-covered loans were $16.7 million versus $4.9 million in 2013.
- Regulatory capital remained above well-capitalized thresholds: the company reported a Tier 1 leverage ratio of 8.5%, Tier 1 risk-based capital ratio of 10.9% and total risk-based capital ratio of 12.5%.
Material changes versus the prior comparable period
- Revenue growth benefited from larger non-covered loan balances and the MetroCorp acquisition, but the decline in high-yielding covered loans reduced the overall net interest margin. Covered-loan interest income fell to $60.5 million in Q3 2014 from $108.9 million.
- Noninterest income improved primarily because the reduction associated with the FDIC indemnification asset and payable was less severe, while loan-sale gains increased to $7.7 million from $3.9 million.
- Noninterest expense increased sharply due to a $28.8 million litigation accrual, higher amortization of tax-credit investments, increased compensation and benefits, and merger-related expenses.
- Non-covered loan provisions increased to $7.6 million in Q3 and $24.5 million for the nine months, reflecting portfolio growth and higher net charge-offs.
- The FDIC indemnification asset was replaced by a net payable to the FDIC of $64.5 million at September 30, 2014, compared with a $145.0 million asset at September 30, 2013, because of improving covered-loan performance and lower expected reimbursements.
- Accumulated other comprehensive loss improved to $2.4 million from $30.5 million at December 31, 2013, primarily from improved unrealized values of available-for-sale securities.
Guidance, outlook, commentary and unusual items
The filing does not provide formal earnings or revenue guidance. Management emphasized continued loan and low-cost commercial deposit growth, active capital management and maintaining capital above regulatory requirements. Management expects the expiration of commercial-loan FDIC shared-loss coverage beginning December 31, 2014 to have no material impact because of the performance of the covered portfolio.
- FDIC shared-loss coverage reimburses 80% of eligible losses on covered assets, subject to the applicable agreement terms. Commercial coverage ends December 31, 2014 for UCB assets and June 30, 2015 for WFIB assets; residential coverage continues through 2019 and 2020, respectively.
- The company recorded a $28.8 million accrual related to a jury verdict awarding $38.9 million in damages in the F&F, LLC and 618 Investment, Inc. litigation. The verdict was subject to further proceedings and appeal, and the ultimate liability remained uncertain.
- Affordable housing and other tax-credit investments generated significant tax benefits but also increased amortization expense. Related unfunded commitments were $112.7 million at September 30, 2014.
- Interest-rate sensitivity analysis indicated that a 200-basis-point increase could increase projected 12-month net interest income by 13.2%, while a 200-basis-point decrease could reduce it by 1.5%. These are model-based estimates, not forecasts.
- Subsequent to quarter-end, the board declared a $0.18 per-share dividend, and the company sold $253.8 million of student loans on October 6, 2014.
Principal risks and contingencies
Key risks include borrower performance and loan losses, concentrations in California residential and commercial real estate, changes in U.S. and Chinese economic conditions and monetary policy, interest-rate movements, regulatory and accounting changes, competitive pressures, liquidity and reputational risk, the ability to realize MetroCorp synergies, management of FDIC-assisted portfolios, litigation outcomes and the potential expiration of FDIC loss protection. The company disclosed no material changes to the risk factors in its 2013 Form 10-K.
Off-balance-sheet exposures included $4.00 billion of undisbursed loan commitments, $1.14 billion of standby letters of credit and $66.1 million of commercial letters of credit. Loans sold or securitized with recourse created maximum potential future payments of $273.4 million, supported by a $2.4 million reserve.
Important facts for investors to verify
- Whether MetroCorp integration costs, headcount additions and expected synergies develop as planned.
- The sustainability of earnings excluding tax-credit benefits, FDIC-related accounting changes, loan-sale gains and other unusual items.
- Whether net interest margin continues to compress as high-yielding covered loans run off and interest rates change.
- Trends in non-covered loan growth, net charge-offs, nonaccrual loans, troubled debt restructurings and allowance coverage.
- The final outcome and total cost of the F&F litigation, including possible punitive damages and attorney fees.
- The financial impact as UCB and WFIB commercial-loan FDIC coverage expires.
- The liquidity and capital effects of continued balance-sheet growth, deposit concentration, repurchase agreements and off-balance-sheet commitments.