East West Bancorp, Inc. — 1Q14 Form 10-Q Summary
Business context and reporting period
East West Bancorp, Inc. is the holding company for East West Bank, serving customers through retail, commercial banking, international finance and trade operations. This unaudited report covers the three months ended March 31, 2014, with comparisons to the three months ended March 31, 2013 and December 31, 2013 balance-sheet data.
On January 17, 2014, the Company completed its acquisition of MetroCorp Bancshares, Inc., expanding its presence in Houston, Dallas and San Diego through 19 branches. Consideration totaled approximately $291.4 million, consisting primarily of $190.8 million of East West common stock and $89.4 million of cash. The acquisition added approximately $1.19 billion of loans, $1.32 billion of deposits and $121.0 million of goodwill.
Financial performance and key metrics
| Metric | 1Q14 | Comparable period |
|---|---|---|
| Net interest income | $258.0 million | $209.3 million in 1Q13 |
| Net interest margin | 4.26% | 4.10% in 1Q13 |
| Net income | $76.7 million | $72.1 million in 1Q13 |
| Diluted EPS | $0.54 | $0.50 in 1Q13 |
| Noninterest income/(loss) | $(14.9) million | $(2.1) million in 1Q13 |
| Noninterest expense | $124.4 million | $96.4 million in 1Q13 |
| Effective tax rate | 31.3% | 32.3% in 1Q13 |
| Return on average assets | 1.18% | 1.30% in 1Q13 |
| Return on average common equity | 12.05% | 12.45% in 1Q13 |
| Cash flow from operating activities | $36.5 million | $80.4 million in 1Q13 |
- Interest and dividend income increased to $286.2 million from $238.4 million, primarily from loan growth. Interest expense declined to $28.2 million from $29.1 million.
- The $14.9 million noninterest loss included a $53.6 million reduction in the FDIC indemnification asset and receivable, partially offset by $6.2 million of loan-sale gains, $3.4 million of securities-sale gains and higher fee income.
- Noninterest expense rose 29% year over year. Compensation increased because of MetroCorp-related severance and retention costs and higher headcount; data-processing expense included one-time system-contract termination costs and acquisition-related costs.
- Gross total loans reached approximately $19.92 billion at March 31, 2014, up 10% from year-end 2013. Net loans receivable were $19.08 billion, including $2.03 billion of covered loans.
- Total assets increased 11% to $27.40 billion, while stockholders’ equity increased 11% to $2.62 billion.
- Total deposits increased 12% to $22.83 billion, including core deposits of $16.44 billion. Management emphasized continued growth in low-cost commercial and core deposits.
- Debt and secured funding included $315.6 million of FHLB advances, $1.01 billion of repurchase agreements and $240.7 million of long-term debt. The Company repaid $15.3 million of long-term debt during the quarter.
- Cash and cash equivalents increased to $1.88 billion from $895.8 million at year-end, primarily reflecting deposit growth and financing cash inflows. Net cash used in investing activities was $74.2 million, while financing activities provided $1.03 billion.
- Regulatory capital remained above well-capitalized thresholds: Company total risk-based capital was 13.0%, Tier 1 risk-based capital was 11.2% and Tier 1 leverage was 8.5%. East West Bank reported 11.8%, 10.5% and 8.0%, respectively.
Material changes versus prior comparable periods
- Net income increased 6% and diluted EPS increased 8% year over year, although annualized ROA and ROE declined because of the larger balance sheet and higher expenses.
- Net interest income increased 23%, driven mainly by higher average non-covered loan balances and the MetroCorp acquisition. Covered-loan interest income declined to $80.7 million from $86.2 million, while the covered-loan yield increased to 15.61% from 12.29% because of accretion.
- Non-covered loan-loss provision increased to $8.0 million from a $762 thousand reversal in 1Q13. Non-covered net charge-offs increased to $4.1 million from $540 thousand.
- The allowance for non-covered loan losses increased to $245.6 million, but declined to 1.42% of non-covered loans from 1.54% at year-end 2013 and 1.85% in 1Q13.
- Non-covered nonperforming assets increased to $160.9 million, or 0.59% of assets, from $130.6 million, or 0.53%, at year-end. Nonaccrual loans increased to $132.5 million from $111.7 million.
- Covered loans declined 7% from year-end because of payoffs and paydowns. The related FDIC indemnification asset declined to $27.6 million from $74.7 million, reflecting amortization, loan disposals, recoveries and improved loss assumptions.
- Investment securities available for sale declined to $2.47 billion from $2.73 billion. Net unrealized losses improved to approximately $30.0 million from $52.7 million, primarily because of market-rate movements.
- No shares were repurchased under the $100 million repurchase authorization during the quarter. The common dividend was increased to $0.18 per share from $0.15 in 1Q13.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide formal earnings or revenue guidance. Management stated that liquidity sources were stable and adequate for day-to-day requirements, that capital levels were strong, and that the Company intended to maintain capital above regulatory requirements while supporting balance-sheet growth.
- Management expects covered-loan balances and related accretion income to decline over time as loans pay off, reducing their contribution to net interest margin.
- FDIC shared-loss agreements reimburse 80% of eligible losses on covered assets, but commercial loss-sharing provisions for the UCB and WFIB acquisitions expire in November 2014 and June 2015, respectively. Future losses on remaining loans after expiration would be borne by the Company.
- Credit risk is concentrated in California real estate: approximately 81% of non-covered commercial real estate and residential loans were secured by California properties. Deterioration in commercial or residential real estate could increase provisions and charge-offs.
- Non-covered substandard loans increased to $524.9 million, and doubtful or loss-grade loans totaled $1.1 million at March 31, 2014, compared with no doubtful or loss-grade loans at year-end.
- Covered-asset accounting produced significant earnings effects, including $61.2 million of covered-loan accretion, $28.5 million of FDIC indemnification-asset amortization and a $53.6 million noninterest loss related to FDIC asset and receivable reductions.
- Off-balance-sheet exposures included $4.34 billion of undisbursed loan commitments, $1.12 billion of standby letters of credit and $52.4 million of commercial letters of credit.
- Affordable housing and other tax-credit investments totaled $268.1 million, with $84.7 million of unfunded commitments. These investments are subject to potential tax-credit recapture if projects fail to meet compliance requirements.
- The Company disclosed ordinary-course litigation and regulatory matters whose outcomes are inherently uncertain, although it reported no material legal proceedings at March 31, 2014. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Most important facts for investors to verify
- Assess the sustainability of earnings excluding covered-loan accretion, FDIC-related adjustments, acquisition benefits and loan-sale gains.
- Monitor MetroCorp integration costs, realized synergies, branch performance and the effect of the acquisition on credit quality and operating efficiency.
- Track nonaccrual loans, nonperforming assets, classified loans, net charge-offs and allowance coverage as the loan portfolio expands.
- Evaluate the effect of declining FDIC loss-sharing protection and the remaining FDIC indemnification asset on future earnings and capital.
- Review California commercial and residential real-estate concentrations and sensitivity to interest-rate and property-market changes.
- Confirm liquidity and capital ratios under deposit outflows, loan growth, higher funding costs and adverse interest-rate scenarios.
- Reconcile reported gross loan growth with net loans receivable, covered-loan discounts, loans held for sale and acquisition accounting adjustments.