Business Context and Reporting Period
East West Bancorp, Inc. is the holding company for East West Bank and related subsidiaries. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, with comparative periods ended June 30, 2012 and balance-sheet comparisons to December 31, 2012.
The company operates through Retail Banking, Commercial Banking and Other segments, with significant lending exposure to California real estate, commercial and industrial borrowers, trade finance and consumer loans. Covered loans acquired through FDIC-assisted acquisitions remain subject to FDIC shared-loss agreements.
Key Financial Metrics
| Metric | Q2 2013 | Q2 2012 | Six Months 2013 | Six Months 2012 |
|---|---|---|---|---|
| Net income | $74.0 million | $70.6 million | $146.1 million | $138.6 million |
| Net income available to common stockholders | $72.3 million | $68.8 million | $142.7 million | $135.2 million |
| Diluted EPS | $0.52 | $0.47 | $1.03 | $0.92 |
| Net interest income | $227.6 million | $233.2 million | $436.9 million | $452.1 million |
| Net interest margin | 4.29% | 4.81% | 4.20% | 4.66% |
| Noninterest expense | $94.4 million | $101.6 million | $190.8 million | $216.4 million |
| Provision for loan losses | $9.0 million | $15.5 million | $13.3 million | $33.6 million |
| Efficiency ratio | 40.40% | 41.54% | 41.81% | 42.86% |
Net income increased 5% year over year in the second quarter and 5% for the first half. Diluted EPS increased 11% in the second quarter and 12% in the first half, aided in part by the reduction in weighted-average shares from repurchases.
- Total assets were $23.31 billion at June 30, 2013, up from $22.54 billion at December 31, 2012.
- Total loans receivable, net, were $15.77 billion, including $13.26 billion of non-covered loans and $2.50 billion of covered loans. Total loans grew to $16.28 billion during the second quarter, according to management.
- Non-covered loans increased 14% from year-end 2012, primarily in commercial and industrial, single-family residential, commercial real estate and consumer portfolios.
- Total deposits were $19.28 billion, up 5% from year-end 2012. Core deposits increased 9% to $13.33 billion, while time deposits declined 3%.
- Cash and cash equivalents were $1.05 billion, down from $1.32 billion at December 31, 2012.
- Debt and funding included $314.0 million of Federal Home Loan Bank advances, $995.0 million of repurchase agreements and $137.2 million of long-term debt. Other borrowings were eliminated from the balance sheet during the period.
- Six-month operating cash flow was $157.7 million, compared with $63.5 million in the prior-year period. Investing activities used $1.13 billion, while financing activities provided $703.2 million, primarily from deposit growth. Cash and cash equivalents declined $272.9 million during the first half.
- Non-covered nonperforming assets were $133.5 million, or 0.57% of total assets, compared with $141.0 million, or 0.63%, at year-end. Nonaccrual loans increased to $112.0 million from $108.1 million.
- The allowance for non-covered loan losses was $233.5 million, or 1.73% of non-covered loans. Total allowance for loan losses, including covered loans, was $243.1 million.
- Regulatory capital remained above stated minimum and well-capitalized thresholds: Bancorp total risk-based capital was 14.3%, Tier 1 risk-based capital was 12.9% and Tier 1 leverage was 8.8%.
Material Changes Versus Comparable Periods
- Net interest income declined 2% in Q2 and 3% for the first half, while net interest margin contracted 52 basis points in Q2 and 46 basis points for the first half. Management attributed the decline primarily to downward repricing of investment securities and loans and excess liquidity from deposit growth.
- Provision expense declined substantially because of improved credit quality and lower non-covered charge-offs, although covered-loan provisions increased and reflected concentrated deterioration in certain acquired loan pools.
- Noninterest income was a loss of $12.4 million in Q2 and $14.5 million for the first half, compared with losses of $11.7 million and income of $10.1 million, respectively. The principal drag was the reduction in the FDIC indemnification asset and related receivable.
- FDIC indemnification-asset and receivable reductions were $47.9 million in Q2 and $79.8 million for the first half, compared with $40.3 million and $45.8 million, respectively, in the prior-year periods.
- Net gains on investment-security sales increased to $5.3 million in Q2 and $10.9 million for the first half, versus $71 thousand and $554 thousand, respectively. Conversely, loan-sale results declined to a $354 thousand loss in Q2 and a $260 thousand loss for the first half, compared with gains of $6.4 million and $11.6 million.
- Noninterest expense decreased 7% in Q2 and 12% for the first half. Lower OREO-related expense, the absence of FHLB prepayment penalties and lower legal and consulting costs were significant contributors.
- The company completed a $200 million stock-repurchase program, buying 8.0 million shares during the first half, and converted all remaining Series A preferred stock into 5.6 million common shares on May 1, 2013.
- Accumulated other comprehensive income changed from a $4.7 million gain at year-end 2012 to a $21.7 million loss at June 30, 2013, principally because of unrealized investment-security losses following higher long-term interest rates.
Guidance, Outlook, Commentary and Risks
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. The Board declared a third-quarter common dividend of $0.15 per share and authorized a new $100 million share-repurchase program in July 2013.
- Management stated that liquidity sources, including deposits, Federal Reserve facilities, FHLB advances, federal funds lines, repurchase facilities and long-term debt, were stable and adequate for day-to-day requirements.
- Covered-loan commercial shared-loss agreements expire in 2014 and 2015, while certain residential loss-sharing provisions extend through 2019 and 2020. Management did not expect expiration to have a material impact based on portfolio performance, but future losses after expiration would be borne by the company.
- The recorded estimated liability to the FDIC under the shared-loss agreements increased to $50.7 million at June 30, 2013 from $27.7 million at year-end 2012.
- Key risks include California real estate concentration, borrower performance, credit deterioration in covered and non-covered portfolios, interest-rate movements, declining investment yields, regulatory and compliance costs, FDIC shared-loss terms, liquidity and reputational risk, litigation, changes in U.S. and Chinese economic conditions, and changes in tax or banking regulations.
- Investment securities had $37.5 million of net unrealized losses at June 30, 2013. The company reported no other-than-temporary impairment for the first six months of 2013 and stated it did not intend, and was not likely, to sell affected securities before recovery.
- Off-balance-sheet exposures included $3.15 billion of undisbursed loan commitments, $953.6 million of standby letters of credit and $83.4 million of commercial letters of credit. Loans sold or securitized with recourse totaled $386.6 million.
- The company disclosed ordinary-course litigation and claims but no material legal proceedings as of June 30, 2013. Management stated that outcomes of pending or threatened matters remain inherently uncertain.
Important Facts for Investors to Verify
- Whether net interest margin stabilizes or continues to decline as loans and securities reprice and deposits continue to grow.
- The sustainability and credit quality of the rapid non-covered loan growth, particularly in California commercial real estate, commercial and industrial and consumer portfolios.
- The level and timing of future FDIC indemnification-asset reductions, the $50.7 million estimated FDIC liability and the effect of shared-loss agreement expirations.
- Whether nonaccrual loans, troubled debt restructurings and covered-loan deterioration remain contained despite higher second-quarter additions to nonaccrual loans.
- The impact of higher interest rates on accumulated other comprehensive income, investment-security valuations, capital and liquidity.
- The effect of share repurchases, preferred-stock conversion and the new $100 million repurchase authorization on capital ratios, shares outstanding and per-share earnings.
- The company’s ability to maintain liquidity while funding loan growth after cash and cash equivalents declined during the first half of 2013.