East West Bancorp, Inc. — Form 10-Q Summary
Business context and reporting period
East West Bancorp, Inc. is a bank holding company whose principal subsidiary, East West Bank, provides commercial and retail banking services in the United States and Greater China, with a focus on cross-border banking and the Chinese-American community. The filing covers the unaudited quarter and six months ended June 30, 2018, compared primarily with the corresponding 2017 periods and December 31, 2017 balance-sheet amounts.
Financial performance and condition
| Metric | Three months ended June 30, 2018 | Year-over-year change | Six months ended June 30, 2018 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $389.9 million | 16% | $791.1 million | 9% |
| Net interest income before provision | $341.7 million | 18% | $668.4 million | 19% |
| Provision for credit losses | $15.5 million | 45% | $35.8 million | 101% |
| Net income | $172.3 million | 46% | $359.4 million | 25% |
| Diluted EPS | $1.18 | 45% | $2.46 | 25% |
| Net interest margin | 3.83% | Up 34 basis points | 3.78% | Up 37 basis points |
| Return on average assets | 1.84% | Up 48 basis points | 1.93% | Up 27 basis points |
| Return on average equity | 17.02% | Up 397 basis points | 18.15% | Up 186 basis points |
At June 30, 2018, total assets were $38.07 billion, up 2% from December 31, 2017. Gross loans held for investment were $30.23 billion, up 4%, led by single-family residential and commercial and industrial loans. Deposits were $32.78 billion, up 4%; time deposits increased 39% while core deposits declined 4%. The loan-to-deposit ratio was 92%, compared with 90% at year-end 2017.
Cash and cash equivalents were $2.30 billion. Management reported $5.30 billion of liquidity sources, equal to approximately 14% of total assets, and available borrowing capacity of $6.75 billion from the FHLB, $3.16 billion from the Federal Reserve and $738.0 million through unsecured federal funds lines.
Stockholders’ equity increased 7% to $4.11 billion. The Company reported a CET1 ratio of 12.2%, total risk-based capital ratio of 13.7% and Tier 1 leverage ratio of 10.0%; both the Company and the Bank were classified as well-capitalized.
For the six months ended June 30, 2018, operating activities provided $434.9 million of cash, investing activities used $1.48 billion and financing activities provided $1.17 billion, resulting in a $122.9 million increase in cash and cash equivalents.
Material changes versus comparable periods
- Net interest income benefited from loan growth, higher variable-rate loan yields and rising interest rates. The average loan yield increased to 4.95% in the quarter from 4.40% in the prior-year quarter, while the cost of deposits increased to 0.64% from 0.36%.
- Interest expense increased 79% in the quarter and 64% year to date, reflecting higher deposit costs and other funding costs.
- Noninterest income was broadly stable in the quarter at $48.3 million but declined 25% year to date to $122.7 million. The prior-year period included a $71.7 million gain on the sale of a California commercial property; 2018 included a $31.5 million pretax gain on the sale of eight Desert Community Bank branches.
- Noninterest expense increased 5% in the quarter and 8% year to date, primarily because of higher compensation, headcount, salaries and incentive compensation.
- The effective tax rate declined to 12.5% for the quarter and 12.1% year to date, compared with 25.0% and 25.3%, respectively, principally because of the Tax Cuts and Jobs Act.
- The allowance for loan losses was $301.6 million, or 1.00% of held-for-investment loans, compared with $287.1 million, or 0.99%, at December 31, 2017. Net charge-offs were $20.6 million year to date, compared with net charge-offs of $2.9 million in the prior-year period.
- Nonaccrual loans declined 10% to $102.8 million, and non-PCI nonperforming assets declined to $103.5 million, or 0.27% of total assets.
Outlook, commentary, risks and unusual items
Management described second-quarter results as solid and emphasized continued organic growth in loans, deposits and revenue, investment in talent, technology and risk-management infrastructure, and relationship-focused banking. The filing does not provide specific earnings, revenue or balance-sheet guidance.
The Company is asset-sensitive: modeled 12-month net interest income would increase 10.1% under a 100-basis-point rate increase and decrease 8.6% under a 100-basis-point decline, subject to deposit migration and other modeling assumptions. Management noted that competition for deposits has increased and may raise funding costs and margin volatility.
Key risks include credit deterioration, California commercial real estate concentration, changes in interest rates and deposit mix, liquidity and funding conditions, economic conditions in the United States and China, foreign-exchange risk, cyber and operational risks, litigation, regulatory changes, and changes in tax and accounting standards. The Company’s CRE portfolio was 77% concentrated in California, while 64% of single-family residential loans and 71% of HELOCs were concentrated in California.
The Bank’s 2015 BSA/AML and OFAC-related Written Agreement with the Federal Reserve and related California regulatory memorandum were terminated in July 2018. Management cautioned that the related compliance programs must remain satisfactory and that future examinations could still result in adverse regulatory actions, expenses or restrictions.
The Company early adopted several accounting standards in 2018. The expected credit loss standard, CECL, is effective January 1, 2020, with early adoption permitted in 2019. Management expects CECL may increase the allowance for credit losses, but the filing does not provide a quantified impact. The Board declared a third-quarter 2018 dividend of $0.23 per share, payable August 15, 2018.
Important facts for investors to verify
- Assess how much of the year-to-date earnings and EPS improvement remains after excluding the $31.5 million pretax DCB branch-sale gain; management reported non-GAAP diluted EPS of $2.31 versus $1.70 in the prior-year period after excluding unusual gains.
- Monitor deposit migration from core deposits to time deposits, deposit pricing and the resulting effect on net interest margin.
- Evaluate whether loan growth, higher C&I charge-offs and the increased credit-loss provision justify the $301.6 million allowance and whether future CECL adoption could materially increase reserves.
- Review California CRE, multifamily, construction, single-family and HELOC concentrations and related collateral values.
- Verify the sustainability of strong capital ratios and liquidity capacity as assets and loans continue to grow.
- Confirm continued compliance with BSA/AML and OFAC requirements following termination of the prior regulatory agreements.
- Review the effect of unrealized available-for-sale securities losses, which increased to $92.0 million net of tax-related effects, on tangible capital and accumulated other comprehensive income.