East West Bancorp, Inc. — 2Q16 Form 10-Q Summary
Business context and reporting period
East West Bancorp, through East West Bank and subsidiaries, operates more than 130 locations in the United States and Greater China. Its strategy is to serve as a financial bridge between the U.S. and Greater China through retail banking, commercial banking, international finance, trade services and cross-border products. This unaudited filing covers the three and six months ended June 30, 2016, with comparisons to the same periods in 2015 and to December 31, 2015 for balance-sheet data.
Key financial metrics
| Metric | Three months ended June 30, 2016 | Six months ended June 30, 2016 | Comparable change |
|---|---|---|---|
| Net income | $103.3 million | $210.8 million | Up 5% and 6% |
| Diluted EPS | $0.71 | $1.45 | Up 4% and 5% |
| Revenue (net interest income before provision plus noninterest income) | $297.8 million | $590.6 million | Up 11% and 8% |
| Net interest income | $253.6 million | $505.8 million | Up 11% and 9% |
| Noninterest income | $44.3 million | $84.8 million | Up 9% and approximately flat |
| Noninterest expense | $148.9 million | $295.5 million | Up 24% and 19% |
| Net interest margin | 3.31% | 3.31% | Flat and down 10 basis points |
| Return on average assets | 1.27% | 1.30% | Down 7 and 7 basis points |
| Return on average equity | 12.71% | 13.15% | Down 54 and 43 basis points |
| Effective tax rate | 27.7% | 26.7% | Down from 31.6% and 31.8% |
Provision for credit losses was $6.1 million in the second quarter and $7.5 million year to date, compared with $3.5 million and $8.5 million, respectively, in the prior-year periods. The lower tax rate primarily reflected increased tax credit investments.
At June 30, 2016, total assets were $32.95 billion, up $601.3 million, or 2%, from year-end 2015. Gross loans held for investment were $24.24 billion, up 2%, and net loans including loans held for sale were $24.02 billion. The allowance for loan losses was $266.8 million, or 1.10% of loans held for investment, versus 1.12% at December 31, 2015.
Total deposits were $28.22 billion, up 3%, with core deposits increasing 8% to $22.48 billion and representing 80% of total deposits. Time deposits declined 13% to $5.73 billion. Cash and cash equivalents were $1.59 billion, while cash, short-term investments and available-for-sale securities totaled approximately $5.06 billion, or 15% of assets.
Six-month operating cash flow was $271.3 million, compared with $289.5 million in 2015. Investing activities used $49.7 million, compared with $798.6 million used in the prior-year period. Financing activities provided $13.7 million, including deposit growth, partly offset by repayment of $700.0 million of FHLB advances. Cash increased $231.9 million to $1.59 billion.
Long-term debt was $196.2 million, down from $206.1 million at year-end 2015. FHLB advances were $320.5 million, down from $1.02 billion. Net repurchase agreements were $200.0 million, compared with none reported at year-end due to balance-sheet netting. The Company reported available borrowing capacity of $5.59 billion with the FHLB and $3.00 billion with the Federal Reserve Bank, plus $716.0 million of unsecured federal funds lines.
Capital remained strong: the Company’s June 30 CET1 ratio was 10.7%, total risk-based capital ratio was 12.4%, and Tier 1 leverage ratio was 8.7%. Management stated that the Company and Bank met Basel III requirements and were well capitalized.
Material changes versus prior comparable periods
- Loan growth and lower repurchase-agreement interest expense drove higher net interest income, although the six-month net interest margin declined to 3.31% from 3.41% and loan yield declined to 4.28% from 4.40%.
- Noninterest expense rose substantially, particularly tax-credit investment amortization, compensation, regulatory assessments, OREO expense and consulting costs.
- Consulting expense increased to $6.0 million in the quarter and $14.4 million year to date, primarily for BSA/AML compliance efforts.
- Wealth management fees, loan-sale gains and securities-sale gains declined year over year, while letters-of-credit fees and foreign-exchange income increased.
- Nonaccrual loans increased 41% to $171.6 million from $121.4 million at year-end, and total nonperforming assets increased to $176.5 million from $128.4 million. The allowance for loan losses nevertheless increased to $266.8 million.
- Available-for-sale securities declined 14% to $3.24 billion, primarily due to lower U.S. Treasury holdings. Net unrealized gains were $20.3 million at June 30, versus net unrealized losses of $10.6 million at year-end.
- The Company securitized $201.7 million of multifamily loans and retained a $160.1 million senior tranche classified as held to maturity.
Outlook, commentary, risks and unusual items
No formal earnings or financial guidance was provided. Management emphasized continued balance-sheet growth, the bridge-banking strategy, risk-management investment and regulatory compliance. Management stated that liquidity sources were sufficient for foreseeable needs and that no material liquidity trends or capital-expenditure commitments were identified.
The Bank remains subject to a November 2015 Federal Reserve Written Agreement and related California Department of Business Oversight Memorandum of Understanding addressing BSA/AML program deficiencies. Management reported progress but cautioned that regulators may require additional remediation, resources or restrictions, which could materially affect expenses and results.
Material risks include credit deterioration, especially in commercial real estate and commercial and industrial loans; California real-estate exposure; the low-interest-rate environment; deposit migration and funding costs; regulatory compliance; litigation; China-related economic and currency conditions; cybersecurity and operational risk; and changes in accounting standards. The Company reported $4.76 billion of loan commitments and $1.45 billion of commercial letters of credit and standby letters of credit.
Litigation accruals were $37.2 million at June 30, 2016, including the appealed F&F, LLC and 618 Investment, Inc. matter. Management believed pending matters were not expected to have a material adverse effect, but acknowledged that legal outcomes are difficult to predict. The Board subsequently declared a third-quarter dividend of $0.20 per share, payable August 15, 2016.
Most important facts for investors to verify
- Whether elevated nonaccrual loans, impaired loans and troubled debt restructurings continue to rise, particularly in CRE and C&I portfolios.
- Whether loan growth remains accretive as margins face pressure from low rates, lower loan yields and deposit repricing.
- Whether elevated compliance, consulting, compensation and tax-credit amortization expenses moderate or continue.
- Progress under the Federal Reserve Written Agreement and DBO MOU, including any additional regulatory findings or restrictions.
- Core-deposit stability, deposit migration under higher-rate scenarios and continued access to secured and unsecured liquidity.
- Potential effects of the F&F litigation appeal and other legal or contingent obligations.
- Future allowance requirements and the eventual impact of the expected-credit-loss accounting standard.