East West Bancorp, Inc. — Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended June 30, 2012, compared primarily with the three and six months ended June 30, 2011 and December 31, 2011 balance-sheet amounts. The interim financial statements are unaudited. East West Bancorp is a bank holding company whose principal subsidiary is East West Bank, with retail, commercial banking, trade finance and international operations.
Financial performance and condition
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net interest income | $233.2 million | $227.3 million | $452.1 million | $436.2 million |
| Provision for loan losses | $15.5 million | $26.5 million | $33.6 million | $53.0 million |
| Noninterest income | $(11.7) million | $12.5 million | $10.1 million | $23.5 million |
| Noninterest expense | $101.6 million | $117.6 million | $216.4 million | $224.4 million |
| Net income | $70.6 million | $60.5 million | $138.6 million | $116.6 million |
| Diluted EPS | $0.47 | $0.39 | $0.92 | $0.76 |
| Net interest margin | 4.81% | 4.70% | 4.66% | 4.61% |
- Profitability: Q2 net income increased 17% year over year, while diluted EPS increased 21%. Annualized return on average assets was 1.32% and return on average common equity was 12.46% in Q2 2012.
- Margins: Net interest income rose 3% in Q2 and 4% for the first half. Management attributed the margin improvement primarily to lower deposit and other funding costs, partly offset by lower yields and balances on covered loans and investment securities.
- Balance sheet: Total assets were $21.53 billion at June 30, 2012, down 2.0% from year-end 2011. Net loans were $13.97 billion, including $3.42 billion of FDIC-covered loans. Available-for-sale securities declined 39% to $1.87 billion.
- Liquidity: Cash and cash equivalents increased to $2.43 billion from $1.43 billion at year-end, primarily from investment-security sales, maturities and calls that had not yet been redeployed. Total deposits were $17.34 billion. Core deposits increased 7.1% to $11.04 billion, while time deposits declined 11.8% to $6.30 billion.
- Cash flow: Six-month operating cash flow was $25.8 million, investing cash flow was $1.35 billion, and financing cash flow was $(374.5) million. The financing outflow included $150.0 million of common-stock repurchases and $32.6 million of dividends.
- Capital and debt: Stockholders’ equity was $2.29 billion. East West Bancorp reported a 9.7% Tier 1 leverage ratio, 15.7% Tier 1 risk-based capital ratio and 17.3% total risk-based capital ratio. Long-term debt was $212.2 million; FHLB advances were $362.9 million and repurchase agreements were $995.0 million.
Material changes versus comparable periods
- Credit trends improved: Q2 provision expense declined 42% year over year and Q2 net charge-offs declined to $11.7 million from $31.6 million. Non-covered nonaccrual loans decreased to $112.4 million from $145.6 million at year-end 2011, and non-covered nonperforming assets declined to $155.7 million from $175.0 million.
- The allowance for non-covered loan losses was $219.5 million, or 2.03% of non-covered loans, versus $209.9 million, or 2.04%, at year-end 2011.
- Noninterest income deteriorated in Q2 because of a $40.3 million reduction in the FDIC indemnification asset and related receivable, compared with an $18.8 million reduction in Q2 2011. This more than offset fee and loan-sale income.
- Noninterest expense declined 14% in Q2, primarily because of lower OREO expense, deposit insurance costs, legal expense and FHLB prepayment penalties. Compensation expense increased 5% in Q2 and 13% year to date, largely due to higher restricted-stock awards.
- The company sold securities to reduce exposure to certain corporate-debt industries. Corporate debt securities declined by $663.6 million during Q2, and total available-for-sale securities declined by $1.20 billion from year-end.
- During the first half, the company repurchased 6.8 million common shares for $149.9 million under a $200 million authorization. Approximately $28.8 million of additional repurchases occurred after June 30.
- The company modified $300 million of fixed-rate FHLB advances into adjustable-rate advances, reducing the effective rate from 2.27% to 1.36%, but incurred a $37.7 million deferred modification cost.
Outlook, commentary, risks and unusual items
- Management cited continued credit-quality improvement, growth in commercial and trade-finance lending, lower-cost core-deposit growth and strong capital as favorable trends. The filing does not provide formal earnings or revenue guidance.
- FDIC shared-loss agreements cover significant acquired loan and OREO exposures, generally reimbursing 80% of eligible losses. Covered loans were $3.42 billion net, and the FDIC indemnification asset was $409.3 million at June 30, 2012. The estimated potential liability to the FDIC under loss-sharing provisions was $17.7 million.
- California real estate exposure remains material: approximately 91% of non-covered residential and commercial real estate loans were secured by California properties. Further deterioration could increase charge-offs, provisions and capital requirements.
- Covered-loan income includes accretion from acquisition discounts. The covered-loan accretable yield declined to $620.5 million from $785.2 million at year-end 2011, creating potential future variability in interest income.
- The investment portfolio had $57.7 million of gross unrealized losses at June 30, including $47.4 million on investment-grade corporate debt and $9.8 million on non-investment-grade securities. The company recorded $99 thousand of credit-related impairment through earnings and $5.1 million of noncredit impairment through other comprehensive income during the first half.
- Interest-rate sensitivity modeling indicated that a 200-basis-point decline could reduce projected net interest income by 1.2% and net portfolio value by 13.3%; a 200-basis-point increase could increase them by 6.6% and 4.0%, respectively.
- Off-balance-sheet exposures included $2.32 billion of undisbursed loan commitments, $1.90 billion of standby letters of credit and $78.6 million of commercial letters of credit. Loans sold or securitized with recourse totaled $527.0 million, supported by a $5.6 million reserve.
- The filing reports no material legal proceedings and no material changes to the risk factors disclosed in the 2011 Form 10-K. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Investor verification checklist
- Verify the sustainability of earnings given the significant contribution from FDIC-covered loan accretion and the recurring reductions in the FDIC indemnification asset.
- Monitor California commercial and residential real estate concentrations, nonaccrual loans, OREO additions and the adequacy of the $226.6 million total allowance for loan losses.
- Assess the effect of continued investment-security sales and unrealized corporate-debt losses on liquidity, accumulated other comprehensive income and future net interest income.
- Review deposit mix trends, particularly whether core-deposit growth can continue to offset the runoff of time deposits and reduce funding costs.
- Evaluate the capital impact of stock repurchases, preferred dividends, Basel III implementation and the scheduled phase-out of trust-preferred securities from regulatory capital.
- Track obligations under FDIC shared-loss agreements, including the estimated $17.7 million potential payment and the timing of reimbursement receipts.
- Confirm subsequent-period effects of the July 2012 dividends and post-quarter-end share repurchases.