East West Bancorp, Inc. (NASDAQ:EWBC) Q2 2023 Earnings Call Transcript

East West Bancorp, Inc. (NASDAQ:EWBC) Q2 2023 Earnings Call Transcript July 20, 2023

East West Bancorp, Inc. misses on earnings expectations. Reported EPS is $2.2 EPS, expectations were $2.22.

Operator: Good morning, and welcome to the East West Bancorp Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Diana Trinh, Vice President and Investor Relations Officer. Please go ahead.

Diana Trinh: Thank you, Anthony. Good morning, and thank you, everyone, for joining us to review the financial results of East West Bancorp’s second quarter 2023. Joining me are Dominic Ng, Chairman and Chief Executive Officer; and Irene Oh, Chief Financial Officer. This call is being recorded and will be available for replay on our Investor Relations website. The slide deck referenced on this call is available on our Investor Relations site. Management may make projections or other forward-looking statements which may differ materially from the actual results due to a number of risks and uncertainties, and management may discuss non-GAAP financial measures. For a more detailed description of the risk factors and a reconciliation of GAAP to non-GAAP financial measures, please refer to our filings with the Securities and Exchange Commission, including the Form 8-K filed today. I will now turn the call over to Dominic.

Dominic Ng: Thank you, Diana. Good morning, and thank you, everyone, for joining us for our earnings call. I will begin the review of our financial results with Slide 3 of our presentation. This morning, we reported solid results, revenue, pretax pre-provision profitability, efficiency and earnings all improved from a year ago. Second quarter 2023 net income of $312 million and diluted earnings per share of $2.20 were both up 21% and from the prior year period. For the second quarter, both deposits and loans grew 7% linked quarter annualized to $55.7 billion for deposits and $49.8 billion for loans. The hallmark for East West has been our consistent financial performance throughout various interest rate and market cycles, while maintaining high capital ratios.

Our profitability and return levels continue to be industry-leading. For the second quarter, we returned 1.5% on average assets, 21% on average tangible common equity. Net interest margin of 3.55% although down from the first quarter was a healthy margin in the current environment and asset quality continued to be outstanding with net charge-offs of 6 basis points annualized. Slide 4 presents a summary of our balance sheet. As of June 30 2023, total loans reached impacted $49.8 billion an increase of $906 million or 7% annualized from March 31. Second quarter average loan growth was 6% annualized from the first quarter. Growth in average residential mortgage and commercial real estate loans was partially offset by a decrease in average commercial and industrial loans.

Total deposits were $55.7 billion as of June 30, 2023, an increase of $921 million or 7% annualized from March 31. The Second quarter average deposits were up from the year ago quarter but down $669 million or 5% annualized from the first quarter. During the second quarter, growth in average interest-bearing checking and time deposits were offset by decline in other deposit categories, which reflect customers seeking higher yields in a rising interest rate environment. Our deposit book is well diversified by deposit type and 30% of total deposits were noninterest-bearing demand deposit as of June 30, and our loan-to-deposit ratio was 90%. Turning to Slide 5. As shown on this slide, all of our capital ratios expanded quarter-over-quarter due to the strength of our earnings.

East West capital ratios continued to be among the highest for regional banks. Also on this slide, our pro forma capital calculation as of June 30. The key takeaway is that our capital is very strong. The pro forma capital ratios adjusting for investment security marks and the allowance of loan losses not already included show very solid capital ratios. Including these items, tangible common equity improved to 9.37% as of June 30. Quarter-over-quarter, our tangible book value per share increased 3%. East West’s Board of Directors have declared third quarter 2023 dividends for the Company’s common stock. The quarterly common dividend of $0.48 per share will be payable on August 15, 2023 to stockholders of record on August 1, 2023. Moving on to a discussion of our loan portfolio, beginning with Slide 6.

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As of June 30, 2023, C&I loans outstanding were $16.7 billion, up by $28 million or 1% annualized from the prior quarter end and up 2% year-over-year. As shown on this slide, our C&I portfolio continues to be well diversified by industry and sector. Greater China loans decreased 11% linked quarter annualized to $2.1 billion as of June 30. Slide 7 and 8 show the details of our commercial real estate portfolio, which is well diversified by geography and property type. Further, we have a seasoned customer base and a low LTV CRE portfolio. The average loan-to-value for our commercial real estate portfolio is 61%. Also, we typically originate amortized loans with a final maturity of 7 to 10 years. As of June 30, only 3% of the income-producing CRE portfolio matures in the second half of 2023 and another 7% only matures in 2024.

Total commercial real estate loans grew $19.9 billion as of June 30, 2023, up 10% annualized from March 31 and up 7.5% year-over-year. Credit quality for our loan portfolio remains very strong. Criticized CRE loans to total CRE loans decreased from 2.4% as of March 31 to 1.8% as of June 30 due to upgrades for loans with improved cash flows and loan payoffs. We remain vigilant and proactive in managing our credit risk. Given the attention on CRE, we have provided more details about our office and retail commercial real estate loans on Slide 9 and 10. As you can see on Slide 9, our office commercial real estate portfolio is very granular, with few large lots. We have only six loans that are greater than 30 million in size, which is only 11% of our office CRE loans.

The weighted average loan-to-value of our office CRE portfolio is in low 52% and the loan-to-value is consistently low across the different loan size segments. The portfolio is well diversified by geography with limited exposure to the downtowns of central business districts in the office markets we primarily lend in. On Slide 10, you can see that our retail commercial real estate portfolio is also very granular with few large loans. We have only eight loans that are greater than 30 million size, which is only 7% of our retail CRE loans. The weighted average loan-to-value of our retail CRE portfolio is a low 48% and the loan-to-value is also consistently low across different long-sized segments. The portfolio is well diversified by geography and the footprint largely reflects our branch network.

In Slide 11, we provide details regarding our residential mortgage portfolio, which consists of single-family mortgages and home equity lines of credit. Our residential mortgage loans are primarily originated through our branch network. I would like to highlight that 81% of our HELOC commitments were in first lien positions as of June 30, 2023. Residential mortgage loans totaled $14.2 billion as of June 30, up 12% linked quarter annualized at up 13% and year-over-year. Slide 12 breaks out our deposit mix by segment and further by industry for commercial deposits. Our deposits totaled $55.7 billion as of June 30, 2023, an increase of 7% linked quarter annualized and 2% year-over-year. We have over 570,000 deposit accounts at East West as of June 30, and our average commercial deposit account size is approximately 366,000.

Our retail branch-based consumer deposits totaled 32% of our deposits and have an average size of approximately $38,000. Our commercial deposits are well diversified by industry. We do not have significant depositors, all sectors of concentration. I will now turn the call over to Irene for a more detailed discussion of our asset quality and income statement. Irene?

Irene Oh: Thank you, Dominic, and good morning to all on the call. Turning to Slide 13. The asset quality of our portfolio remains strong. During the second quarter, we recorded net charge-offs of $7.5 million or 6 basis points, a modest increase from net charge-offs of 1 basis point in the first quarter. The increase primarily came from higher C&I gross charge-offs, partially offset by higher recoveries. Quarter-over-quarter, criticized improved 11%, and the criticized loans ratio improved 24 basis points. Nonperforming assets as of June 30 increased modestly to 17 basis points of total assets from 14 basis points as of March 31, reflecting loan growth, our stable asset quality metrics. In the current macroeconomic outlook, we recorded a provision for credit losses of $26 million in the second quarter compared with $20 million for the first quarter, increasing the allowance for loan losses to $128 million.

And now starting the discussion of our income statement on Slide 14. On this slide, we detailed out specifics on the tax weighted investments as the amortization and effective tax rate to fluctuate quarter-over-quarter, reflecting the timing of when tax price investments closed. We currently anticipate that for the third quarter the amortization of tax for investments will be approximately $40 million. And for the full year of 2023, the effective tax rate will be approximately 20%. Turning to Slide 15. Second quarter 2023 net interest income was $567 million, a decrease of 5.5% from the first quarter. Net interest margin of 3.55% compassed by 41 basis points quarter-over-quarter. As you can see from the waterfall chart on this slide, this was largely due to the impact of higher interest-bearing deposit costs and the deposit mix shift, partially offset by expanding asset yields.

Turning to Slide 16. The second quarter average loan yield was 6.33% an increase of 19 basis points quarter-over-quarter. As of June 30, 2023, the spot coupon rate of our loans was 6.45% compared with 6.21% as of March 31. On this slide, we also present the coupon spot yields for each major loan portfolio for the last five quarters. In total, 61% of our loan portfolio was variable rate as of due including 27% linked to prime rate and 28% linked to SOFR. Over the last several years, while rates were low, we continue to help many of our CRE and C&I customers to a lesser extent, hedge against rising rates through the use of swaps, pass and collars, fixed rate and synthetically fixed rate loans or 65% of the total CRE book as of June 30. These clients are protected against the rising debt service costs and a higher rate environment.

Turning to Slide 17. Our average cost of deposits for the second quarter was 212 basis points, up 52 basis points from the first quarter. Our spot rate on total deposits was 228 basis points as of June 30, equivalent to a 44% cumulative beta relative to the 500 basis point increase in the target Fed funds rate since December 31, 2021. In comparison, the cumulative beta on our loans has been 60% over the same time period. Moving on to fee income on Slide 18. Total noninterest income in the second quarter was $79 million. Fee income was $69 million, reflecting growth across all fee income categories during the quarter. For the second quarter, other investment income of $4 million was up $2 million from the first quarter largely reflecting higher income from Community Reinvestment Act investments.

Moving to Slide 19. Second quarter noninterest expense was $262 million, excluding the amortization of tax credits and C&I, adjusted noninterest expense was $205 million in the second quarter, up a modest 1% sequentially. The second quarter compensation and employee benefits expense was lower by $5 million due to a higher seasonal cost in the first quarter. The second quarter adjusted efficiency ratio was 31.8% compared with 13.5% in the first quarter. Our adjusted pretax pre-provision income was $440 million in the second quarter and our pretax pre-provision ROA was an industry-leading 2.61%. And with that, I will now review our updated outlook for the full year of 2023 on Slide 20. For the full year 2023 compared to our full year 2020 results, we expect year-over-year loan growth in the range of 5% to 7%, unchanged from the prior outlook.

Year-over-year, net interest income growth in the range of 12% to 15%. Underpinning our net interest income assumptions is the for interest rate curve as of June 30, which assumes one Fed funds rate hike of 25 basis points in October with a year-end Fed funds target rate of 5.50%. Adjusted noninterest expense growth in the range of 9% to 11% and we expect our revenue and expense outlook to result in positive operating leverage year-over-year. In terms of credit, for the full year 2023, we currently expect to report a provision for credit losses in the range of $110 million to $130 million. Provisions for credit losses for 2023 will be largely driven by loan growth and changes in the macroeconomic outlook. Today, asset quality is excellent, and we believe the potential losses from any problem loans are limited and very manageable.

Finally, we expect that our effective tax rate for the full year will be approximately 20% and based on approximately $150 million of tax rate investments, excluding light investment and an estimated related tax credit amortization of $145 million for the full year. With that, I will now turn the call back to Dominic for closing remarks.

Dominic Ng: Thank you, Irene. In closing, we are pleased with our consistent financial performance and strong core earnings, although net interest Income decreased given the deposit competition. Our revenue and pretax pre-provision profitability remains very strong. The East West business model is resilient and diversified and our balance sheet is healthy. We operate with high capital levels, and we are well positioned to deliver earnings growth and strong profitability. I would now open the call to questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question will come from Ebrahim Poonawala with Bank of America. You may now go ahead.

Ebrahim Poonawala: First question, Irene, for you on NII. So, it was a decent step down in the second quarter. If I have it right, your guidance implies that NII stabilizes about 5.65% per quarter in the back half of the year. One, give us your assumptions around terminal deposit betas, NIB mix underpinning the NII guide? And what leads NII to being at the lower end of your guide at 12% versus 15%?

Irene Oh: Yes. Great question. First of all, when we look at where we stand today, what’s positive, although the — with the deposit competition, the cost of deposits did increase in the second quarter. What’s positive is we keep growing, right? We’re bringing on new customer deposits. And through that, we have the opportunity to lay off some of these higher-cost broker deposits that we have — we placed on the balance sheet after the mid-March disruption. And I’ll just share since June 30, and we’ve laid off about a little over $600 million at 5.15% have replaced that with lower cost customer deposits. So, the momentum is here, and that is one of the underpinning drivers for why we think NII will stabilize. Of course, the expectation is that the Fed will increase rates next week.

That will help a little bit on the yield side as well. And the min/max around the guidance, I do think a lot of that is going to be — how successful we are, as I mentioned, were positive and the momentum is there on the deposit side, but how successful we are in growing those customer deposits over the course of the year. And then, of course, also a little bit as far as the range of where we’ll be on the loan growth.

Ebrahim Poonawala: And where do you expect the NIB balances to stabilize, Irene?

Irene Oh: Yes. So right now, my expectation is from the level that we were at June 30, it will decrease a little bit. I’ll share that also quarter date has been positive, and we’re 31% as of yesterday. And DDA, I’m sorry. Yes.

Dominic Ng: So just to clarify. So as of June 30, DDA was 30%. M&S of two days ago, it’s now 31%. And just another perspective is that the spot rate for deposits as of June 30, 2.28%, and then as two days ago, 2.27%. So, we actually are maintaining the deposit rate pretty steady. Quite frankly, if you look at even — well, if we reflect back even in May and June, the deposit rate relatively was very stable around close to 2.28%. And the fact is it was just the Silicon Valley Bank and situation in March, which caused a spike in April. And to a certain extent, we kind of — we try and do it on our own tool because we wanted to be extraordinarily cautious and prudent, and we did not need that much deposit to come in. We have very good loan-to-deposit ratio could have just less some of the deposit outflow and not worrying about showing up deposit, but we did.

We actually brought in broker deposits and so forth. So once we saw it stabilized after April, so we now decided that we can just ease it off because the momentum of new customer deposits, existing customer deposits and whatnot, all together give us some confidence that things are stabilizing, and we can move forward. And by replacing the high-cost institutional money to retail and commercial clients deposit. And we think that with that, we should be able to in a much more stabilized situation going forward.