East West Bancorp, Inc. (NASDAQ:EWBC) Q3 2023 Earnings Call Transcript

East West Bancorp, Inc. (NASDAQ:EWBC) Q3 2023 Earnings Call Transcript October 19, 2023

East West Bancorp, Inc. beats earnings expectations. Reported EPS is $2.02, expectations were $2.01.

Operator: Good day, everyone, and welcome to the East West Bancorp’s Third 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 Adrienne Atkinson, Director of Investor Relations. Please go ahead.

Adrienne Atkinson: Thank you, operator. Good morning, and thank you, everyone, for joining us to review East West Bancorp’s third quarter 2023 financial results. With me are Dominic Ng; Chairman and Chief Executive Officer; Christopher Del Moral-Niles, our new Chief Financial Officer; and Irene Oh, Chief Risk Officer. This call is being recorded and will be available for replay on our Investor Relations website. The slide deck referenced during this call is available on our Investor Relations site. Management may make projections or other forward-looking statements, which may differ materially from actual results due to a number of risks and uncertainties. Management may discuss non-GAAP financial metrics. For a more detailed description of the risk factors and the 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, Adrienne. Good morning, and thank you everyone for joining us for our earnings call. Before we start, I would like to welcome Adrienne and Chris. I would also like to congratulate Irene on assuming the role of Chief Risk Officer and thank her for her service as CFO, and help in ensuring a smooth transition. Their leadership will be integral in advancing the Company’s growth strategy and risk capabilities. I will now begin the review of our financial results on Slide 3 of our presentation. This morning, we reported strong results. Third quarter 2023 net income was $288 million and diluted earnings per share was $2.02, driven by a record level of quarterly revenue and net interest income. Our continued customer focus and diversified growth strategy allowed East West to grow loans from the prior quarter and add significant customer deposits.

We kept expenses well controlled generated quarterly positive operating leverage and grew tangible book value. We also maintained broadly stable asset quality and continue to proactively manage our creditors. Slide 4 presents a summary of our balance sheet position that is strong, well-diversified and efficient. You can see that we grew the customer deposits by $1 billion from the prior period, with notable growth in both our consumer and commercial balances. These customer deposits largely funded this quarter’s loan growth, allowing us to use excess cash to pay down maturing wholesale deposits. We’re also pleased with the mix of our loan growth where nearly half the growth came from low-risk residential mortgages. In the third quarter, we generated industry-leading returns on our capital.

We continue to maintain strong capital ratios, which are now the highest for regional banks. East West is on track for another year of record earnings in 2023, and we are looking forward to starting 2024 from a position of strength. Given our earnings stability, solid credit performance and strong capital levels, our Board of Directors has approved the resumption of our share repurchase program in the fourth quarter. I will now turn the call over to Irene for a more detailed discussion of our portfolio and asset quality. Irene?

Irene Oh: Thank you, Dominic, and good morning to all on the call. I’ll start with a discussion of our loan portfolio. Slide 5 provides detail on our overall loan book. East West loans are largely balanced by type across residential mortgage, commercial real estate and C&I. Within C&I, our exposures are also well diversified by industry. Our greater China exposures remain limited at roughly 4% of total loans and nearly all our C&I loans, also well diversified by industry. Slide 6 shows the details of our commercial real estate portfolio. It is important to note that East West’s portfolio remains well diversified by geography and property type. When comparing our portfolio to the FFIEC commercial real estate concentration guidelines, we have consistently been below the guidelines since the end of 2009.

Slide 7 provides additional detail on commercial real estate. As you see, the portfolio is very granular with an average loan size of $3 million. The weighted average loan-to-value for the portfolio was a low 51%. Fewer than 25% of our commercial real estate loans have a loan-to-value of 60% or over. In the appendix, we have shared similar trends of low average loan sizes and LTVs within our office and retail commercial real estate portfolio. Many of our commercial real estate borrowers have had long-standing relationships with our bank and a large portion of our loans are full recourse with personal guarantees. As a reminder, we typically originate amortizing loans with a maturity of 7 to 10 years. We also have low risk from near-term maturity.

As of quarter end, only 8% of the income-producing commercial real estate portfolio matures in the fourth quarter of 2023 and for all of 2024. On Slide 8, we provide detail on our residential mortgage portfolio, which is made up largely of single-family mortgages and also home equity lines of credit. Like commercial real estate, our residential mortgage portfolio is well diversified by geography and property. The average loan-to-value for our residential mortgage portfolio is also quite low at 51% and with close to 90% of our portfolio below a 60% LTV. As you can see on the slide in our distribution behind geography, our residential mortgage loans are overwhelmingly in footprint with the primary source of origination coming through our branch network.

Residential mortgage has proven to be a resilient source of loan growth for us growing 3% from the second quarter. I would also like to highlight that over 80% of our HELOC commitments, we are in first lien position. Turning to Slide 9. The asset quality of our portfolio remains broadly stable. During the third quarter, we reported net charge-offs of $18 million or 14 basis points, an increase from net charge-offs of 6 basis points in the second quarter. Quarter-over-quarter, non-performing assets as of September 30, decreased modestly to $104 million or 15 basis points of total assets from 17 basis points as of June 30. The criticized loan ratio increased 38 basis points from June 30 to 2.01% of loans held for investment. The special mention loan ratio increased 29 basis points, quarter-over-quarter to 95% of loans held for investment as of September 30, and the classified loans ratio increased 9 basis points to 106% as credit continues to normalize.

A woman discussing her mortgage plan with a banker in the office of the bank.

The increases were driven primarily by CN as some borrowers are being impacted by higher rates and inflation. There were no industry or sector trends for this increase in criticized C&I loans and also no geographic trends to highlight and the slight uptick in commercial real estate criticized loans. We remain vigilant and proactive in monitoring and managing our credit risk. We reported a provision for credit losses of $42 million in the third quarter compared with $26 million for the second quarter building the allowance for loan losses ratio 1 basis point to $1.29. Turning to Slide 10. As shown on this slide, all of our capital ratios expanded quarter-over-quarter due to the strength of our earnings. If adjustments were made for AFS and HTM security mark and the allowance for loan losses that is not already reflected in equity, our capital ratios would still be very strong.

Tangible common equity grew to 9.03% as of September 30. Quarter-over-quarter, our tangible book value per share increased 2%. Year-over-year, tangible book value per share increased 18%. East West’s Board of Directors has declared fourth quarter 2023 dividends for the Company’s common stock. The quarterly common stock dividend of $0.48 per share will be payable on November 15, 2023, to stockholders of record on November 1, 2013. We currently have $254 million of repurchase authorization that remains available for future buybacks. Although we did not repurchase any shares during the third quarter of 2023, as announced in our earnings release, we intend to resume repurchases in the fourth quarter. I’ll now turn the call over to Chris for a more detailed discussion of the drivers of our income statement and outlook.

Chris?

Christopher Del Moral-Niles: Thank you, Irene, and good morning to all. I will start with a discussion of our deposit strength and then review the key drivers of net interest income and net interest margin. Slide 11 highlights our deposit mix by segments, customer type and source. In the third quarter, we grew both commercial and consumer deposit balances, increased the number of customer accounts and reduce higher cost wholesale deposits. Year-over-year, we have successfully grown deposits across our client sectors. Our commercial deposits remain well diversified by industry and our consumer deposits are fairly granular. Turning to the balance sheet on Slide 12. Third quarter average loans grew 2% sequentially, driven by growth in all major categories.

Third quarter average deposits of $55.2 billion increased $900 million or 2% from the second quarter. During the third quarter, growth in average money market and time deposits was offset by declines in other deposit categories, largely reflecting customers optimizing their yield in a higher interest rate environment. Our average loan-to-deposit ratio was 90% during the third quarter and average noninterest-bearing demand deposits made up 30% of average deposits for the period. Turning to the NIM on Slide 13. Third quarter 2023 net interest income was $571 million, a new third quarter record for East West. Net interest margin was 3.48%, which compressed by 7 basis points quarter-over-quarter. As you can see from the waterfall chart on this slide, NIM compression was largely due to the impact of higher interest-bearing deposit costs and the deposit mix shift to higher-cost customer deposit categories, partially offset by the lower wholesale deposits and higher loan bodies.

Turning to Slide 14. The third quarter average loan yield increased by 18 basis points quarter-over-quarter, and the spot coupon rate on our loans was 6.62% at quarter end compared with 6.45% at June 30. In total, nearly 60% of our loan portfolio was variable rate at September 30 with a fairly balanced split between prime rate and SOFR-linked loans. Over the last several years, while rates were low, we continue to help many of our CRE and also some C&I customers hedge against rising rate risk through the use of swaps, caps and collars. As a result, on the customer side, nearly 2/3 of the total CRE book was fixed rate to them at September 30. These clients are partially protected against the rising debt service costs and the payment shocks from the higher rate environment over the near term.

Turning to Slide 15. Our average cost of deposits for the third quarter was 243 basis points, up 31 basis points from the second quarter. Our spot rate on total deposits was 248 basis points as of September 30, reflecting a 46% cumulative beta relative to the change in Fed funds since December 21. In comparison, the cumulative beta on our loans has been 61% over the same period. We were pleased with our ability to manage deposit costs during the quarter. We paid down $1.6 billion of higher cost wholesale deposits and replaced much of that with lower cost customer funds. Moving on to noninterest income on Slide 16. Total noninterest income in the quarter was $77 million. For the third quarter, interest rate contracts and other derivatives income of $11 million increased $4 million from the second quarter, primarily reflecting changes in market valuations.

Other investment income of $2 million was down a bit quarter-over-quarter, reflecting higher valuation marks on CRA investments recognized during the second quarter. Our fee income for the period was $67 million. Moving on to Slide 17. Third quarter noninterest expense was $252 million, a 4% decrease quarter-over-quarter. Excluding amortization of tax credit and CDI adjusted noninterest expense was $202 million in the third quarter, down over $3 million or down 2% sequentially. This was driven by decreases in several categories including lower consulting costs lower loan-related expense, lower comp and benefits expense and lower occupancy expense. The third quarter adjusted efficiency ratio was 31.2% compared with 31.8% in the prior quarter.

We are pleased with our ability to consistently deliver industry-leading efficiency. And with that, I’ll now review our updated outlook for the full year on Slide 18. For the full year, we are reaffirming our prior guidance for the end of period loans, net interest income, adjusted noninterest expense and credit items. Regarding tax items, we now expect our effective tax rate for the full year will be between 19% to 20% based on about $185 million of tax credit investments. We currently anticipate that for the fourth quarter, the amortization of tax credit investments will be approximately $45 million. With that, I’ll now turn the call back to Dominic for his closing remarks.

Dominic Ng: Thank you, Chris. In closing, we are looking forward to finishing 2023 on a high note. Our revenue, net interest income and profitability measures remain high. The East West business model is resilient and diversified and our balance sheet has positioned us well to continue to focus on our customers. I want to thank our associates for all their hard work last quarter, which was reflected in our strong performance. I will now open the call to questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Casey Haire with…

Casey Haire: Yes. Thanks. Good morning, everyone, and welcome back, Chris. First question for you, Chris. Just on the NII. Curious about the cash position and working down those wholesale deposits, going forward? How much more can you lean into the cash position to retire the rest of those wholesale deposits?

Christopher Del Moral-Niles: Sure. As Irene mentioned on the last call, it was our intention to pay down up to $1.75 billion by year-end and we’ve obviously talked a lot of that wood here in the third quarter with $1.6 billion paid off. So, there’s a little bit that we had planned that’s maturing, that we’re going to take care of as we go forward. And then we will continue to evaluate the optimal level of cash as we move into next year’s planning.

Casey Haire: Got it. Okay. And just as my follow-up on the buyback resumption, just curious how aggressive you might be with that? I know you have the $250 million authorization, but are you looking to a specific CET1 ratio or payout ratio? Just trying to get a sense of how aggressive you might be on the buyback with the stock at obviously at attractive evaluation?

Dominic Ng: I don’t know. I would use the word aggressive. I think we’re always opportunistic. We have $254 million left to go, that’s already been authorized. And so I think, obviously, price pretty good, and so we will proceed. And so I will leave it at that.

Operator: Our next question comes from Brandon King with Truist Securities. Please go ahead.

Brandon King: So, I wanted to give more context in regards to net interest margin trends, potentially being in the higher for longer rate environment. When do you think we could see some stabilization or potential bottoming?

Christopher Del Moral-Niles: Well, I think we expect generally continued modest compression given the current rate outlook and given our expectations that there’s potentially another Fed action towards year-end. In the medium term, of course, we’re managing more towards dollar NII, and in the long term, obviously, our largest risk is actually to rapidly declining rates. So, we’re taking proactive measures to make sure we’re positioned for the long term.

Brandon King: Okay. And doing that next year is going to be more challenging from a revenue standpoint. What are you thinking about in terms of managing or maintaining positive operating leverage with regard to expense base?

Christopher Del Moral-Niles: I think it’s a little early for us to give you 2024 guidance. We typically do that in January call, and we’ll be happy to follow up then.

Operator: Our next question comes from Broderick Preston with UBS. Please go ahead.

Broderick Preston: Using my full name, I like it. I wanted to ask maybe a more pointed question on the buyback, Dominick. So you got $254 million of authorization. Capital is obviously robust. The stock is cheap and well below where you bought it back in the past. And you had $220 million left over after paying the dividend out of net income in 3Q alone. So would you consider using the full amount in the fourth quarter?

Dominic Ng: Well, as I said earlier, we are opportunistic. And so we don’t really have any specific sort of like direction that we have to be doing it in one quarter or not. And we’ll see how — what the price is and how things go. And one thing you can be rest assured, East West Banks always shareholders-friendly. And we always do the right thing at the right time. And whatever that makes sense that we’ll go according to what we think is the best.