Q3 2022 East West Bancorp Inc Earnings Call
Good day and welcome to the East West Bancorp third quarter 2022 earnings call.
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I would now like to turn the conference over to Julianna <unk> director of Investor Relations. Please go ahead.
Thank you Betsy good morning, and thank you everyone for joining east West Bancorp's third quarter 2022 earnings call with our.
Our chairman and Chief Executive Officer, and Irene Oh, our Chief Financial Officer. This call is being recorded and will be available for replay on our Investor Relations website.
During their remarks, Dominic and Irene will reference the slide deck that 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 <unk>.
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.
Thank you Julianna.
Good morning, and thank you everyone for joining us for our earnings call.
I will begin the review of our financial results with slide three of our presentation.
This morning, we reported net income of 295 million and earnings per share of $2 <unk> for the third quarter 2022.
Earnings per share grew.
58% annualized for the second quarter of 2022.
Total revenue of $627 million crude.
55% linked quarter annualized and included record.
Net interest income of $552 million.
Strong revenue growth and improve efficiency drove third quarter 2022.
Adjusted pre tax.
Pre provision income growth of 66% linked quarter annualized.
Asset quality continued to be healthy.
With very low charge offs.
Our bottom line returns are industry, leading.
We returned one 9% on average assets.
20% on average equity.
And 22% on average tangible equity.
This quarter.
Quarter over quarter or our profitability ratios expand.
And importantly.
All our capital ratios grew.
With our impressive operating margins and strong capital.
We are well positioned for continued success.
And to appropriately navigate a range of possible outcomes.
In an environment of elevated uncertainty.
Slide four presents a summary of balance sheet.
As of September 32022.
Total loans reached a record $47 5 billion and.
An increase of $926 million or 2% from June 30.
As anticipated loan growth slowed in the third quarter.
Year to date loans are up 15%.
Excluding the forgiveness of P. P. P loans and we continue to expect the full year loan growth will be in the range of 16% to 18%.
Our loan portfolio is well balanced between commercial real estate.
Commercial and industrial.
And residential mortgage.
This diversification is a sound demento strength that provides both stability.
And optionality to generate prudent growth.
Economic cycles change.
Total deposits were $53 9 billion as of September 32022, a decrease of $486 million or 1% from June 30.
Third quarter average deposit was $54 1 billion essentially unchanged from the second quarter.
Deposit book is well diversified by deposit type.
And 40% of total deposits were noninterest bearing demand accounts as of September 30.
Turning to slide five we have a resilient balance sheet with strong capital and high liquidity.
As you can see in the exhibit on this slide.
Our capital ratios expanded quarter over quarter.
As of September 32022.
We had a common equity tier one ratio of 12, 3%.
Our total capital ratio of 13, 6%.
And a tangible common equity ratio of 8.38.
835%.
East West Board of Directors has declared fourth quarter 2022 dividends for the company's common stock.
The quarterly common stock dividend of <unk> 40 cents is payable on November 15, 2022 to.
<unk> to stockholders of record.
On November one 2022.
We did not execute any buybacks in the third quarter.
Moving on to a discussion of our loan portfolio beginning with slide six.
As of September 32022, C N life CNI loans outstanding was $15 6 billion sequentially up 2%.
And total C&I commitments with $22 2 billion sequentially up 1%.
C&I loan utilization rate was unchanged quarter over quarter at 70%.
Our C&I portfolio is well diversified by industry and sector.
Slides seven and eight show the details of our commercial real estate portfolio.
Which is well diversified by geography, and property type and consists of low loan to value loans.
Total commercial real estate loans were $18 7 billion as of September 32022 up 1% from June 30.
In slide nine we provide details regarding our residential mortgage portfolio.
Which consist of single family mortgages and home equity lines of credit and it's primarily originated through east West Bank branches.
I will highlight that 83% of our home equity lines of credit in a first lien position.
As a national mortgage loans totaled 13 billion as of September 32022.
<unk>, 4% from June 30.
I will now turn the call over to Irene for a more detailed discussion of our asset quality and income statement.
Thank you Dominic I'll start with our asset quality metrics in components of our allowance for loan losses on slides 10, and 11, the asset quality of our portfolio continues to be strong.
Quarter over quarter criticized loans decreased 11% and the criticized loan ratio of 29 basis points special mention loans decreased 20% largely from upgrades of CRE loans largely hotel loan.
Due to improvements in financial performance and liquidity classified loans were essentially unchanged as of September 30th nonperforming assets were 97 million or 16 basis points of assets.
During the third quarter, we booked net charge offs of 7 million or a low six basis points of average loans annualized compared with net recoveries of six basis points annualized in the second quarter, our allowance totaled 583 million as of September 30th or one 3% of loans compared with one.
Two 1% of loans as of June 30th during the third quarter, we recorded a provision for credit losses of 27 million compared to 13 5 million from the second quarter.
Quarter over quarter, Belden reserve and allowance coverage largely reflects the current macro economic outlook, which is weaker than a quarter ago as well as third quarter alone.
While credit quality remains strong and the current credit environment is benign.
Watchful there is challenges affecting the economy and our customers taking proactive actions, we have warranted, including conservatively building our allowance.
And now moving to a discussion of our income statement on slide 12. This slide summarizes the key line items of the income statement, which I'll discuss in more detail on the following slides of note amortization of tax credit and other investments in the third quarter was $20 million compared with 15 million in the second quarter.
This is lower than what we had previously anticipated because of timing of certain tax credit projects are delayed the recognition of the associated amortization expense will be in the fourth quarter. Accordingly, we currently expect the amortization of tax credit and other investments.
Ben to be approximately $30 million in the fourth quarter.
Third quarter 2020 to income tax expense was 89 million compared with income tax expense of 83 million for the second quarter of 2022 year to date, the effective tax rate for the first nine months of 2022 was 23%. We currently expect.
Expect that the full year effective tax rate will be approximately 22%, including the impact of tax credit investments expected in the fourth quarter.
I'll now review the key drivers of our net interest income and net interest margin on slides 13 through 16, starting with the average balance sheet third quarter average loans of $46 9 billion grew $2 2 billion or 20% annualized with strong growth across all loan categories drove a favorable mix shift.
Average, earning assets quarter over quarter in the third quarter average loans made up.
79% of average, earning assets compared with 76% in the prior quarter.
Third quarter average deposits at $54 1 billion declined only 78 million quarter over quarter remaining essentially flat growth in interest bearing deposits nearly offset the decrease in demand deposits at some customers shifted excess balances to higher yielding options, reflecting market dynamics in a rising interest rate.
Environment.
Average noninterest bearing deposits held up and made up 41% of total deposits in the third quarter.
Turning to slide 14 third quarter 2022, net interest income of 552 million was the highest quarterly net interest income in the history of east West growing 66% linked quarter annualized the net interest margin of 368 expanded by 45 basis points Cordova.
Water.
You can see from the waterfall chart on this slide net interest margin expansion in the third quarter reflected the impact of higher loan and earning asset yields which increased the NIM by 71 basis points.
Plus a favorable earning asset mix shift, which expanded the NIM by seven basis points. This was partially offset by a 33 basis points of compression on the funding side.
Turning to slide 15, the second quarter average loan yield was 475, an increase of 80 basis points quarter over quarter. The average loan yield comprised an average coupon yield of 465, plus yield adjustments, which can be contributed 10 basis points to the overall loan yield.
In the third quarter as of September 30th the spot coupon rate on our loans was 510 in this slide we also present the coupons spot yields for each major loan portfolio through last four quarter and period, you can see the positive impact of rising interest rates on each loan portfolio as loans are repricing.
In total 62% of our loan portfolio is variable rate, including 30% linked to prime rate and 27% linked to LIBOR or sofa rates most of the loans repriced at least monthly.
I would also highlight that 43% of our variable rate CRE loans have customer level interest rate derivative contracts in place.
We all help our customers enter into low level interest rate derivatives, helping to protect them against rising debt service costs at the same time the loans remain variable rate on our balance sheet and the big benefits from the asset sensitivity. Additionally, 2 billion of the 86% of variable rates.
In Ireland also have derivative contracts in place.
Turning to slide 16, our average cost of deposits for the third quarter was 51 basis points up 34 basis points from the second quarter, our spot rate on total deposits was 74 basis points as of September 30th 2022, a year to date increase of 65 basis points. This time.
<unk> blades to a 22% cumulative beta relative to the 300 basis point increase in the target fed funds rate over the same period in comparison, the cumulative beta on our loans has been 55% as our loan coupons spot rates increased to 166 basis points year to date.
When we started the rising interest rate cycle from a position of strength with historically high levels of demand deposits for east West Bank and strong liquidity. This is bolstered the asset sensitivity benefits of our variable rate loan and securities portfolios supporting strong revenue growth through the cycle as rates continue to rise.
We're pleased with the lag in deposit betas cycle. Today. This has come through careful deposit cost management as rates continue to rise.
We believe our approach will continue to support an expanding net interest margin and robust net interest income growth in the coming new year with 41% of our average deposits are noninterest bearing accounts and with the growth that we've had in treasury management products and annualized accounts since before the.
Pandemic, we felt comfortable about continuing to navigate the cycle well.
Moving on to fee income on slide 17, total noninterest income in the third quarter was $76 million down from $78 million in the second quarter customer driven fee income and net gains on sales of loans were 69 million up 7% or 26% annualized from the second quarter.
And up 10% year over year, we saw growth across most of the fee income lines of business this quarter.
Moving to slide 18 third quarter noninterest expense was $216 million, excluding amortization of tax credits and other investments and core deposit intangible amortization adjusted noninterest expense was 196 million in the third quarter up 14 million or 8% sequentially.
<unk> driven by higher compensation and employee benefits expense.
In comparison, our success sequential total revenue growth was 14% exceed.
Exceeding expense growth and generating positive operating leverage quarter over quarter, our efficiency improved third quarter adjusted efficiency ratio was 31% compared with 33% in the second quarter, our adjusted pretax pre provision income grew 17% sequentially or 66.
Percent annualized and our pretax pre provision ROA was an attractive 2.7% in the third quarter and with that I'll now review our updated outlook for the full year of 2022 on slide 19.
For the full year 2022 compared to our full year 2021 result, we currently expect year over year loan growth, excluding PPP, approximately 16% to 18% unchanged from our prior outlook year over year net interest income growth, excluding PPP approximately 35.
This narrows down to the upper end of our prior outlook, which was for net interest income growth ranging from 30% to 35% underpinning. Our interest income assumptions is a forward interest rate curve as of September 30th 2022, with fed funds expected to reach 450 by year end.
Adjusted noninterest expense growth.
<unk> tax credit investment amortization of approximately 11% year over year, which is a slight increase from our previous outlook with our strong revenue growth, we expect positive operating leverage and modestly improving efficiency next quarter for the full year of 2022, we now expect that the provision for credit loss.
<unk> will be approximately $80 million. This is up from our previous outlook and largely with Fox the changed macroeconomic backdrop compared with a quarter ago.
We currently expect that the full year of 2022 effective tax rate will be approximately 22%.
Slightly higher than our previous outlook, which was for an effective tax rate of 21%. The change in our outlook reflects higher pre tax income and a lower amount of tax credit investments as compared with our previous forecast. We currently expect that the fourth quarter tax credit investment amortization expense will be approximately 30.
Yes.
With that I'll now turn the call back over to Dominic for closing remarks, Thank you Irene.
In closing we are looking forward to finishing 2022 on a high note.
Strong operating margins and capital give us the confidence that we would navigate emerging and changing economic cycle well.
I wish to thank all of our dedicated bankers for their excellent work, which is reflected in our strong financial performance.
I will now open up the call to questions operator.
Yeah.
We will now begin the question and answer session.
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In the interest of time, please limit yourself to one question and one follow up.
At this time, we will pause momentarily to assemble our roster.
Okay.
Okay.
The first question today comes from Ebrahim <unk> with Bank of America. Please go ahead.
Good morning.
Good morning.
Maybe first question just around deposits, obviously, a lot of focus in terms of client behavior.
Given the rising rate.
The loan to deposit ratio crept up 88%, one maybe just talk about how high you think that loan to deposit ratio going before you start being more active in terms of managing deposit and second how does this translate into where you think the margin peaks and for east West would that also mark a little bit of a.
Beacon NII or do you expect and I go to continue until you do.
Driven by loan growth.
Yeah.
All of that there are a lot of question her Abraham I don't know if I remember them, all but I'll try to get to throw out I'm, sorry, I hit the early flow data. Okay. So if we look at I'm going to start with I think at the end of your question, which is probably the more important one given where things are at right. Now we do expect the margin will continue to grow.
From here, we expect it to grow in the fourth quarter and when we look year over year. We also expect the margin and net interest income to increase in 2023, we won't go into guidance and specifics around that but I just wanted to make sure that that was very clear right. Even though the we do expect that deposit betas will incur.
Kris and have continued to increase you saw that a little in the third quarter are resolved.
With that sad from our loan book and our Securities book, the increase that we're seeing and the pickup we're seeing they're far outpaces that.
I think on the question about the deposit and a loan to deposit ratio. We ended the quarter at 88% in little under that from an average perspective 87 herself. We do feel comfortable increasing from this point in time I don't think that we have said that publicly in the past and that still is our position right now.
Our core funding is very strong and I think go into kind of the low ninety's is something that we're comfortable with.
Got it and I guess, just a separate question you talked about the <unk>.
Hedging that your customers are done but talk to us.
Heading into a recession, where you see the biggest drivers of creditors for east West loan book.
Yeah, I think at this point in time, so the hedging I think honestly for us it's been a balance sheet management strategy. In this period of time until this year when rates were so low, but certainly we wanted to share that that it certainly protects our customers in this period.
At a time because the debt services easier for CRE for multifamily also for CNI loans are on the credit side you know at this point in time credit, it's still very benign Oh, we certainly if you look at kind of the results that we have in the third quarter criticized loans are down now.
Charge offs are still very benign you know as we look through the portfolio. It's I wouldn't say, there's an area that we're really concerned with from a credit perspective, but we'll continue to monitor and continue to evaluate our portfolio.
I think from a.
Macroeconomic perspective.
That's why we have increased our provision simply because with this kind of a spike in interest rate one would expect that the economy will slow down and so therefore, we are anticipating maybe things are going to slow down and however.
However, we just haven't seen much in terms of more quiet quality issue at this point everything seem to look pretty good as you see that our criticized asset actually come down and then so forth.
Okay.
The next question comes from Chris Mcgratty with Kate BW. Please go ahead.
Hey, good morning.
I really want to circle back to the NII question, just I think that's part of the reason your stocks weak this morning.
The NII guide the implied guide for Q4.
Can you just put a little bit more of a clarity around it because the one 5 billion that you cite as a starting point.
Your actual numbers, a little bit lower than that excluding PPP I just wanted to get a little bit of a.
A fine tune on the fourth quarter.
Well I think when we look at the fourth quarter, maybe I'll just share a little bit more specifics right.
With the.
Based on the forward curve at 930 a M.
If you can kind of break it down and maybe this will help you Chris and kind of the analysis, Yeah, we expect loan yields to continue to increase right.
Maybe not the same pace of the increase that we saw in the fourth.
But close to that on the security side based on the variable rate and the nature of the portfolio, probably another 20 to 30 basis points right in total, especially if you look at from a NIM perspective, NII now I think the timing of the increase in the cost of deposits is something where we are.
Modeling that the deposit betas will continue to increase and we've been very fortunate as we've talked about in our prepared remarks of the lab, but I think we're just realistic as rates continue to increase Sunday and chop, but overall I think the other guidance that we gave in the specifics as far as and.
NII.
NII grow at that higher end of that range, 35% is the number that we're comfortable with at this point in time.
Okay, and I guess as my follow up just I can't go back to the one five is that that's the starting point or is it like 1.4 dollars seven six sorry to get in the weeds, but there's a big difference.
And the implied trajectory I'm trying to get a sense of whether.
NII into Q1, we'll grow off of the Q4 number that we're talking about.
And this is giuliano if I can jump in with the precision level that you are looking for a guidance that has the word approximately and it is.
You start with the 147, starting point from 2021 a 35% increase on that implies an NII growth of $560 million.
The increase of 36% offer that implies NII growth of $5 $74 5 million right now we put in the word approximately because quite frankly, whether it can be 35 or 36% right now impossible for us to tell given the fact that some of the things such as deposit betas, you cannot know two months in advance.
But what we are comfortable telling you is that we are hitting at the upper end of our guidance and we're seeing higher as we're talking about because as Irene said, we expect our NII to continue to grow but in terms of the actual precision got unfortunately from where we sit I cannot provide that level of detail.
So I'll just take the word approximately and use your judgment.
Okay.
The next question comes from Gary Tenner with D. A Davidson. Please go ahead.
Yeah.
Hi, there. This is clarke on for Gary. This morning, I just had some thoughts on capital excuse me some questions I mean in terms of the buyback stock is now trading below where your where you repurchased in <unk>. How are you thinking about the buyback you're moving forwarded to cover economic headwinds and our revised economic outlook.
At this point, we have we don't anticipate to make.
Do any buyback simply because.
We are looking at that map.
<unk> economic.
Situation with deferred.
Making these unprecedented like rates spike.
I think it would be prudent for us to hold onto all.
Very very healthy capital ratio.
One of the great thing about where we are today, so when we looked at.
East West.
Credible.
Earnings power there.
Very high margin high liquidity.
Benign credit quality issue.
Very strong capital ratio.
<unk> have always done well.
Whenever economic cycle.
Go down.
That's what we actually make most about money well, we're very proud of our financial performance for the first three quarters. So far however, I think we will be even prouder is actually economy situation got worse.
Simply because we have always have a very strong balance sheet and allow us to have all the flexibility to do whatever we want.
So that's the reason why we have always been somewhat since.
In terms of not wanted to do too much buyback because having all the dry powder in place.
In a down cycle, maybe much more advantageous for us.
Okay.
Got it. Thank you and then if I could just pivot over to loan growth and your outlook, where do you where are your thoughts on the mix heading into 2023.
You had strong single family growth here this quarter.
But just in terms of CRE and.
C&I, where is that going to be going in at what are your kind of your thoughts heading into the next year.
Yeah.
Well, we obviously expect loan growth to slow down compared with $2.
'twenty to 'twenty, one simply because with that kind of rate environment.
Naturally we will expect that investors may not all.
Isn't as enterprises are not going to go in there and start making aggressive acquisition of let's say commercial real estate investment or <unk>.
Building apartments.
Barring warehouses.
A lot of those activities that were taking place in a much more.
Normal interest rate environment.
Looking at into early part of 2023, I would I would expect that those type of activities will slow down.
Massively sort of like increasing inventory is also something that I would say most likely out of the question. So with that we will expect a CNI and CRE growth.
We will most likely be coming down.
So we will provide guidance.
Yes.
What the title release, our fourth quarter earnings when it come to residential mortgages. We are also expecting somewhat of a slowdown simply that I would expect that it would not be as much refinancing.
Or even home purchases, but as of today, we still see in pipeline, both C&I and CRE and also in.
Single family mortgages, while we are seeing those numbers and the pipeline report.
Feel very positive about it.
We also are very prudent and looking at the macroeconomic situation and the interest rate environment coming forward.
We are.
Taking a more conservative outlook in terms of what it may be.
The next question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.
Hey, good morning, everybody I guess first just back on the deposits, what's your expectation for sort of a through cycle beta on deposits and does that assume that DVA stays roughly stable as a percentage of the total.
Yeah, Great question when earlier in the year I think we shared that given the expectation for where rates were and where the fed was moving that we thought our through cycle beta of.
For deposits would be about 30% as a reminder, in the last cycle, although a very different cycle I'll add our through cycle beta was 37% as we shared on the details of.
The presentation cumulatively, our cumulative beta today has been 22% quite a bit of a lag and then also but up right from where we were at 630, which was 15% at this point in time your given the pace of the rate increases.
From the fed we do expect that the through cycle deposit betas will increase from that 30% and more specifics as far as what's happening next year as Dominic mentioned, we will share next year and I'll also add that with that said, we expect the loan betas to continue to increase and there will still be.
Significant NII expansion.
Okay.
Okay. That's good color, thanks, and then.
I'm looking at the at the allowance for loan loss in the the growth this quarter.
Should we think that the ratio of allowance to loans can continue to March up if a if we don't see a significant change in our in the economy or would that really be more dependent upon.
Either you know portfolio performance or incremental deterioration from here.
Yeah, Great question I think so when we look at our models.
Largely the drivers for the models are GDP growth unemployment GPI for CRE the market dynamics in the areas, where we have CRE loan.
Also for the single family and HELOC also H P I E.
These deteriorate or change you know we are appropriately booking the reserve I think if there aren't at this point in time as we talked about earlier, there's no major weaknesses that we see but we want to just be realistic and prudent, especially with them where the calculations are for allowance.
To increase as appropriate at that macroeconomic factors decrease that was one of the reasons for the increase in the allowance of two basis points a share of the 27 million that we booked approximately $10 million was related to the new loan growth that we had in the quarter.
And if I can add Darren to your prior question.
The deposit betas that I was answering one of your questions was about the deposit mix. Let me just highlight that before the pandemic we were at 30% DDA.
At the end of 2019 today, we're at 40% DDA, we do not think we're going to go back to the pre pandemic levels. We are confident we're gonna be above seasonal downtick because of the growth in DDA has come from operating accounts Treasury management products and services linked accounts. So we have a much stronger deposit mix the last cycle.
And also I want to add that those accounts and those accounts come from a lot of.
New customers or existing.
Existing customers that used to use other banks for operating accounts, because we did not offer the services.
Because east West Bank has improved.
GTS product offerings that we were able to transition many of these <unk>.
Bank clients to move their operating accounts from other larger banks to us. So the last two years that operating accounts growth has been quite phenomenal and fact that reflect even on some of the GTS fee income growth there too.
As a reminder, if you have a question. Please press star then one to be enjoined into the question queue.
The next question comes from Brandon King with Truth Securities. Please go ahead.
Thank you good morning.
Good morning, Brandon.
Yes. So I was curious if you can give us an update on I dunno planning strategically as far as potentially locking game.
You ready sensitivity for the balance sheet and protecting against the downside of rates potentially in the future.
Brendan.
It came in it out would you mind repeating your question I'm, sorry, I didn't quite catch it.
Yes, Yes, I was curious if you can update us on your plan or thoughts on potentially locking in the asset sensitivity of the balance sheet against kind of falling rates into the future.
Oh, Okay great.
We have.
Increase kind of our balance sheet hedging strategy with our asset sensitivity as you know that you know we're trying to walk in and I think those are great words, our asset sensitivity. So I can share that.
As of 930, well actually we entered into a trade just after 930 as well so as of today, we have about $2 75 billion.
Of hedges and also colors that we have entered into to help preserve our margin and they're not NII, if and when rates fall.
And that's something that we'll continue to evaluate looking at with our Alco Committee as far as what's appropriate given the asset sensitivity and the balance sheet of the bank.
Gotcha.
And if you don't mind sharing what is the kind of the duration of those hedges collars.
They range I think four to five years.
Okay.
Okay.
Yeah.
This concludes our question and answer session I would like to turn the conference back over to Dominic <unk> for any closing remarks.
Well. Thank you all for joining us for this call and we are looking forward to.
Speaking with you.
In January .
To share with you our 2022.
Year end result.
Thank you.
Okay.
Okay.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
[music].