East West Bancorp, Inc. (NASDAQ:EWBC) Q4 2022 Earnings Call Transcript

East West Bancorp, Inc. (NASDAQ:EWBC) Q4 2022 Earnings Call Transcript January 26, 2023

East West Bancorp, Inc. beats earnings expectations. Reported EPS is $2.37, expectations were $2.24.

Operator: Good day and welcome to the East West Bancorp Fourth Quarter and Full-Year 2022 Earnings Conference Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Julianna Balicka, Director of Investor Relations. Please go ahead.

Julianna Balicka: Thank you, . Good morning, and thank you, everyone, for joining East West Bancorp’s fourth quarter and full-year 2020 earnings call with Dominic Ng, 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 a 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 descriptions 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, 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 3 of our presentation. Our strong financial performance in 2022 was characterized by strong revenue growth, which was driven by strong loan growth and net interest margin expansion in a rising interest rate environment, combined with disciplined expense management, and solid and stable asset quality. Together, all these drivers result in industry-leading profitability, both for the full-year and the fourth quarter of 2022. East West achieved record earnings of $1.1 billion or $7.92 per share for the full-year of 2022, an increase of 30% year-over-year. Our 2022 total revenue of $2.3 billion was our highest ever and grew 29% year-over-year.

Our pretax pre-provision income of $1.6 billion grew 40% year-over-year in 2022. We returned a 1.8% on assets and 21% on tangible equity for the full-year. Now, for the fourth quarter of 2022, we reported net income of $337 million and earnings per share of $2.37, which grew 55% annualized quarter-over-quarter. Our industry-leading returns were 2.1% on assets, and 25% on tangible equity for the fourth quarter. Our fourth quarter pretax pre-provision profitability was nearly 3%. Now let’s go to Slide 4, and Slide 4 presents a summary of our balance sheet. As of as of December 31, 2022, total loans reached an all-time high of $48.2 billion, an increase of $771 million or 6% annualized from September 30. Fourth quarter average loan growth was likewise 6% annualized.

Average loan growth in the fourth quarter was well balanced between our major loan portfolios of commercial real estate, residential mortgage, and commercial and industrial. Total deposits were record $56 billion as of December 31, 2022, an increase of $2.1 billion or 16% annualized from September 30. Fourth quarter average deposit growth was 7% annualized. Growth was driven by time deposits, reflecting a successful branch-based CD campaign during the fourth quarter. Our deposit book is well diversified by deposit type and 38% of total deposits were in noninterest-bearing demand deposits as of December 31. Our loan-to-deposit ratio decreased to 86% as of the end of the year from 88% as of September 30. Turning to Slide 5. As you can see in the exhibit on this slide, all our capital ratios expanded quarter-over-quarter.

As of December 31, 2022, we had a common equity Tier 1 ratio of 12.7%, a total capital ratio of 14% and a tangible common equity ratio of 8.7%. Quarter-over-quarter, our book value and our tangible equity per share increased 6%. I’m pleased to announce that East West Board of Directors approved a 20% increase to the quarterly common stock dividend from $0.40 per share to $0.48 per share and equivalent to an annual dividend of $1.92 per share. The new dividend will take effect in the first quarter, payable on February 21, 2023, to stockholders of record on February 6, 2023. Moving on to a discussion of our loan portfolio, beginning with Slide 6. As of December 31, 2022, C&I loans outstanding were $15.7 billion, sequentially up 2% annualized, and up 11% year-over-year.

Our C&I portfolio is well diversified by industry and sector. Slide 7 and 8 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 $19.1 billion as of December 31, 2022, up 8% annualized from September 30 and up 18% year-over-year. In Slide 9, 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 East West Bank branches. I would highlight that 82% of our HELOC commitments were in a first lien position as of December 31, 2022. Residential mortgage loans totaled $13.3 billion as of December 31, 2022, up 9% annualized from September 30 and up 19% year-over-year.

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. I’ll start with our asset quality metrics and components of our allowance for loan losses on Slides 10 and 11. The asset quality of our portfolio continues to be stable and strong. Quarter-over-quarter, criticized loans decreased 1% and the criticized loan ratio improved 5 basis points. Both classified and special mention loans decreased from already low level as of September 30. At year-end, the nonperforming asset ratio was 16 basis points of assets unchanged quarter-over-quarter. Charge-offs continue to be a low loan. During the fourth quarter, we recorded net charge-offs of 10 million or 8 basis points, compared with net charge-offs of 6 basis points in the third quarter. Our allowance totaled 596 million as of December 31 or 1.24% of loans, up from 1.23% as of September 30.

During the fourth quarter, we reported a provision for credit losses of 25 million, compared with 27 million for the third quarter. While asset quality remains strong and the current credit environment is benign, we continue to remain vigilant about credit. We are actively managing the loan portfolio and taking proactive measures to build our allowance for loan losses. 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 fourth quarter was 65 million, compared with 20 million in the third quarter. At the same time, the quarterly effective tax rate was 13% in the fourth quarter, compared with 23% in the third quarter.

This fluctuation is due to tax credit investments that were closed in the fourth quarter and the related projects that were placed into service. This resulted in a lower effective tax rate and an increase in the amortization expense for the fourth quarter. For the full-year of 2022, the effective tax rate was 20%. I’ll now review the key drivers of our net interest income and net interest margin on Slide 13 through 16, starting with average balance sheet. As Dominic mentioned in his remarks, fourth quarter average loan growth of 6% annualized was well balanced among our major loan portfolios and average deposit growth of 7% annualized reflected a successful branch-based deposit campaign. Our average loan-to-deposit ratio was stable quarter-over-quarter at 87%.

Average noninterest-bearing demand deposits made up 39% of our average deposits in the fourth quarter. Turning to Slide 14. Fourth quarter 2022 net interest income of $605.5 million was the highest quarterly net interest income in the history of East West, growing 39% linked quarter annualized. Our net interest margin of 3.98% expanded 30 basis points quarter-over-quarter. As you can see from the waterfall chart on the slide, net interest margin expansion in the fourth quarter reflected the impact of higher loan and earning asset yields, which increased the net interest margin by 82 basis points, partially offset by 52 basis points of compression from the funding side. Our net interest income growth benefited from rising benchmark interest rates because of our asset-sensitive loan portfolio.

To preserve net interest income when interest rates go down, we added 3.25 billion of swaps and collars in 2022, which included 1 billion added early in the fourth quarter. Turning to Slide 15. The fourth quarter average loan yield was 5.59%, an increase of 84 basis points quarter-over-quarter. The average loan yields comprised an average coupon yield of 5.53%, plus yield adjustments, which contributed 6 basis points to the overall loan yield in the fourth quarter. As of December 31, the spot coupon rate of our loans was 5.92%. In this slide, we also present the coupon spot yields for each major loan portfolio for the last five quarter end. You can see the positive impact of rising interest rates on each of the loan portfolios as loans have repriced.

In total, 61% of our loan portfolio was variable rate, including 30% linked to the prime rate and 27% linked to LIBOR or SOFR rates. I would also highlight that over 40% of our variable rate commercial real estate loans have customer level interest rate derivative contracts in place. To clarify, this is distinct from the balance sheet hedging I discussed a minute ago. With the customer level derivative contracts, we’ve helped our customers enter into low level interest rate swaps, collars and caps, currently structured to help protect customers against rising debt service costs. At the same time, the loans remain variable rate on our balance sheet and the bank benefits from the asset sensitivity. Turning to Slide 16. Our average cost of deposits for the fourth quarter was 106 basis points, up 55 basis points from the third quarter.

Our spot rate on total deposits was 134 basis points as of December 31, a year-over-year increase of 125 basis points. This translates to a 29% cumulative beta relative to the 425 basis point increase in the target Fed funds rate over the same period. In comparison, the cumulative beta on our loans has been 58% as our loan coupon spot rate increased 248 basis points year-over-year. 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 has bolstered the asset sensitivity benefits of our variable rate loan portfolio supporting strong revenue growth through the cycle. We are pleased with the lag in deposit beta cycle to date. This has come through careful deposit cost management.

With a 29% cumulative beta cycle to date, we are outperforming prior rising interest rate cycles. With 39% of our average deposits and interest-bearing accounts and with the growth that we have had in treasury management products and services since €“ for the pandemic, we feel comfortable about continuing to navigate the current cycle well. Moving on to fee income on Slide 17. Total noninterest income in the fourth quarter was 65%, down from 76% in the third quarter. Customer-driven fee income and net gains on sales of loans were $66 million, down 4.5% or 18% annualized from the third quarter and up 4% from a year ago. Year-over-year, we saw growth across most of our fee income lines of business. Moving on to Slide 18. Fourth quarter noninterest expense was $257 million.

Excluding amortization of tax credits and other investments and core deposit intangible amortization, adjusted noninterest expense was $192 million in the third quarter, down 2% quarter-over-quarter or 7% annualized, driven by lower compensation and employee benefits expense. Once again, we generated strong positive operating leverage, with total revenue growth of 27% annualized in the fourth quarter, plus a sequential decrease in expenses. The fourth quarter adjusted efficiency ratio was 29%, compared to 31% in the third quarter. Our adjusted pretax pre-provision income grew 43% linked quarter annualized, and our pretax pre-provision ROA was an attractive 2.95% in the fourth quarter. And with that, I’ll now review our updated outlook for the full-year of 2023 on Slide 19.

For the full-year 2023, compared to 2022, we currently expect year-over-year loan growth in the high-single-digit percentage range. We expect production from all of our major loan portfolios in 2023. Year-over-year, we expect net interest income growth in the low 20% rate range. Underpinning our interest income assumption is the forward interest rate curve as of year-end, which assumes a peak Fed funds target rate of 5% by April 2023 and the year-end Fed fund’s target rate of 4.75% with the cut late in the year. In our modeling, we assume that deposit betas will continue to rise in 2023. Adjusted noninterest expense growth, excluding tax credit and investment amortization in the range of 10% to 11%. We expect our revenue and expense outlook to result in positive operating leverage year-over-year.

In terms of credit, for 2023, the provision for credit losses will largely be driven by changes in the macroeconomic outlook. We are providing our expectations for gross charge-offs, which are expected to be in-line with our recent gross charge-off experience if macroeconomic conditions stay stable. For context, the gross charge-off ratio was 8 basis points in 2022 and 17 basis points in 2021. Asset quality today is excellent, and the potential losses from any problem loans are limited. However, realistically, if the economic backdrop weakened, we would expect to see some credit normalization from the very low levels today. In terms of tax items, we currently expect that approximately $150 million of tax credit investments, excluding low income housing tax credit will close to go into service in 2023, and therefore, be part of our tax rate calculation for the full-year.

The tax credit amortization related to these tax permits should be approximately 95% of the tax credit investment amount for the full year. For the first quarter of 2023, we expect that $92 million of these tax credits will be reflected in the tax rate calculation and the tax credit amortization to be approximately for the quarter. There will be quarterly variability in the tax rate and the tax credit amortization, due to the timing of tax rate investments placed into service. With that, I’ll now turn the call back over to Dominic for closing remarks.

Dominic Ng: Thank you, Irene. In closing, 2022 was an excellent year for East West with our highest ever earnings, revenue, loans and deposits, and the achievement industry-leading profitability metrics. Our annual earnings now exceed $1 billion. We look forward to 2023 with excitement as we celebrate our 50-year anniversary. The bank and our customers have come a long way since 1973. Throughout our history, the pillar of our success has been and continues to be our spirit of going above and beyond to service our customers. We are honored to be the bank of choice for our clients and wish to thank all our associates for their dedication and contribution to making our bank a success. Lastly, I want to take this opportunity to wish everyone a happy Lunar New Year. May the Year of the Rabbit bring health, prosperity, and happiness to all of us. I will now open up the call to questions. Operator?

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Q&A Session

Operator: Thank you. The first question comes from Dave Rochester with Compass Point. Please go ahead.

Dave Rochester: Hi good morning guys. Nice quarter. My first question is on the NII guide. On Slide 16, you guys highlight the total deposit beta 29%, you’ve got 47% interest-bearing deposit beta during the last year. I was wondering what the positive beta you’re baking into the guide at this point? I know you mentioned you expected deposit betas would rise through this year. But are you thinking mid-30s or upper 30s for the overall cycle, are you making it something higher than that? And then how do you think about deposit growth from here and what that means for borrowing levels, which are still very low? Thanks.

Irene Oh: Yes. Great question, Dave. At this point in time, we’re modeling the full cycle beta will be 40% for 2023 and at the same time for interest-bearing deposits, a deposit beta of 60%. And that’s factored in with our NII guidance that we have of the increase in the low 20%. Overall, I think with the good growth that we’ve had in deposits in general, along with our successful campaigns for CDs that are lower than other competitors in the market, at this point in time, I think we’ll be able to continue to fund our loan growth with the deposits. Certainly, we’re very opportunistic to look at that from the perspective of cost.

Dave Rochester: Great. And then just one follow-up. On the back end of the year, when you include your Fed rate cut, I was curious what you’re expecting for the deposit cost movement as a result of that cut. Are you thinking that you’ll get immediate benefit or are you thinking there might be a little bit of a lag there with the first couple of cuts? Thanks again.

Irene Oh: Yes. I think it’s still late in the year at this point. The expectation around that, we’re not baking that in, Dave.

Dave Rochester: Great. Thanks.

Operator: The next question comes from Manan Gosalia with Morgan Stanley. Please go ahead.

Manan Gosalia: Hi, good morning.

Irene Oh: Good morning.

Manan Gosalia: I wanted to ask on the hedges that you’ve been putting on, on the books. Can you speak to how those might impact loan betas for both the remaining of the rate cycle, the rate hike cycle and also when the Fed begins cutting rates and also how much more you plan to do on your hedging efforts from here?

Irene Oh: Yes, great question. Certainly, the specifics of how much that’s impacted us, , I do not have that, but we can get that information after the call. Certainly, as we started adding this fourth quarter, third quarter, there was a little bit of an impact as far as largely against the CRE loans that we’ve kind of hedged. We have 3.25 billion of swaps and also collars that we put on. At this point in time, in discussion with our ALCO Committee, there’s probably another couple of million that we would look to do, but certainly, we’re opportunistic about this and also evaluating the overall balance sheet and the positioning of that. So, that’s something that we’ll continue to evaluate to see what we think makes the most sense given the changes in the interest rate environment as well.

Manan Gosalia: Got it. And is there a bottom we can think about on NIM in the event the Fed begins cutting or is that too early to say right now?

Irene Oh: I think it’s too early to say.