Earnings Call Transcript - EWBC Q1 2024

Operator, Operator

Good day. Welcome to the East West Bancorp's First Quarter 2024 Earnings Call. Please note, 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, Director of Investor Relations

Thank you, operator. Good afternoon, and thank you, everyone, for joining us to review East West Bancorp's first quarter 2024 financial results. With me are Dominic Ng, Chairman and Chief Executive Officer; Christopher Del Moral-Niles, 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 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. Management may discuss non-GAAP financial measures. 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, Chairman and Chief Executive Officer

Thank you, Adrienne. Good afternoon, and thank you for joining us for our first quarter earnings call. I'm pleased to report first quarter results that laid a strong foundation for 2024. First quarter 2024 net income was $285 million, or $2.03 per diluted share. Excluding the FDIC charge, first quarter adjusted earnings per share was $2.08, up 3% from the fourth quarter. We grew average assets during the quarter, with average loans up 1%. We continue to grow residential mortgages driven by our differentiated mortgage product. Average C&I balances were higher, and commercial real estate loans remained flat. We grew average deposits by $2 billion to a new record level, reflecting the success of our branch-based Lunar New Year CD campaign. During the quarter, we paid off $4.5 billion of BTFP while reducing our total borrowings by $1 billion. We also took an opportunity to invest excess cash into Ginnie Mae floating rate securities. Our asset quality remains solid, and credit is performing as expected. First quarter annualized net charge-offs were up by 2 basis points to 17 basis points. The non-performing assets ratio was 23 basis points at quarter end. We continue to proactively manage our credit risk. We added 10% to our commercial real estate loan allowances, bringing our total allowance for loan losses to 1.29%. These efforts continue to drive shareholder value with an 18% return on tangible common equity and a 1.6% return on average assets. Tangible book value per share also grew 2% quarter-over-quarter and 14% year-over-year. Our first-quarter results speak to the strength of our diversified business model and our conservatively managed balance sheet. Looking forward, we remain focused on serving our customers and growing relationships and are well-positioned to outperform the industry in 2024 and beyond. I will now turn the call over to Chris to provide more details on our first quarter financial performance. Chris?

Christopher Del Moral-Niles, Chief Financial Officer

Thank you, Dominic. Turning to loans on Slide 4. Let me comment on the trends in each of our major lending categories. First, demand for residential mortgage proved relatively durable despite seasonal slowdowns. Even with the generally elevated rate environment, we continue to add residential mortgage loans in Q1, and we are pleased to see both our residential and home equity pipelines strengthening going into the second quarter. Second, average C&I balances grew 2%, driven in part by an uptick of utilization we saw at the end of the fourth quarter. On a period end basis, balances declined, but that was really driven primarily by decreases in capital call line usage and drops in our Hong Kong portfolio. Based on our current pipeline, we expect C&I growth to pick up in Q2. Third, average CRE balances remained flat, while period-end CRE balances were down for the quarter. We continue to work with our long-standing relation clients, but we are targeting only modest CRE growth for 2024. Slide 5 summarizes trends in our securities portfolio. During the first quarter, we took steps to enhance our liquidity profile by putting our cash to work in high-quality liquid assets. We added short duration Ginnie Mae floaters at a rate of SOFR plus 115 bps, much of which settled towards the end of the quarter. With the purchase of these securities, the book yield of our portfolio rose 67 basis points to 3.61% at quarter-end. Our cash and securities portfolio rose to 23% of total assets, a level of on-balance sheet liquidity we see as appropriate at our current size. Moving on to deposits on Slide 6. As Dominic mentioned, we grew deposits to record levels this quarter with average growth of 4% or $2 billion and nearly $2.5 billion on a period-end basis. We saw growth in retail, commercial, and across all geographies. This growth reflects the focus and dedication of our bankers and the loyalty and resilience of our broad-based customer base. Looking forward, we continue to focus on adding granular consumer and business deposits. During the quarter, we also put up $3.5 billion of floating rate federal home loan bank advances at a cost of SOFR plus approximately 20 basis points. These advances have a laddered maturity schedule with $1.5 billion maturing in the next 12 months and the balance over 2025. Slide 7 covers our net interest income trends. Q1 dollar net interest income was $565 million, while our net interest margin was 3.34%. The margin compressed more than expected as we decided to extend and upsize our CD campaign. Time deposits accounted for much of the NIM impact of 14 basis points. We expect further NIM compression in Q2 as deposit mix shift continues in this higher-for-longer environment. Nonetheless, as we move through the year, we expect an acceleration of asset growth will lead to more NIM stability and a bottoming of the NIM later in the second half of the year. And now I'll hand the call over to Irene to talk about asset quality.

Irene Oh, Chief Risk Officer

Thank you, Chris, and good afternoon to all on the call. As you can see from Slide 8, the asset quality of our portfolio continues to broadly outperform the industry, but with credit beginning to normalize. As Dominic mentioned, we recorded net charge-offs of 17 basis points in the first quarter or $23 million. Quarter-over-quarter, non-performing assets rose by 7 basis points to 23 basis points of total assets. The increase in commercial real estate was driven by two credits, one construction and one office property. Nonetheless, the absolute levels remain relatively low. The criticized loans ratio increased during the quarter to 2.3% of loans. The special mention loans ratio also increased 28 basis points quarter-over-quarter to 1.05% of loans, and the classified loans ratio increased 15 basis points to 1.25%. We recorded a lower provision for credit losses of $25 million in the first quarter compared with $37 million for the fourth quarter, given the resilient economic environment and current CECL outlook. We remain vigilant and proactive in managing our credit risks. As we look forward, we continue to expect quarterly net charge-offs to be in the range of 15 basis points to 25 basis points. Turning to Slide 9. The total allowance for loan losses increased $1 million quarter-over-quarter, primarily reflecting a $21 million increase in our allowance for loan losses for commercial real estate loans. Specifically, we increased the reserve for office by $6 million, bringing the coverage ratio to 273 basis points for office loans. We believe we are adequately reserved for the content of our loan portfolio given the current economic outlook. Turning to Slide 10. All of East West regulatory capital ratios remain well in excess of regulatory requirements for well-capitalized institutions and well above regional and national bank averages. East West common equity Tier 1 capital ratio stands at a robust 13.5%, while the tangible common equity ratio stayed relatively flat at 9.3%. These capital levels place us among the most well-capitalized banks in the industry. East West repurchased 1.2 million shares of common stock during the first quarter for approximately $82 million at just under $70 a share. We currently have $89 million of repurchase authorization that remains available for future buybacks. East West’s second quarter 2024 dividend will be payable on May 17, 2024, to stockholders of record on May 3rd, 2024. I will now turn the call back to Chris to share our outlook for the 2024 full year. Chris?

Christopher Del Moral-Niles, Chief Financial Officer

Thank you, Irene. Our full-year outlook has shifted slightly. Let me highlight the changes. We now assume a resilient first half with the economy beginning to soften later in the year. We now expect rate cuts to begin in Q3. We expect loan growth to pick up in the second quarter and for end-of-year loan growth to still be in the range of 3% to 5%, buoyed by continued strength in our residential mortgage and a growing C&I portfolio. Given fewer expected rate cuts, we're raising our net interest income guidance and now only expect a decline in the range of 2% to 4%, up from our prior guidance. With that, I will now open the call to questions. Operator?

Operator, Operator

Your first question comes from Jared Shaw with Barclays. Please go ahead.

Jared Shaw, Analyst

Hi, good afternoon, everybody.

Dominic Ng, Chairman and Chief Executive Officer

Hi, Jared.

Jared Shaw, Analyst

Yes, just looking at margin and NII. I guess what's holding you back from being more optimistic there? You're seeing loan growth, you have the securities, the tailwind from securities. Is that just all being absorbed by higher expected deposit costs? Maybe just walk us through some of that would be great.

Christopher Del Moral-Niles, Chief Financial Officer

Sure. So for the record, we are raising our NII guidance for the year. And so I think we are a little more optimistic here as we move into the rest of the year. That has been said, yes, we expect more deposit mix migration if we stay in a higher-for-longer environment, and that seems to be what we're sort of on pace for here for the second quarter. So we'll give some of that up in the deposit mix and the cost of deposits. And I would also remind you that late in March, we refinanced the BTFP and that had been at a very attractive level and we obviously replaced that largely with the CD campaign balances, but those are of a higher cost. So there's an inherent drag from that refinancing that's just baked in. And the federal home loan bank advances are also at a slightly higher cost, of course.

Jared Shaw, Analyst

Thank you for that. As a follow-up, considering capital, even after the buyback and the redemption of the trust preferred, we are still seeing CET1 increase. How should we view the upper limits of capital where you feel comfortable, and will the buyback be the main method to manage that, given the expected loan growth?

Christopher Del Moral-Niles, Chief Financial Officer

We've commented that we thought TCE was a relevant measure for us to focus in on and we're focused in on maintaining that and no longer warehousing additional capital. And so we'll be proactive in all the actions. Obviously, we announced a dividend again today. We still have some authorization and we'll continue to of course use our balance sheet to support our customers and grow our balance sheet to optimize capital.

Operator, Operator

The next question comes from Casey Haire with Jefferies. Please go ahead.

Casey Haire, Analyst

Yes, thank you. Good afternoon. I have a follow-up regarding the margin. Chris, if I understand you correctly, you anticipate more negative mix shift on the funding side. I get the BTFP and the borrowings, but what about the DDA mix? What does your guidance assume regarding the potential attrition there?

Christopher Del Moral-Niles, Chief Financial Officer

Look, we're still at 25% even as we sit here today, April 19, 20. So we feel comfortable that, that number has come down reasonably, and it will probably bottom somewhere in the mid-20s area, which we might be close to, I think it's a function of how we see the outlook shift as we move later into the quarter. Our expectation previously had been that when the Fed started to lower rates, we would see that deposit migration ease. Fed hasn't started to lower rates yet. So, that is continuing sort of month-over-month as we move through and it's somewhat outlook-dependent.

Casey Haire, Analyst

Got you. Okay. And then just switching to credit, I guess, Irene, for you. You guys are sticking with your guidance on loss rates despite some decent migration trends. We've seen that from other banks. Just wondering what gives you the confidence to keep the rather benign loss guide given these migration trends?

Irene Oh, Chief Risk Officer

Yes. Great question. I think when we look at it and a granular level, loan-by-loan, loan reviews that we're doing, we're very comfortable as far as the reserving that we are doing, the ground-up kind of analysis of the portfolio and on the charge-offs and our guidance. I think quite honestly, it is, in my mind, kind of a wide range if you look at it quarter-by-quarter but reflects kind of our views and our understanding of the portfolio today, right?

Operator, Operator

Your next question comes from Dave Rochester with Compass Point. Please go ahead.

Dave Rochester, Analyst

Hi, good afternoon, guys. Just back on capital, should we just assume that you mentioned, I think the TCE ratio or CET1 ratio sort of flat lines from here since you're focused on those going forward and whatever you guys need to do in buybacks to sort of solve for that, we should just expect to see some kind of a quarterly buyback going forward.

Christopher Del Moral-Niles, Chief Financial Officer

I think we're going to obviously use our balance sheet to support our customers and lending growth will still be the primary use of capital and that will continue to be the case. To the extent lending growth perhaps is a little softer, maybe as it was in Q1, we might add securities, and that can also manage that number. We'll continue to pay a strong dividend and buyback is always sort of our last choice, but one that we have the flexibility to opportunistically call upon when we see the right environment.

Operator, Operator

Your next question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

Hi, good afternoon. I guess just a follow-up on credit, like on Slide 19, I think where you disclose 47% of CRE customers have interest derivative contracts, I guess, hedging them against higher rates. Just talk to us in terms of the deep dive, or the portfolio reviews that you've done. If we are in a higher for longer over the next two years, how much risk within that CRE book increases, as these derivative contracts? I'm assuming at some point roll-off, and just how you've assessed that in terms of the potential risk exposure tied to this book? Thank you.

Christopher Del Moral-Niles, Chief Financial Officer

Sure, Eb. So the good news is most of our customers put on swaps to the maturity of their loan. And so, there really isn't a significant inter-maturity rate rollover risk on the vast majority of them. So that risk for us is highly contained, and that's by design and the way we market the solution to our customers. We have been steadily growing the fixed rate portfolio, the other side of that chart. And the combination means that as we think about the future, we're locking in more and more fixed rate, as we move towards the expectation that there might be a downdraft in rates in the future. And the swaps that we put on to hedge our balance sheet have all been received fixed forwards. And so, to the extent that in 2025, we're staring at inherently a lower rate environment. And today, we think that combination of factors will all play into our benefits. Our customers who have locked in will be perfectly fine, continue to be perfectly fine through maturity and our balance sheet, we will be more fixed and receiving more fixed in what we expect to be a declining rate outlook, which we think is to our benefit and our shareholders' benefit.

Ebrahim Poonawala, Analyst

And just give us a perspective, Chris, in terms of when these loans are coming up for maturity, what's happening? Are they refinanced into another sort of fixed rate loan on the balance sheet? Or how many of these are moving out getting refinanced by insurance companies, etc.?

Christopher Del Moral-Niles, Chief Financial Officer

I think we see the gamut of activity. The good news is there's a history here of relatively low LTV lending. And so, there's plenty of equity for these guys, to always find another outlet, if not back with us.

Operator, Operator

Your next question comes from Chris McGratty with KBW. Please go ahead.

Chris McGratty, Analyst

Great. Thanks. Chris, going back to the comments on the HQLA. You referenced your about where you need to be. If you kind of zoom out, is that comment more about the size of the balance sheet today? Or kind of you think where you need to be, for when you cross 100?

Christopher Del Moral-Niles, Chief Financial Officer

No, I'm going to comment on where we are for the current institution. Keep in mind, we're only 70%. It's a pretty long way from 100.

Chris McGratty, Analyst

No, I get it. Okay. But in terms of, I guess, asking the capital question a little bit differently, you commented about buybacks. But should we be thinking about perhaps more liquidity, but at a lower NIM producing higher NII as kind of a dynamic of what you're doing to the balance sheet right now?

Christopher Del Moral-Niles, Chief Financial Officer

Probably the implication of what we did in the first quarter for sure. And that will play itself out. But we're optimistic that we'll see loan growth pick up in the second quarter and continue to drive towards the loan guidance that we've laid out. And we think that will contribute to, again helping the NIM bounce back later in the year while still growing NII.

Operator, Operator

Your next question comes from Samuel Varga with UBS. Please go ahead.

Samuel Varga, Analyst

Good afternoon.

Dominic Ng, Chairman and Chief Executive Officer

Good afternoon.

Samuel Varga, Analyst

I just wanted to follow up on the loan growth funding question, I guess, understanding the sort of backdrop of the HQLA build. How much of a willingness do you have to actually use some of the cash to fund the loan growth?

Christopher Del Moral-Niles, Chief Financial Officer

Sure. So the investment portfolio will throw off $450 million per quarter of net proceeds. And so, we think that is part of how we could fund some of the growth as we look forward.

Samuel Varga, Analyst

Okay. Thank you. And then, in terms of just the trade-off between putting on the CDs at very competitive rates versus FHLB, is that going to be a simple always CD preference? Or how do you think about that sort of funding mix?

Christopher Del Moral-Niles, Chief Financial Officer

Yes. Look, I think we obviously know the FHLB is there for us. We clearly would rather pay at the margin, our customers a better rate than borrow from a wholesale institution. And we think that is both a better economic outcome and a better outcome for the franchise and the value that we create for our customers. So there is a preference there, but I think we will look to optimize our cost of funding in the ordinary course and do incrementally the right thing as we move forward.

Irene Oh, Chief Risk Officer

And maybe just I'll add one thing. The FHLB we put on is the variable rate. So that also was part of the analysis for us.

Operator, Operator

Your next question is a follow-up question from Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

Hi, good afternoon. Again...

Christopher Del Moral-Niles, Chief Financial Officer

Eb, you cut out.

Dominic Ng, Chairman and Chief Executive Officer

We cannot hear you.

Ebrahim Poonawala, Analyst

Hi, can you hear me now?

Christopher Del Moral-Niles, Chief Financial Officer

We can hear you now. Go ahead.

Ebrahim Poonawala, Analyst

Yes. Just wanted to understand, given East West's capital positioning, the market disruption, just talk to us in terms of investment and banker hiring, like how fertile is it to attract talent and maybe move market share in a world where overall growth may be slow? Thank you.

Dominic Ng, Chairman and Chief Executive Officer

The question on investment in talent.

Ebrahim Poonawala, Analyst

Yes.

Dominic Ng, Chairman and Chief Executive Officer

Yes. I think that we will - we're always on the lookout for new talent to join the organization. And frankly, with what happened 12 months ago, there's a lot of disruption in the market. And so, we do feel that there are plenty of talent out there in the market that are possibly looking for new homes, but we've been very, very selective, because it's not every banker that fit into the East West Bank culture. It's not every banker that actually like to do the things that we do. And oftentimes, if you look at it, is that there are a lot of banks out there that have bankers who habitually do much bigger loans, and that doesn't fit into our diversification strategy. And so, we are going to continue to be very selective and choosy in terms of making sure we find the right fit. And when we do finalize it, we absolutely will be delighted to welcome them to be part of the East West Bank family. And this is something that we're not going to be rushing to it. And I do notice that there are other banks, who may be all looking into getting a big group of talent from a specific bank that having some turmoil. We don't necessarily feel that that is going to be actually an attractive strategy for East West Bank. We have been able to grow organically pretty nicely, for the last almost 10 years now. So we have not made an acquisition since January of 2014. And even that was a very small acquisition. So most of our growth for the last 10 years has been through organic direction. So we like that approach, and we think that bringing the right talent understanding the East West specific value proposition, and understanding that the importance of a balance between risk management, and also growth. And those are the people that fit into us well, and then we will continue to identify these types of talents and bring them on.

Ebrahim Poonawala, Analyst

That's great color. Thanks, Dominic. Thanks again. Bye.

Dominic Ng, Chairman and Chief Executive Officer

Thank you.

Irene Oh, Chief Risk Officer

Thank you.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back for closing remarks.

Dominic Ng, Chairman and Chief Executive Officer

Well, again, thank you for joining our earnings call today. And we're looking forward to speaking to you in July.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.