East West Bancorp

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

East West Bancorp is a financial institution primarily serving Asian communities in the U.S. and China, offering a range of commercial and consumer banking products and services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

East West Bancorp, Inc. (EWBC) is a regional bank holding company focused on serving Chinese-American communities and operating mainly in California, but also with locations in other U.S. states and China.

Business Overview

East West Bancorp operates through three main segments: Consumer and Business Banking, Commercial Banking, and Treasury and Other.

  • Consumer and Business Banking: This segment provides a range of financial products and services tailored to individual clients, small and medium businesses, with a focus on serving the Asian communities.
  • Commercial Banking: This involves commercial loan products, primarily focusing on real estate. Also provides services such as trade finance.
  • Treasury and Other: It includes the company’s investment portfolio, capital management, and other functions that are not part of the other segments.

The bank aims to leverage its branch network and expertise in Asian markets to provide a range of products such as mortgages, business loans, wealth management, and foreign exchange.

East West Bancorp provides a wide range of financial services such as checking accounts, savings, wealth management, and various types of loans tailored to their community, with a notable focus on the Asian American population and Chinese businesses.

The banking industry is currently marked by high competition, rising interest rates, evolving regulatory landscape and the increasing adoption of financial technology.

  • Interest Rate Sensitivity: Banks are very sensitive to changes in interest rates, which directly impacts their net interest income. This aspect has been more critical recently as the FED has been increasing rates rapidly.
  • Regulatory Environment: Banks are highly regulated, and changes in regulatory rules can affect their operations and costs. This is something to watch out for, especially after the banking failures of the year 2023.
  • Technological Advancements: The adoption of digital banking and financial technology (FinTech) is reshaping the industry, with both a potential threat and an opportunity for banks. Legacy banks have to adapt to technological changes.
  • Competition: Competition from larger banks, credit unions, and FinTech firms is a constant threat for the regional banks.

The current high interest rate environment and economic uncertainty can have an adverse impact on all the bank stocks because the higher interest rates could reduce lending and increase the probability of loan defaults.

In this environment, EWBC differentiates itself by specializing in certain market sectors and maintaining a strong presence in its geographical locations.

Financials Analysis

  • Earnings: For the first nine months of 2023, East West Bancorp reported net income of $727.4 million. The net interest margin was 3.56%, representing a 4 basis points increase over last year. Earnings in the third quarter were also impacted by the FDIC special assessment, which created a dip in EPS.
  • Loan Growth: The company experienced a 9% growth in total loans on a year over year basis, which was primarily driven by residential and commercial real estate. However, the bank has emphasized that it is not focusing on high growth, but instead wants to prioritize a “balanced” loan portfolio.
  • Deposits: Total deposits were at $60.8 billion as of September 30, 2023. Despite the recent banking stress and regional bank failures, they have seen significant growth in deposits over the last quarters.
  • Net Interest Income: The bank has been able to drive growth in net interest income by managing and growing their assets and liabilities.
  • Credit Quality: Credit quality metrics continue to be strong for EWBC, as nonaccrual loans and past-due loans have remained low.
  • Capital: EWBC has healthy capital levels, and has a Tier 1 capital ratio of 14.8%, exceeding all minimum regulatory requirements. They have also been increasing Tier 1 and TCE ratios.
  • Market Cap: As of today, East West Bancorp has a market capitalization of about $8 billion, making it a large regional bank.

The most important thing to note here is that EWBC is not trying to become a high-growth bank, but rather to maintain stability by growing its deposit base, maintaining a high credit quality loan portfolio and not taking too much risks.

Moat Analysis

While EWBC has some differentiating factors, its “moat” isn’t particularly strong.

  • Brand: EWBC has a strong brand presence within the Asian communities it serves, which is a valuable asset. However, this type of brand recognition may not be as defensible or replicable as a brand with global reach.
  • Cost Advantages: The bank has strong efficiency ratios. However, this low-cost structure may not be unreplicable over the long run.
  • Switching Costs: There is some stickiness among the deposit customers of EWBC, but there are other competing institutions offering similar services, which will create competition and lower the switching costs.
  • Scale: The bank has a decent size as a mid-sized regional bank, but it lacks economies of scale benefits that are enjoyed by the largest banks.

Moat Rating: 2/5 Based on the above analysis, EWBC has a “narrow moat”. It has some competitive advantages, particularly among its specific customer base in Asian communities and strong balance sheet management, but these advantages are not durable and easily replicable enough for a “wide moat” rating.

Legitimate Risks to the Moat

Several risks threaten EWBC’s moat:

  • Economic Conditions: Changes in economic conditions (inflation, recession, interest rates) can directly affect the bank’s lending and deposit rates, which in turn can impact profitability.
  • Competition: Competition from larger banks or FinTech companies could reduce the bank’s margins and take away its market share, particularly with the rise of online banking.
  • Regulatory Changes: Regulatory requirements may increase operating costs, hurt their flexibility, and overall profitability.
  • Loan Losses: The bank might be exposed to loan defaults, especially in the commercial real estate loans or to certain credit segments.
  • Technological Disruption: The rise of FinTech could reduce profitability as well as change customer expectations, requiring constant reinvestment in the technology infrastructure.
  • Geopolitical Risk: Given that a high percentage of their business is from China, any instability and political risk from China can affect their operations.
  • Interest Rate Risk: Higher interest rates could increase costs for customers, leading to lower demand in loans or increase the number of loan defaults.

Business Resilience

EWBC has a resilient business model because:

  • Conservative Approach: The bank is growing conservatively by putting emphasis on credit quality over growth, creating a good base for the future.
  • Experienced Management Team: A strong and experienced management team can improve the likelihood of maintaining performance.
  • Stable Funding Sources: Having a strong deposit base, including from Chinese-American customers, helps the bank reduce volatility in its funding costs.
  • Strong Capital Position: The bank has enough capital buffer to absorb any negative economic shocks, giving them resilience over time.

However, any significant downturn in the market, or any of the aforementioned risks manifesting themselves could create instability to earnings and share price.

Understandability

East West Bancorp’s operations are more complex compared to a typical retail bank that focuses primarily on deposit-taking and residential lending. Understanding their loan portfolio, and the interplay with the Chinese and other Asian markets requires a high degree of financial knowledge and analysis.

Understandability Rating: 3/5 The banking sector itself is complex, so, although the basic business model may be easy to understand, the details are not simple and require a good understanding of the financial statements and metrics of the company, to know what is going on.

Balance Sheet Health

The bank has a relatively healthy balance sheet.

  • Strong Capital: The bank has a strong Tier 1 capital and Tier 1 leverage ratios, exceeding regulatory requirements, and this helps to absorb future potential losses.
  • Low Credit Losses: Non-performing loans and loan charge-offs are both low, indicating a strong credit profile. Also, the bank has increased its provisions for credit losses over time.
  • Adequate Liquidity: The bank maintains ample cash to cover operating requirements and unexpected circumstances.
  • Conservative Loan Portfolio: Majority of their loan portfolio are from CRE and residential real estate, with a focus on credit quality.
  • Funding: Has a stable deposit base and also has the capacity to raise more capital when needed.
  • Liability Management: Is able to pay its debt obligations and also able to manage its liabilities effectively.

Balance Sheet Health: 4/5 Overall, the balance sheet is pretty healthy and stable, however, there are some inherent risks associated with the banking sector as mentioned before, including interest rate and credit risk.

Recent Concerns

  • FDIC Special Assessment: The special assessment to cover bank failures in 2023 has slightly impacted the earnings and will lead to higher expenses for several quarters.
  • Economic Slowdown: In the most recent earnings call, it was revealed that management believes there is a slowdown on the economy, and thus have increased the provisions for loan losses.
  • Rising Interest Rates: The rapid increase in interest rates is creating some stress on the economy as well as creating concerns around banks’ profitability.

Management’s strategy for now is to continue to grow in a conservative way, maintaining higher credit standards, and focus on strengthening their relationships with its current clientele. They are aware that the increase in provisions for credit losses can result in short-term earnings downturn. Also, the management indicated it is ready to adapt to any external changes.

Conclusion

East West Bancorp is a well-established regional bank that is currently focused on serving Asian communities in various US states and China. However, it faces strong competition and is subject to volatile economic conditions and high regulation, making it important to constantly reevaluate the business.