EAST WEST BANCORP INC - Annual Report: 2020 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-24939
EAST WEST BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
95-4703316
(I.R.S. Employer Identification No.)
135 North Los Robles Ave., 7th Floor, Pasadena, California, 91101
(Address of principal executive offices) (Zip Code)
(626) 768-6000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | |||||||||||||||
| Common Stock, $0.001 Par Value | EWBC | Nasdaq Global Select Market | |||||||||||||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☒ | Accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||||||
| Non-accelerated filer | ☐ | Emerging growth company | ☐ | ||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the registrant’s common stock held by non-affiliates was approximately $5,090,501,829 (based on the June 30, 2020 closing price of Common Stock of $36.24 per share). As of January 31, 2021, 141,565,473 shares of East West Bancorp, Inc. Common Stock were outstanding.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A relating to its 2021 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.
EAST WEST BANCORP, INC.
2020 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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PART I
Forward-Looking Statements
This Annual Report on Form 10-K (“this Form 10-K”) contains certain forward-looking information about us that is intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical facts, and are based on current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control, particularly with regard to developments related to the Coronavirus Disease 2019 (“COVID-19”) pandemic. These statements relate to the Company’s financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking language, such as “likely result in,” “expects,” “anticipates,” “estimates,” “forecasts,” “projects,” “intends to,” “assumes,” or may include other similar words or phrases, such as “believes,” “plans,” “trend,” “objective,” “continues,” “remains,” or similar expressions, or future or conditional verbs, such as “will,” “would,” “should,” “could,” “may,” “might,” “can,” or similar verbs, and the negative thereof. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including, but not limited to, those described in the documents incorporated by reference. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements the Company may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company.
There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such differences, some of which are beyond the Company’s control, include, but are not limited to:
•the impact of disease pandemics, such as the resurgences and subsequent waves of the COVID-19 pandemic on the Company, its operations and its customers, employees and the markets in which the Company operates and in which its loans are concentrated; and the measures that international, federal, state and local governments, agencies, law enforcement and/or health authorities implement to address it, which may precipitate or exacerbate one or more of the below-mentioned and/or other risks, and significantly disrupt or prevent the Company from operating its business in the ordinary course for an extended period;
•changes in governmental policy and regulation, including measures taken in response to economic, business, political and social conditions, such as the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”), the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and any similar or related rules and regulations, the Board of Governors of the Federal Reserve System (“Federal Reserve”) efforts to provide liquidity to the United States (“U.S.”) financial system, including changes in government interest rate policies, and to provide credit to private commercial and municipal borrowers, and other programs designed to address the effects of the COVID-19 pandemic, as well as the resulting effect of all such items on the Company’s operations, liquidity and capital position, and on the financial condition of the Company’s borrowers and other customers;
•changes in the U.S. economy, including an economic slowdown or recession, inflation, deflation, housing prices, employment levels, rate of growth and general business conditions;
•changes in laws or the regulatory environment including regulatory reform initiatives and policies of the U.S. Department of Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency, the U.S. Securities and Exchange Commission (“SEC”), the Consumer Financial Protection Bureau (“CFPB”) and the California Department of Financial Protection and Innovation (“DFPI”) - Division of Financial Institutions, and SBA;
•the changes and effects thereof in trade, monetary and fiscal policies and laws, including the ongoing trade dispute between the U.S. and the People’s Republic of China;
•changes in the commercial and consumer real estate markets;
•changes in consumer spending and savings habits;
•fluctuations in the Company’s stock price;
•changes in income tax laws and regulations;
•the Company’s ability to compete effectively against other financial institutions in its banking markets;
•success and timing of the Company’s business strategies;
•the Company’s ability to retain key officers and employees;
•impact on the Company’s funding costs, net interest income and net interest margin from changes in key variable market interest rates, competition, regulatory requirements and the Company’s product mix;
•changes in the Company’s costs of operation, compliance and expansion;
•the Company’s ability to adopt and successfully integrate new technologies into its business in a strategic manner;
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•impact of benchmark interest rate reform in the U.S. that resulted in the Secured Overnight Financing Rate (“SOFR”) being selected as the preferred alternative reference rate to the London Interbank Offered Rate (“LIBOR”);
•impact of a communications or technology disruption, failure in, or breach of, the Company’s operational or security systems or infrastructure, or those of third parties with whom the Company does business, including as a result of cyber-attacks; and other similar matters which could result in, among other things, confidential and/or proprietary information being disclosed or misused and materially impact the Company’s ability to provide services to its clients;
•adequacy of the Company’s risk management framework, disclosure controls and procedures and internal control over financial reporting;
•future credit quality and performance, including the Company’s expectations regarding future credit losses and allowance levels;
•impact of adverse changes to the Company’s credit ratings from major credit rating agencies;
•impact of adverse judgments or settlements in litigation;
•impact on the Company’s international operations due to political developments, disease pandemics, wars or other hostilities that may disrupt or increase volatility in securities or otherwise affect economic conditions;
•heightened regulatory and governmental oversight and scrutiny of the Company’s business practices, including dealings with consumers;
•impact of reputational risk from negative publicity, fines and penalties and other negative consequences from regulatory violations and legal actions and from the Company’s interactions with business partners, counterparties, service providers and other third parties;
•impact of regulatory enforcement actions;
•changes in accounting standards as may be required by the Financial Accounting Standards Board (“FASB”) or other regulatory agencies and their impact on critical accounting policies and assumptions;
•impact of other potential federal tax changes and spending cuts;
•the Company’s capital requirements and its ability to generate capital internally or raise capital on favorable terms;
•impact on the Company’s liquidity due to changes in the Company’s ability to receive dividends from its subsidiaries;
•any future strategic acquisitions or divestitures;
•continuing consolidation in the financial services industry;
•changes in the equity and debt securities markets;
•fluctuations in foreign currency exchange rates;
•a recurrence of significant turbulence or disruption in the capital or financial markets, which could result in, among other things, a reduction in the availability of funding or increases in funding costs, a reduction in investor demand for mortgage loans and declines in asset values and/or recognition of other-than-temporary impairment (“OTTI”) on securities held in the Company’s available-for-sale (“AFS”) debt securities portfolio; and
•impact of natural or man-made disasters or calamities, such as wildfires and earthquakes, which are particular to California, or conflicts or other events that may directly or indirectly result in a negative impact on the Company’s financial performance.
Given the ongoing and dynamic nature of the COVID-19 pandemic circumstances, it is difficult to predict the full impact of the COVID-19 pandemic on the Company’s business. The extent to which the COVID-19 pandemic impacts the Company will depend on future developments that are uncertain and unpredictable, including the scope, severity and duration of the pandemic and its impact on the Company’s customers, the actions taken by governmental authorities in response to the pandemic as well as its impact on global and regional economies, and the pace of recovery when the COVID-19 pandemic subsides, among others.
For a more detailed discussion of some of the factors that might cause such differences, see Item 1A. Risk Factors presented elsewhere in this report. The Company does not undertake, and specifically disclaims any obligation to update or revise any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.
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ITEM 1. BUSINESS
Organization
East West Bancorp, Inc. (referred to herein on an unconsolidated basis as “East West” and on a consolidated basis as the “Company,” “we” or “EWBC”) is a bank holding company incorporated in Delaware on August 26, 1998 and is registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”). The Company commenced business on December 30, 1998 when, pursuant to a reorganization, it acquired all of the voting stock of East West Bank (the “Bank”), which became its principal asset. East West’s principal business is to serve as a holding company for the Bank and other banking or banking-related subsidiaries that East West may establish or acquire. The Company operates in more than 120 locations in the U.S. and Greater China. In the U.S., the Bank’s corporate headquarters and main administrative offices are located in California, and its branches are located in California, Texas, New York, Washington, Georgia, Massachusetts and Nevada. The Bank has a banking subsidiary based in China - East West Bank (China) Limited.
As of December 31, 2020, the Company had $52.16 billion in total assets, $37.77 billion in total loans (including loans held-for-sale, net of allowance), $44.86 billion in total deposits, and $5.27 billion in total stockholders’ equity.
Strategy
The Bank continues to develop its international banking presence with its network of overseas branches and representative offices that include four full-service branches in Greater China, located in Hong Kong, Shanghai, Shantou and Shenzhen. The Bank also has four representative offices in Greater China, located in Beijing, Chongqing, Guangzhou and Xiamen. In addition to facilitating traditional letters of credit and trade financing to businesses, these representative offices allow the Bank to assist existing clients and to develop new business relationships. Through these branches and offices, the Bank is focused on growing its cross-border client base between the U.S. and Greater China, helping U.S. based businesses expand in Greater China and companies based in Greater China pursue business opportunities in the U.S.
The Bank believes that its customers benefit from the Bank’s understanding of the Greater China markets through its physical presence, corporate and organizational ties in Greater China, as well as the Bank’s international banking products and services. The Bank believes that this approach, combined with its senior management’s and Board of Directors’ extensive ties to Chinese business opportunities and Chinese-American communities, provides the Bank with a competitive advantage. The Bank utilizes its presence in Greater China to identify and build corporate relationships, which the Bank may leverage to create business opportunities in California and other U.S. markets.
The Bank continues to explore opportunities to establish other foreign offices, subsidiaries, strategic investments and partnerships to expand its international banking capabilities and to capitalize on long-term cross-border business opportunities between the U.S. and Greater China.
Banking Services
As of December 31, 2020, the Bank was the fourth largest independent commercial bank headquartered in California based on total assets. The Bank is the largest bank in the U.S. focused on the financial service needs of individuals and businesses that operate both in the U.S. and Greater China. The Bank also has a strong focus on the Chinese-American community. Through its network of over 120 banking locations in the U.S. and Greater China, the Bank provides a wide range of personal and commercial banking services to businesses and individuals. The Bank provides services to its customers in English and in over 10 other languages. In addition to offering traditional deposit products that include personal and business checking and savings accounts, money market, and time deposits, the Bank also offers foreign exchange, treasury management, and wealth management services. The Bank’s lending activities include commercial and residential real estate, lines of credit, construction, trade finance, letters of credit, commercial business, affordable housing lending, asset-based lending and equipment financing. In addition, the Bank is focused on providing financing to clients in need of a financial bridge to facilitate their business transactions between the U.S. and Greater China.
The integration of digital channels and brick and mortar channels has been our focus, and an area of investment for the bank, for both commercial and consumer banking platforms. Our strategic priorities include the use of technology to innovate and expand commercial payments and treasury management products and services. We are also developing a digital consumer banking platform to enhance our customer user experience and offer a full suite of banking services tailored to our customers’ unique needs. The omnichannel banking service approach increases efficiency, enables us to provide a better customer experience and deepen customer relationships.
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Operating Segments
The Bank’s three operating segments, (1) Consumer and Business Banking, (2) Commercial Banking and (3) Other, are based on the Bank’s core strategy. The Consumer and Business Banking segment primarily provides financial products and services to consumer and commercial customers through the Company’s domestic branch network. The Commercial Banking segment primarily generates commercial loans and deposits. The remaining centralized functions, including the corporate treasury activities of the Company and eliminations of inter-segment amounts, are aggregated and included in the Other segment. For complete discussion and disclosure, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) — Operating Segment Results and Note 18 — Business Segments to the Consolidated Financial Statements in this Form 10-K.
Competition
The Bank operates in a highly competitive environment. The Company faces intense competition from domestic and foreign lending institutions and numerous other providers of financial services. Competition is based on a number of factors including, among others, customer service and convenience, quality and range of products and services offered, reputation, interest rates on loans and deposits, and lending limits. Competition also varies based on the types of customers and locations served. The Company is a leader of banking market share among the Chinese-American community, and maintains a differentiated presence within selected markets by providing cross-border expertise to customers in a number of industry specializations between the U.S. and Greater China.
While the Company believes it is well positioned within a highly competitive industry, the industry could become even more competitive as a result of legislative, regulatory, economic, and technological changes, as well as continuing consolidation.
Human Capital
As a company that delivers relationship-driven financial solutions to a diverse customer base, we believe that the strength of our workforce is one of the significant contributors to our success. Our key human capital objectives are to attract, retain and develop quality talent, who we reward through competitive pay and benefits. To achieve these objectives, our human resource programs have been designed based on our core values and attributes which include absolute integrity, customer-centric principles, creativity, respect, teamwork, expertise, and selflessness. These core values and attributes are used to prepare our employees for leadership positions and to advance their careers. East West is committed to promoting diversity in employment and advancement.
As of December 31, 2020, we had approximately 3,200 full-time equivalent employees, of which 220 are in China and Hong Kong. None of our employees are subject to a collective bargaining agreement.
Diversity and Inclusion
East West Bank was founded in 1973 in Chinatown, Los Angeles, California as a savings & loan association for immigrants who were underserved by mainstream banks, and, as such, we have a long history of, and commitment to, diversity and inclusion. As of December 31, 2020, the Bank had grown to be the largest FDIC-insured, minority-operated depository institution headquartered in the continental United States, serving communities with diverse ethnicities and socio-economic backgrounds in seven states across the nation. Our operations are concentrated in areas that include larger numbers of immigrants and minorities. We proudly offer financing for affordable housing, provide community development loans, and partner with a diverse list of nonprofit and community-based organizations to promote wealth generation and entrepreneurship in underserved communities. Throughout our history, the diversity of our employees has been essential to successfully grow customer relationships.
Our commitment to diversity is reflected in the composition of our employees. In 2020, 74% of the Company’s employees are Asian or Asian-American, 15% are other minorities of color, and 11% are Caucasian. Nearly two-thirds of our employees are women. Our managers are equally as diverse as our employees: 75% of our managers are Asian or Asian-American and 11% are other minorities of color, and 57% of our managers are women. In addition, given our diverse customer base and the diversity of the communities that we serve, our retail bankers are able to assist customers in English and in over 10 other languages.
The composition of our Board of Directors exemplifies our commitment to diversity. Of our eight directors, six are minorities, representing four ethnic groups, and three are women.
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Talent Acquisition, Development and Promotion
We endeavor to attract, retain and develop diverse talent as part of our ongoing commitment to building a stronger workforce to serve our customers and communities. We offer a total compensation package, including salary, benefits and incentive pay, which is competitive with those offered by our peers in the businesses and markets where we operate. We are committed to fair and equitable compensation programs, and regularly assess the current business environment and labor markets to review our compensation and benefits programs for pay equity.
To foster a strong sense of ownership and to align the interests of our employees with our shareholders, restricted stock units are awarded to eligible employees under our stock incentive programs. We award stock grants under our “Spirit of Ownership” program to all of our employees, regardless of job title or part-time/full-time status. The program allows each employee to share directly in the success they help create. The fact that our employees are also owners is a source of pride for EWBC.
We recognize the importance of employee development and career growth in achieving personal development for our employees and also the Company’s strategic objectives. We provide a variety of resources to help our employees grow in their current roles and build new skills for future advancement, including tuition reimbursement and a management trainee program. Our success in talent development is evident by our internal promotions into leadership positions.
Health, Safety and Wellness
We are committed to supporting our employees’ well-being by offering flexible and competitive benefits. Comprehensive health insurance coverage is offered to employees working at least 30 hours or more each week. Prior to the COVID-19 pandemic, we offered a variety of programs and benefits designed to promote employee wellness. In addition, we encourage our employees to engage with our local communities by leading or participating in events to foster community and development, as COVID-19 safety protocols permit. Based on the guidance from health authorities regarding the COVID-19 pandemic, we provided resources and implemented measures to limit the risk of exposure to our employees, and the communities in which they live and work. Refer to Item 7 MD&A — Overview — Our response to the COVID-19 pandemic for further discussion.
Available Information
The Company’s website is www.eastwestbank.com. The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, proxy statements, Current Reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and other filings with the SEC are available free of charge at http://investor.eastwestbank.com under the heading “SEC Filings”, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. These reports are also available for free on the SEC’s website at www.sec.gov. In addition, the Company’s Code of Conduct, Corporate Governance Guidelines, charters of the Audit Committee, Compensation Committee, Executive Committee, Risk Oversight Committee and Nominating/Corporate Governance Committee, and other corporate governance materials are available on the Investor Relations section of the Company’s website. The information contained on the Company’s website as referenced in this report is not part of this report.
Shareholders may also request a copy of any of the above-referenced reports and corporate governance documents free of charge by writing to: Investor Relations, East West Bancorp, Inc., 135 N. Los Robles Avenue, 7th Floor, Pasadena, California 91101; by calling (626) 768-6000; or by sending an e-mail to InvestorRelations@eastwestbank.com.
Supervision and Regulation
Overview
East West and the Bank are subject to extensive and comprehensive regulation under U.S. federal and state laws. Regulation and supervision by the federal and state banking agencies are intended primarily for the protection of depositors, the Deposit Insurance Fund (“DIF”) administered by the FDIC, consumers and the banking system as a whole, and not for the protection of our investors. As a bank holding company, East West is subject to primary regulation, supervision, and examination by the Federal Reserve under the BHC Act. The Bank is regulated, supervised, and examined by the Federal Reserve, the DFPI, and, with respect to consumer laws, the CFPB. As insurer of the Bank’s deposits, the FDIC has back-up examination authority of the Bank as well. In addition, the Bank is regulated by certain foreign regulatory agencies in international jurisdictions where we now, or may in the future wish to conduct business, including China and Hong Kong.
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The Company is also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, as amended, both as administered by the SEC. Our common stock is listed on the Nasdaq Global Select Market under the trading symbol “EWBC” and subject to Nasdaq rules for listed companies. The Company is also subject to the accounting oversight and corporate governance of the Sarbanes-Oxley Act of 2002.
Described below are material elements of selected laws and regulations applicable to East West and the Bank. The descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations described. A change in applicable statutes, regulations or regulatory policies may have a material effect on the Company’s business.
East West
As a bank holding company and pursuant to its election of financial holding company status, East West is subject to regulation, supervision, and examinations by the Federal Reserve under the BHC Act. The BHC Act provides a federal framework for the regulation and supervision of all bank holding companies and their nonbank subsidiaries. The BHC Act and other federal statutes grant the Federal Reserve authority to, among other things:
•require periodic reports and such additional information as the Federal Reserve may require in its discretion;
•require bank holding companies to maintain certain levels of capital and, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), limit the ability of bank holding companies to pay dividends or bonuses unless their capital levels exceed the capital conservation buffer (see Item 1. Business — Supervision and Regulation — Capital Requirements);
•require bank holding companies to serve as a source of financial and managerial strength to subsidiary banks and commit resources, as necessary, to support each subsidiary bank, including at times when bank holding companies may not be inclined to do so, and the failure to do so generally may be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of Federal Reserve regulations or both;
•restrict dividends and other distributions from subsidiary banks to their parent bank holding companies;
•require bank holding companies to terminate an activity or terminate control of or liquidate or divest certain nonbank subsidiaries, affiliates or investments if the Federal Reserve believes that the activity or the control of the nonbank subsidiary or affiliate constitutes a serious risk to the financial safety, soundness or stability of the bank holding company, or if the activity, ownership, or control is inconsistent with the purposes of the BHC Act;
•regulate provisions of certain bank holding company debt, including by imposing interest ceilings and reserve requirements on such debt and requiring a bank holding company to obtain prior approval to purchase or redeem its securities in certain situations;
•approve in advance senior executive officer or director changes and prohibit (under certain circumstances) golden parachute payments to officers and employees, including change in control agreements and new employment agreements, that are contingent upon termination; and
•approve in advance acquisitions of and mergers with bank holding companies, banks and other financial companies, and consider certain competitive, management, financial, financial stability and other factors in granting these approvals. DFPI approval may also be required for certain acquisitions and mergers involving a California-chartered bank such as the Bank.
East West’s election to be a financial holding company as permitted under the Gramm-Leach-Bliley Act of 1999 (“GLBA”), generally allows East West to engage in any activity that the Federal Reserve has determined to be financial in nature or incidental or complementary to activities that are financial in nature, or acquire and retain the shares of a company engaged in any such activity, without prior Federal Reserve approval. Activities that are considered to be financial in nature include securities underwriting and dealing, insurance agency and underwriting, merchant banking activities and activities that the Federal Reserve, in consultation with the U.S. Secretary of the Treasury, determines to be financial in nature or incidental to such financial activity. To maintain financial holding company status and continue to be able to engage in new activities or investments that are financial in nature, a financial holding company and all of its depository institution subsidiaries must be “well capitalized” and “well managed”, and the financial holding company’s depository institution subsidiaries must have Community Reinvestment Act (“CRA”) records of at least “satisfactory.” A depository institution subsidiary is considered to be “well capitalized” if it satisfies the requirements for this status discussed in the sections captioned “Capital Requirements” and “Prompt Corrective Action,” included elsewhere under this item. A depository institution subsidiary is considered “well managed” if it received a composite rating and a management rating of at least “satisfactory” in its most recent examination. See the section captioned “Community Reinvestment Act” included elsewhere under this item. As of December 31, 2020, East West is a financial holding company and has financial subsidiaries, as discussed in Item 1. Business — Organization.
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The Bank and its Subsidiaries
East West Bank is a California state-chartered bank and a member of the Federal Reserve, and its deposits are insured by the FDIC. The Bank’s operations in the U.S. are primarily regulated and supervised by the Federal Reserve and the DFPI, and its activities outside the U.S. are regulated and supervised by both its U.S. regulators and the applicable regulatory authority in the host country in which each overseas office is located. Specific federal and state laws and regulations that are applicable to banks regulate, among other things, their regulatory capital levels, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds, and the nature and amount of collateral for certain loans. Bank regulatory agencies also have extensive discretion to impose various restrictions on management or operations and to issue policies and guidance in connection with their supervisory and enforcement activities and examination policies. California law permits state-chartered commercial banks to engage in any activity permissible for national banks, unless such activity is expressly prohibited by state law. The Bank may also form subsidiaries to engage in the many activities commonly conducted by national banks in operating subsidiaries. Further, pursuant to the GLBA, the Bank may conduct certain “financial” activities in a subsidiary to the same extent permitted for a national bank, provided the Bank is “well capitalized” and “well managed” and has a CRA rating of at least “satisfactory.”
Regulation of Subsidiaries and Branches
The Bank’s foreign-based subsidiary, East West Bank (China) Limited, is subject to applicable foreign laws and regulations, such as those implemented by the China Banking and Insurance Regulatory Commission. East West Bank’s Hong Kong branch is subject to applicable foreign laws and regulations, such as those implemented by the Hong Kong Monetary Authority and the Securities and Futures Commission of Hong Kong.
Regulatory Capital Requirements
The federal banking agencies have imposed risk-based capital adequacy requirements intended to ensure that banking organizations maintain capital that is commensurate with the degree of risk associated with their operations. In July 2013, the federal banking agencies adopted final rules (the “Basel III Capital Rules”) establishing a comprehensive capital framework for U.S. banking organizations that became effective for the Company and the Bank beginning January 1, 2015. The Basel III Capital Rules define the components of regulatory capital, include a required ratio of Common Equity Tier 1 (“CET1”) capital to risk-weighted assets and restrict the type of instruments that may be recognized in Tier 1 and 2 capital (including by phasing out trust preferred securities from Tier 1 capital for bank holding companies). The Basel III Capital Rules also prescribe a standardized approach for risk weighting assets and include a number of risk weighting categories that affect the denominator in banking institutions’ regulatory capital ratios.
Under the Basel III Capital Rules, to be considered adequately capitalized, standardized approach banking organizations, such as the Company and the Bank are required to maintain minimum capital ratios of at least 4.5% CET1 capital to risk-weighted assets, 6.0% Tier 1 capital to risk-weighted assets, 8.0% total capital (Tier 1 plus Tier 2) to risk-weighted assets and a 4.0% Tier 1 leverage ratio of Tier 1 capital to average total consolidated assets. The Basel III Capital Rules also include a “capital conservation buffer” of 2.5% that fully phased in on January 1, 2019, on top of each of the minimum risk-based capital ratios. Banking institutions with a risk-based capital ratio that meets or exceeds the minimum requirement but does not meet the capital conservation buffer will face constraints on dividends, equity repurchases and discretionary bonus payments based on the amount of the shortfall. To avoid these constraints, a banking organization must meet or exceed the following risk-based capital ratios (after any distribution): (i) CET1 capital to risk-weighted assets of 7.0%, (ii) Tier 1 capital to risk-weighted assets of 8.5%, and (iii) total risk-based capital to risk-weighted assets of 10.5%.
As of December 31, 2020, the Company’s and the Bank’s capital ratios exceeded the minimum capital adequacy requirements of the federal banking agencies, including the capital conservation buffer, and the Company and the Bank were classified as “well capitalized.” For additional discussion and disclosure see Item 7. MD&A — Regulatory Capital and Ratios and Note 17 — Regulatory Requirements and Matters to the Consolidated Financial Statements in this Form 10-K.
The Bank is also subject to additional capital requirements under the Prompt Corrective Action (“PCA”) regulations that implement Section 38 of the Federal Deposit Insurance Act (“FDIA”), as discussed below under the Prompt Corrective Action section.
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Recent Regulatory Capital-Related Developments
From time to time, the regulatory agencies propose changes and amendments to, and issue interpretations of, risk-based capital requirements and related reporting instructions. Such proposals and interpretations could, if implemented in the future, affect our regulatory capital requirements and reported capital ratios.
In July 2019, the federal banking agencies issued a final rule (the “Capital Simplifications Rule”) to reduce regulatory compliance burden by simplifying certain risk-based and leverage capital requirements of the Basel III Capital Rules for non-advanced approaches banking organizations (i.e., banking organizations with less than $250 billion in total consolidated assets and with less than $10 billion of on-balance sheet foreign exposures), including the Company and the Bank. The Capital Simplifications Rule became effective for the Company and the Bank on April 1, 2020. Application of the Capital Simplifications Rule to our consolidated balance sheet did not have a significant impact on the capital ratios of the Company and the Bank.
In light of the recent disruptions in economic conditions caused by COVID-19 pandemic, the federal banking agencies have also revised the definition of eligible retained income to be the greater of (1) a banking organization’s net income for the four preceding calendar quarters, net of any distributions and associated tax effects not already reflected in net income, and (2) the average of a banking organization’s net income over the preceding four quarters. This revision reduces the likelihood that a banking organization is suddenly subject to abrupt and restrictive distribution limitations in a scenario where its capital ratios fall below an applicable minimum risk-based capital ratio requirement plus capital conservation buffer, and instead makes the application of these limitations more gradual. The revision became effective on March 20, 2020.
In April 2020, in recognition of the CARES Act requirements and to facilitate the use of the Paycheck Protection Program Liquidity Facility (“PPPLF”), the U.S. banking agencies issued an interim final rule that allows banking organizations to exclude from risk-based and leverage capital requirements any eligible assets sold or pledged to the Federal Reserve on a non-recourse basis through the PPPLF. The interim final rule states that PPP loans originated by a banking organization under the PPP will be risk-weighted at zero percent for regulatory capital purposes and PPP loans pledged as collateral to PPPLF may be excluded from the denominator of the Tier 1 leverage ratio. In addition, the CARES Act, the banking agencies’ “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customer Affected by the Coronavirus (Revised)” (the “Interagency Statement”) issued on March 22, 2020 and April 7, 2020, and the Consolidated Appropriations Act, 2021 (the “CAA”), enacted December 27, 2020, provided options for financial institutions to elect to temporarily suspend troubled debt restructurings (“TDR”) accounting under Accounting Standards Codification (“ASC”) Subtopic 310-40. For additional information, see Note 1 — Summary of Significant Accounting Policies, Troubled Debt Restructurings, to the Consolidated Financial Statements in this Form 10-K. The election to apply the TDR relief under these regulatory guidance provided banking organizations such as the Bank a capital benefit by increasing its regulatory capital ratios as the loan modifications related to the COVID-19 pandemic are not adjusted to a higher risk weighting normally associated with a TDR classification.
In December 2018, the regulatory agencies approved a final rule to address changes to credit loss accounting, including with respect to banking organizations’ implementation of the Accounting Standards Update (“ASU”) 2016-13 Financial Instruments — Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments, which introduced the current expected credit losses (“CECL”) methodology. The final rule among other things provides banking organizations with the option to phase in over a three-year period the day-one adverse effects on regulatory capital upon the adoption of ASU 2016-13. On March 31, 2020, the federal banking agencies issued an interim final rule that provided banking organizations that adopted CECL during 2020, the option to delay for two years the estimated impact of CECL on regulatory capital, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay (i.e., a five-year transition, in total). The Company adopted the five-year transition in 2020. As a result, the effects of CECL on the Company’s and the Bank’s regulatory capital will be delayed through the year 2021, after which the effects will be phased-in over a three-year period from January 1, 2022 through December 31, 2024.
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Prompt Corrective Action
The FDIA, as amended, requires federal banking agencies to take PCA with respect to depository institutions that do not meet minimum capital requirements. The FDIA includes the following five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. Under the federal banking agencies’ regulations implementing the PCA provisions of the FDIA, an insured depository institution generally is classified in the following categories based on the capital measures indicated:
| PCA Category | Risk-Based Capital Ratios | |||||||||||||||||||||||||
| Total Capital | Tier 1 Capital | CET1 Capital | Tier 1 Leverage | |||||||||||||||||||||||
Well capitalized (1) | ≥ 10% | ≥ 8% | ≥ 6.5% | ≥ 5% | ||||||||||||||||||||||
| Adequately capitalized | ≥ 8% | ≥ 6% | ≥ 4.5% | ≥ 4% | ||||||||||||||||||||||
| Undercapitalized | < 8% | < 6% | < 4.5% | < 4% | ||||||||||||||||||||||
| Significantly undercapitalized | < 6% | < 4% | < 3.0% | < 3% | ||||||||||||||||||||||
| Critically undercapitalized | Tangible Equity/Total Assets ≤ 2% | |||||||||||||||||||||||||
(1)Additionally, to be classified as well capitalized, an insured depository institution may not be subject to any written agreement, order, capital directive, or PCA directive issued by its primary federal regulator to meet and maintain a specific capital level for any capital measure.
An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios, if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying PCA regulations and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.
The FDIA generally prohibits a depository institution from making any capital distributions (including payment of any dividend) or paying any management fee to its parent holding company, if the depository institution would thereafter be “undercapitalized.” Undercapitalized institutions are subject to growth limitations and are required to submit capital restoration plans. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, cessation of receipt of deposits from correspondent banks and/or restrictions on interest rates paid on deposits. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator. The FDIA also generally permits only “well capitalized” insured depository institutions to accept brokered deposits, however an “adequately capitalized” institution may apply to the FDIC for a waiver of this restriction.
Economic Growth, Regulatory Relief, and Consumer Act and Stress Testing
In May 2018, the enactment of the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) amended certain provisions in the Dodd-Frank Act and other statutes administered by the Federal Reserve. Amongst other things, the EGRRCPA provided regulatory relief, including from risk committee requirements, for bank holding companies and state member banks with total consolidated assets between $10 billion and $50 billion. We were among the bank holding companies and banks in this range until we exceeded $50 billion in total consolidated assets as of September 30, 2020.
The EGRRCPA also lifted the asset size threshold and provided relief for banks with assets between $50 billion and $100 billion with respect to many of the Dodd-Frank Act’s enhanced prudential standards, except for the risk committee requirements. The EGRRCPA also raised the asset size threshold for required company-run stress testing at banks and bank holding companies from $10 billion to $250 billion. Additionally, based on authority provided in the EGRRCPA, the Federal Reserve raised the asset size threshold for required supervisory stress testing at bank holding companies from $50 billion to $100 billion. Although the Company and the Bank are not required to conduct stress tests, we continue to conduct annual capital and quarterly liquidity stress tests.
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Consumer Financial Protection Bureau Supervision
The Dodd-Frank Act established the CFPB, which has the authority to implement, examine and enforce compliance with federal consumer financial laws that apply to banking institutions and certain other companies. The CFPB has exclusive authority to examine insured depository institutions with assets exceeding $10 billion (such as the Bank) and their affiliates with respect to these consumer financial laws, and may also take enforcement action. The CFPB may focus its supervisory, examination, and enforcement efforts on, among other things:
•risks to consumers and compliance with federal consumer financial laws when evaluating the policies and practices of a financial institution;
•unfair, deceptive, or abusive acts or practices, which the Dodd-Frank Act empowers the CFPB to prevent through rulemaking, enforcement and examination;
•rulemaking to implement various federal consumer statutes such as the Home Mortgage Disclosure Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Electronic Fund Transfer Act, Equal Credit Opportunity Act and Fair Credit Billing Act; and
•the markets in which firms operate and risks to consumers posed by activities in those markets.
The statutes and regulations that the CFPB enforces mandate certain disclosure and other requirements, and regulate the manner in which financial institutions must deal with consumers when taking deposits, making loans, collecting payments on loans and providing other services. Failure to comply with these laws can subject the Bank to various penalties, including, but not limited to, enforcement actions, injunctions, fines or criminal penalties, punitive damages or restitution to consumers, and the loss of certain contractual rights. The Company and the Bank are also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.
Federal Home Loan Bank and the Federal Reserve’s Reserve Requirements
The Bank is a member of the Federal Home Loan Bank (“FHLB”) of San Francisco. As a FHLB member, the Bank is required to own a certain amount of capital stock in the FHLB. The Bank may also access the FHLB for both short-term and long-term secured credit.
The Federal Reserve requires all depository institutions to maintain reserves at specified levels against their transaction accounts either in the form of vault cash or an interest-bearing account at the Federal Reserve Bank, or a pass-through account as defined by the Federal Reserve. On March 26, 2020, in response to the COVID-19 pandemic, the Federal Reserve reduced reserve requirement ratios to zero percent, eliminating the reserve requirement for all deposit institutions, an action that provides liquidity in the banking system to support lending to households and businesses. The Bank is also a member bank and stockholder of the Federal Reserve Bank of San Francisco (“FRBSF”).
Dividends and Other Transfers of Funds
The principal source of liquidity of East West is dividends received from the Bank. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends. In addition, the banking agencies have an authority to prohibit or limit the Bank from paying dividends, depending upon the Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice. Furthermore, under the federal PCA regime, the Federal Reserve or FDIC may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “significantly undercapitalized” or, in some circumstances, “undercapitalized.” It is the Federal Reserve’s policy that a bank holding company should generally pay dividends on common stock only if the company’s net income available to common stockholders over the past four quarters, net of distributions, would be sufficient to fully fund the dividends, and if the prospective rate of earnings retention appears consistent with the company’s capital needs, asset quality and overall financial condition. It is also the Federal Reserve’s policy that a bank holding company should not maintain dividend levels that undermine the company’s ability to be a financial source of strength to its banking subsidiaries. The Federal Reserve requires bank holding companies to continuously review their dividend policy in light of their organizations’ financial condition and compliance with regulatory capital requirements, and has discouraged payment ratios that are at maximum allowable levels, unless both asset quality and capital are very strong.
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Transactions with Affiliates and Insiders
Pursuant to Sections 23A and 23B of the Federal Reserve Act, as implemented by the Federal Reserve’s Regulation W, banks are subject to restrictions that strictly limit their ability to engage in transactions with their affiliates, including their parent bank holding companies. Regulations promulgated by the Federal Reserve limit the types, terms and amounts of these transactions and generally require the transactions to be on an arm’s-length basis. In general, these regulations require that “covered transactions,” which include bank’s extensions of credit to or purchase of assets from an affiliate, be limited to 10% of the bank’s capital and surplus with respect to any one affiliate, and 20% of the bank’s capital and surplus with respect to the aggregate of all covered transactions with all affiliates. In addition, a bank generally may not extend credit to an affiliate unless the extension of credit is secured by specified amounts of collateral. The Dodd-Frank Act expanded the coverage and scope of the limitations on affiliate transactions, including by treating derivative transactions resulting in a bank’s credit exposure to an affiliate as covered transactions. In addition, the Volcker Rule under the Dodd-Frank Act establishes certain prohibitions, restrictions and requirements (known as “Super 23A” and “Super 23B”) on transactions between a covered fund and a banking entity that serves as an investment manager, investment adviser, organizer and offeror, or sponsor with respect to that covered fund, regardless of whether the banking entity has an ownership interest in the fund.
Federal law also limits a bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. The terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital.
Community Reinvestment Act
Under the CRA, an insured depository institution has a continuing and affirmative obligation to help serve the credit needs of its communities, including low- and moderate-income borrowers and neighborhoods. The Federal Reserve periodically evaluates a state member bank’s performance under applicable performance criteria and assign a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The Federal Reserve takes this performance into account when reviewing applications by banks and their parent companies to expand branches, relocate, add subsidiaries and affiliates, expand into new financial activities and merge with or acquire other financial institutions. Unsatisfactory CRA performance may result in the denial of such applications. On September 21, 2020, the Federal Reserve issued an Advance Notice of Proposed Rulemaking that invites the public to comment on its proposal to modernize CRA regulations by strengthening, clarifying, and tailoring them to reflect the current banking landscape and better meet the core purpose of the CRA. The impact on the Company from any changes in CRA regulations will depend on how they are implemented and applied.
FDIC Deposit Insurance Assessments
The FDIC insures the Bank’s customer deposits through the DIF up to $250,000 for each depositor, per FDIC-insured bank, for each account ownership category. The DIF is funded mainly through quarterly insurance assessments on insured banks based on their assessment base. The Dodd-Frank Act revised the FDIC’s fund management authority by establishing a minimum Designated Reserve Ratio of 1.35 percent of total estimated insured deposits and redefining the assessment base to be calculated as average consolidated total assets minus average tangible equity. The Bank’s DIF quarterly assessment is calculated by multiplying its assessment base by the applicable assessment rate. The assessment rate is calculated based on an institution’s risk profile, including capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk ratings, certain financial measures to assess an institution’s ability to withstand asset related stress and funding related stress, and a measure of loss severity that estimates the relative magnitude of potential losses to the FDIC in the event of the Bank’s failure.
As of June 30, 2020, the DIF reserve ratio fell to 1.30 percent, below the statutory minimum of 1.35 percent. The decline in the ratio was due to extraordinary insured deposit growth, which was resulted mainly from the COVID-19 pandemic, specifically monetary policy action, direct government assistance to the consumers and businesses, and an overall reduction in spending. The FDIC projects that the DIF reserve ratio would return to 1.35 percent without further action by the FDIC and has continued to maintain existing schedule of assessment rates.
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In June 2020, the FDIC published a final rule that mitigates the deposit insurance assessment effects of participating in the PPP, PPPLF and the Money Market Mutual Fund Liquidity Facility (“MMLF”). Under the rule, the FDIC provided adjustments to the risk based premium formula and certain of its risk ratios, and an offset to an insured institution’s total assessment amount due for the increase to its assessment base attributable to participation in the PPP and MMLF. Absent such a change to the assessment rules, an insured depository institution could have become subject to increased deposit insurance assessments based on its participation in the PPP, PPPLF or MMLF programs. This final rule became effective on April 1, 2020, which applied the changes to deposit insurance assessments starting in the second quarter of 2020.
The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound, that the institution has engaged in unsafe or unsound practices, or has violated any applicable rule, regulation, condition, or order imposed by the FDIC.
Bank Secrecy Act and Anti-Money Laundering
The Bank Secrecy Act (“BSA”), USA PATRIOT Act of 2001 (“PATRIOT Act”), federal laws and regulations impose obligations on U.S. financial institutions to implement and maintain appropriate policies, procedures and controls, which are reasonably designed to prevent, detect and report instances of money laundering, the financing of terrorism and to comply with the recordkeeping and reporting requirements. Regulatory agencies expect that the Bank will have an effective governance structure for the program which includes effective oversight by our Board of Directors and management. We regularly evaluate and continue to enhance our systems and procedures to comply with the PATRIOT Act and other anti-money laundering (“AML”) initiatives. Failure of a financial institution to maintain and implement adequate BSA/AML programs, or to comply with all of the relevant laws or regulations, could have serious legal, financial and reputational consequences for the institution. The Anti-Money Laundering Act of 2020, which became law in January 2021, made a number of changes to anti-money laundering laws, including increasing penalties for anti-money laundering violations. The Bank regularly evaluates and continues to enhance its systems and procedures to ensure compliance with the regulations.
Office of Foreign Assets Control Regulation
The U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) is responsible for helping to ensure that U.S. financial institutions do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. Banking regulators also examine banks for compliance with regulations administered by the OFAC for economic sanctions against designated foreign countries, designated nationals, and others. OFAC publishes lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. Generally, if a bank identifies a transaction, account or wire transfer relating to a person or entity on an OFAC list, it must freeze the account or block the transaction, file a suspicious activity report and notify the appropriate authorities. Failure to comply with these sanctions could have serious legal, strategic, and reputational consequences, and result in civil money penalties on the Company and the Bank.
Privacy and Cybersecurity
Federal statutes and regulations require banking organizations to take certain actions to protect nonpublic consumer financial information. The Bank has prepared a privacy policy that it must disclose to consumers annually. In some cases, the Bank must obtain a consumer’s consent before sharing information with an unaffiliated third party, and the Bank must allow a consumer to opt out of the Bank’s sharing of information with its affiliates for marketing and certain other purposes. Additional conditions affect the Bank’s information exchanges with credit reporting agencies. The Bank's privacy practices and the effectiveness of its systems to protect consumer privacy are subjects covered in the Federal Reserve’s periodic compliance examinations.
Consumer data privacy and data protection are also the subject of state laws. For example, on January 1, 2020, the Bank became subject to the California Consumer Privacy Act (“CCPA”). This statute grants consumers several rights, including the right to request disclosure of information collected about them and whether that information has been sold or shared with others, the right to request deletion of personal information (subject to certain exceptions), and the right to opt out of the sale of their personal information. However, a consumer does not have these rights with respect to information that is collected, processed, sold, or disclosed pursuant to the GLBA or the California Financial Information Privacy Act. The California Attorney General has adopted regulations to implement the CCPA.
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The Federal Reserve pays close attention to the cybersecurity practices of state member banks and their holding companies and affiliates. The interagency council of the agencies, the Federal Financial Institutions Examination Council (“FFIEC”), has issued a number of policy statements and other guidance for banks in light of the growing threat posed by cybersecurity threats. FFIEC has recently focused on such matters as compromised customer credentials, cyber resilience and business continuity planning. Examinations by the banking agencies now include review of an institution’s information technology and its ability to thwart or mitigate cyber-attacks. Additionally, on December 18, 2020, the federal banking agencies released a notice of proposed rulemaking that would require a banking organization to notify its primary federal regulator within 36 hours of a significant cybersecurity incident.
Future Legislation and Regulation
New statutes, regulations and policies that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions and public companies operating in the U.S. are regularly adopted. Such changes to applicable status, regulations and policies may change the Company’s operating environment in substantial and unpredictable ways, increase the Company’s cost of conducting business, impede the efficiency of the internal business processes, and restrict or expand the activities in which the Company may engage. Accordingly, such changes may have a significant influence on our operations and activities, financial condition, results of operations, growth plans or future prospects and the overall growth and distribution of loans, investments and deposits. We cannot predict whether or in what form any statute, regulation or policy will be proposed or adopted or the extent to which our businesses may be affected by any new statute or regulation.
ITEM 1A. RISK FACTORS
In the course of conducting its businesses, the Company is exposed to a variety of risks, some of which are inherent to the financial services industry and others of which are more specific to the Company’s businesses. The Company’s enterprise risk management (“ERM”) program incorporates risk management throughout the organization in identifying, managing, monitoring, and reporting risks. Our ERM program identifies the Company’s major risk categories as risks related to the COVID-19 pandemic; geopolitical uncertainties; financial risks; capital and liquidity risks; credit risk; operational risk; regulatory, compliance and legal risks; accounting and tax risks; and strategic and reputational risks. The ERM is comprised of senior management of the Company and chaired by the Chief Risk Officer.
The discussion below addresses material factors, of which we are currently aware, that could have a material and adverse effect on our businesses, results of operations and financial condition. Many of the following risks and uncertainties are, and will be, exacerbated by the COVID-19 pandemic and any worsening of the global business and economic environment as a result. These risk factors and other forward-looking statements that relate to future events, expectations, trends and operating periods involve certain factors that are subject to change, and important risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties should not be considered a complete discussion of all the risks and uncertainties the Company may face and although the risks are organized by headings and each risk is discussed separately, many are interrelated.
Risks Related to the COVID-19 Pandemic
The effects of the COVID-19 pandemic have impacted, and may continue to impact, the Company’s businesses, financial condition, liquidity, capital and results of operations, and the extent and duration of these impacts depend on future developments, which remain uncertain and cannot be predicted. The COVID-19 pandemic and governmental responses to the pandemic have had and will likely continue to have a severe impact on global economic conditions, including disruption and volatility in the financial markets, disruption of global supply chains, temporary closures or failures of businesses, increased unemployment, and the imposition of social distancing and restrictions on movement in the U.S. and other countries.
East West Bank is considered an essential business in the seven states where we have branches or office locations. In response to the COVID-19 pandemic and to enhanced health and safety measures, the Company has implemented business continuity plans, prepared all East West Bank facilities with employee safety protocols, including personal protection equipment, visual safety reminders related to social distancing, social distancing markers, temperature checks and sanitary products, and continued to provide financial services to our customers. Subsequent waves of the COVID-19 pandemic may negatively affect our ability to provide services due to increased illnesses among our employees, quarantines, new “stay-at-home” orders or other restrictions on our employees, or the safety measures implemented to prevent illnesses of our employees, including the potential closure of particular branches and certain employees working remotely.
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Governments and regulatory authorities worldwide have taken and may continue to take measures to stabilize the markets and support economic growth. However, the success of these measures is unknown, and these measures may not be sufficient to address the negative economic effects of the COVID-19 pandemic or to avert severe and prolonged slowdowns in economic activity.
We may face increased cybersecurity risks due to the shifting of a majority of our corporate and division office functions to operating remotely in regions impacted by “stay-at-home” orders. Increased levels of remote access may create additional opportunities for cybercriminals to attempt to exploit vulnerabilities, and our employees may be more susceptible to phishing and social engineering attempts due to increased stress caused by the crisis and from balancing family and work responsibilities at home. In addition, our technological resources may be strained due to the number of remote users.
The conditions caused by the COVID-19 pandemic could continue to adversely affect the ability of the Company’s borrowers to satisfy their obligations. Given that many of the Company’s loans are secured by real estate, a potential decline in real estate markets could further impact the Company’s business and financial condition, and the credit quality of the Company’s loan portfolio. In addition, some of the Company’s business customers are in volatile businesses and industries, which are sensitive to global economic conditions, supply chain disruptions and/or commodity prices. Any decline in these businesses and industries could cause decreased borrowings and potentially increase credit losses, which in turn could adversely affect the Company’s financial condition. If unemployment continues to rise and our customers experience credit deterioration, including inability to pay loans as they come due or a decrease in the value of collateral and/or higher than usual draws on outstanding lines of credit, our level of charge-offs and provision for credit losses could continue to increase. Further, the disruptions related to the COVID-19 pandemic may decrease our borrowers’ confidence with respect to purchasing real estate or homes and adversely affect the demand for the Company’s loans and other products and services, the valuation of our loans, securities, derivatives portfolios, goodwill and intangibles, the carrying value of our deferred tax assets, our capital levels and liquidity, and our results of operations.
In addition, the unprecedented developments relating to the COVID-19 pandemic have contributed to heightened volatility in financial markets in the U.S. and worldwide. The continuation of prolonged adverse economic conditions primarily in the U.S. and/or Greater China can be expected to have adverse effects on the Company’s businesses, results of operations and financial condition. Market declines or volatility due to the COVID-19 pandemic could have material impacts on the value of securities, derivatives and other financial instruments which the Company owns. The Company executes transactions with various counterparties in the financial industry, including broker-dealers, commercial banks and investment banks, and defaults by financial services institutions and uncertainty in the financial services industry in general could lead to market-wide liquidity problems and may expose the Company to credit risk in the event of default of its counterparties or clients and further increase the possibility of downgrades in the Company’s credit ratings. Any further measures undertaken by governmental authorities to address the COVID-19 pandemic could significantly disrupt or prevent us from operating our business in the ordinary course for an extended period, which could have a significant adverse effect on our results of operations and financial condition. Economic distress due to the COVID-19 pandemic could exacerbate these effects. Additionally, the earnings impact from recent and continued emergency interest rate cuts could further compress interest margins, which could potentially have an adverse effect on our results of operations and financial condition.
The extent to which the COVID-19 pandemic and associated economic downturn continue to impact our businesses, results of operations and financial condition is uncertain and will depend on numerous evolving factors that are outside our control and cannot be accurately predicted, including the scope, severity and duration of the pandemic, the governmental, business and individual actions in response to the pandemic, the impact of those actions on global economic activities, and the pace of economic recovery when the COVID-19 pandemic subsides.
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The impact of the U.S. federal government actions to mitigate the effects of the COVID-19 pandemic, and our participation in those efforts, may materially and adversely affect our businesses, results of operations and financial condition. The U.S. federal government has taken significant action to address the economic and financial effects of the COVID-19 pandemic. The Federal Reserve has sharply reduced interest rates and instituted quantitative easing measures, as well as domestic and global capital market support programs. In addition, Congress, various federal agencies and state governments have taken measures to address the economic and social consequences of the pandemic, including the enactment on March 27, 2020 of the CARES Act, which, among other things, established various initiatives to protect individuals, businesses and local economies in an effort to lessen the impact of the COVID-19 pandemic on consumers and businesses. These initiatives included the PPP, funding and authority for the Federal Reserve and U.S. Department of Treasury to establish the Main Street Lending Program (“MSLP”), relief with respect to TDRs, mortgage forbearance, and extended unemployment benefits. In response to the continued market disruption and economic impact of the COVID-19 pandemic, the President signed into law the CAA on December 27, 2020. The CAA extended some of these relief provisions in certain respects as well as provided other forms of relief.
The PPP permitted small businesses, sole proprietorships, independent contractors and self-employed individuals to apply for forgivable loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The CARES Act appropriated $349 billion to fund the PPP, and Congress appropriated an additional $310 billion for PPP commitments on April 24, 2020, and amended the PPP on June 5, 2020 to make the terms of the PPP loans and loan forgiveness more flexible. From April to August 2020, we accepted PPP applications and originated loans to qualified small businesses under this program. Consistent with the terms of the PPP, these loans carry an interest rate of 1% and are 100% guaranteed by the SBA. The substantial majority of the Company’s PPP loans have a term of two years. The Federal Reserve established the PPPLF to enable Federal Reserve Banks to extend credit to financial institutions that originate PPP loans, while taking the PPP loans as collateral. Earlier in 2020, we borrowed under the PPPLF by pledging PPP loans as collateral, and paid down all borrowings in the month of October 2020. The CAA provided additional funding to the PPP, expanded eligibility of business for the PPP, extended the PPP to March 31, 2021, and allowed eligible borrowers to obtain a second PPP loan with a maximum amount of $2 million. In January 2021, the Company began processing applications under this latest round of the SBA’s PPP. The Bank was also a participating lender in the MSLP, which was established by the Federal Reserve to support lending to small- and medium-sized businesses and nonprofit organizations that were in sound financial condition before the onset of the COVID-19 pandemic. The Company’s participation in these programs could subject us to increased governmental and regulatory scrutiny, negative publicity or increased exposure to litigation, which could increase our operational, legal and compliance costs and damage our reputation. Moreover, if the federal stimulus measures are not effective in mitigating the effect of the COVID-19 pandemic, credit issues for our loan customers may be severe and adversely affect our businesses, results of operations, and financial condition more substantially over a longer period of time.
The CARES Act, as amended by the CAA, and related guidance from the federal banking agencies provide financial institutions the option to temporarily suspend requirements under the U.S. Generally Accepted Accounting Principles (“GAAP”) related to classification of certain loan modifications as TDRs, to account for the current and anticipated effects of the COVID-19 pandemic. The CARES Act also includes a range of other provisions designed to support the U.S. economy and mitigate the impact of the COVID-19 pandemic on financial institutions and their customers. Among other provisions, sections 4022 and 4023 of the CARES Act, respectively, require mortgage servicers to grant, on a borrower’s request, forbearance for up to 180 days (which can be extended for an additional 180 days) on a federally-backed single-family mortgage loan or forbearance up to 30 days (which can be extended for two additional 30-day periods) on a federally-backed multifamily mortgage loan when the borrowers experience financial hardship due to the COVID-19 pandemic.
Further, in response to the COVID-19 pandemic, the Federal Reserve implemented a number of facilities in addition to the PPPLF and MSLP to provide emergency liquidity to various segments of the U.S. economy and financial markets. Many of these facilities expired December 31, 2020, or were extended for brief periods into 2021. The expiration of these facilities could have adverse effect on U.S. economy and ultimately on our businesses, financial condition and results of operations.
In response to the COVID-19 pandemic, all of the federal banking regulatory agencies have encouraged lenders to extend additional loans, and the federal government is considering additional stimulus and support legislation focused on providing aid to various sectors, including small businesses. The full impact on our business activities as a result of government and regulatory policies, programs and guidelines, as well as regulators’ reactions to such activities, remains uncertain.
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Risks Related to Geopolitical Uncertainties
Unfavorable general economic, political or industry conditions, either domestically or internationally, may adversely affect our businesses, results of operations and financial condition. Our businesses and results of operations are affected by the financial markets and general economic conditions in the U.S. and Greater China, including factors such as the level and volatility of short-term and long-term interest rates, inflation, deflation, home prices, unemployment and under-employment levels, bankruptcies, household income, consumer behavior, fluctuations in both debt and equity capital markets and currencies, liquidity of the global financial markets, the availability and cost of capital and credit, investor sentiment and confidence in the financial markets, and sustainability of economic growth in the U.S. and Greater China. The deterioration of any of these conditions could adversely affect our consumer and commercial businesses, our securities and derivatives portfolios, our level of charge-offs and provision for credit losses, the carrying value of our deferred tax assets, our capital levels, liquidity, and our results of operations. In addition, because the Company’s operations and the collateral securing its real estate lending portfolio are concentrated in Northern and Southern California, the Company may be particularly susceptible to the adverse economic conditions in the state of California. Any unfavorable changes in the economic and market conditions could lead to the following risks:
•the process the Company uses to estimate the expected losses in the Company’s credit exposure requires difficult, subjective and complex judgments, including consideration of how these economic conditions might impair the ability of the borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of the Company’s estimates of expected losses in the Company’s credit exposure which may, in turn, adversely impact the Company’s results of operations and financial condition;
•the Company’s commercial and residential borrowers may not be able to make timely repayments of their loans, or a decrease in the value of real estate collateral securing the payment of such loans could result in credit losses, delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on the Company’s results of operations and financial condition;
•a decrease in the demand for loans and other products and services;
•a decrease in deposit balances;
•future disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in an inability to borrow on favorable terms or at all from other financial institutions;
•the value of the AFS debt securities portfolio that the Company holds may be adversely affected by debt defaults; and
•a loss of confidence in the financial services industry, our market sector and the equity markets by investors, placing pressure on the Company’s stock price.
Changes in the U.S. and Greater China trade policies, including the imposition of tariffs and retaliatory tariffs, may adversely impact the Company’s business, results of operations and financial condition. There have been ongoing discussions regarding potential changes to trade policies, legislation, treaties and tariffs between the U.S. and Greater China. Tariffs and retaliatory tariffs have been imposed and proposed. Changes in tariffs, retaliatory tariffs or other trade restrictions on products and materials that the Company’s customers import or export could cause the prices of their products to increase, possibly reduce demand and hence may negatively impact the Company’s customer margins and their ability to service debt. The Company may also experience a decrease in the demand for loans and other financial products, or experience a deterioration in the credit quality of the loans extended to the customers whose industry sectors that are most sensitive to the tariffs.
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We face risks associated with international operations. A substantial number of our customers have economic and cultural ties to Asia. The Bank’s international presence includes four full-service branches and four representative offices in Greater China. Our presence in Greater China carries certain risks, including risks arising from the uncertainty regarding our ability to generate revenues from foreign operations, risks associated with leveraging and conducting business on an international basis, including among others, legal, regulatory and tax requirements and restrictions, cross-border trade restrictions or tariffs, uncertainties regarding liability, trade barriers, difficulties in staffing and managing foreign operations, political and economic risks, and financial risks including currency and payment risks. Additionally, our business could be adversely affected by the effects of a widespread outbreak of disease pandemics, including the current spread of the COVID-19 pandemic. Any outbreak of disease pandemics, and other adverse public health developments, particularly in Asia, could have a material and adverse effect on our business operations. These could include temporary closures of our branches and offices and reduced consumer spending in the impacted regions or in the U.S., depending upon the severity, globally, which could adversely impact our operating results and the performance of loans to impacted borrowers in Greater China or in the U.S. In addition, a significant outbreak of disease pandemics in the human population, specifically the COVID-19 pandemic, has resulted in a widespread health crisis that have had and continue to adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could adversely affect our customers’ financial results. Further, volatility in the Shanghai and Hong Kong stock exchanges and/or a potential fall in real estate prices in China, among other things, may negatively impact asset values and the profitability and liquidity of the Company’s customers operating in this region. These risks could adversely affect the success of our international operations and could have a material adverse effect on our overall business, results of operations and financial condition. In addition, we face risks that our employees and affiliates may fail to comply with applicable laws and regulations governing our international operations, including the U.S. Foreign Corrupt Practices Act, anti-corruption laws, and other U.S. and foreign laws and regulations. Failure to comply with such laws and regulations could, among other things, result in enforcement actions and fines against us, as well as limitations on our conduct, any of which could have a material adverse effect on our businesses, results of operations and financial condition.
Natural disasters and geopolitical events beyond the Company’s control could adversely affect the Company. Natural disasters such as wildfires, earthquakes, extreme weather conditions, hurricanes, floods, widespread health emergencies or disease pandemics and other acts of nature and geopolitical events involving political unrest, terrorism or military conflicts could adversely affect the Company’s business operations and those of the Company’s customers and cause substantial damage and loss to real and personal property. For example, California, in which the Company’s operations and the collateral securing its real estate lending portfolio are concentrated, contains active earthquake zones and has been, and continues to be, subject to numerous devastating wildfires. These natural disasters and geopolitical events could impair borrowers’ ability to service their loans, decrease the level and duration of deposits by customers, erode the value of loan collateral, and result in an increase in the amount of nonperforming assets, net charge-offs, and provision for credit losses, which could adversely affect the Company’s businesses, results of operations and financial condition.
Risks Related to Financial Matters
A portion of the Company’s loan portfolio is secured by real estate and thus the Company has a higher degree of risk from a downturn in real estate markets. Because many of the Company’s loans are secured by real estate, a decline in the real estate markets could impact the Company’s business and financial condition. Real estate values and real estate markets are generally affected by changes in general economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and natural disasters, such as wildfires and earthquakes, which are particular to California, where a significant portion of the Company’s real estate collateral is located. If real estate values decline, the value of real estate collateral securing the Company’s loans could be significantly reduced. The Company’s ability to recover on defaulted loans by foreclosing and selling the real estate collateral would be further diminished, and the Company would be more likely to suffer losses on defaulted loans. Furthermore, commercial real estate (“CRE”) and multifamily loans typically involve large balances to single borrowers or groups of related borrowers. Since payments on these loans are often dependent on the successful operation or management of the properties, as well as the business and financial condition of the borrowers, repayment of such loans may be subject to adverse conditions in the real estate market, adverse economic conditions, or changes in applicable government regulations. Borrowers’ inability to repay such loans may have an adverse effect on the Company’s businesses, results of operations and financial condition.
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The Company’s businesses are subject to interest rate risk and variations in interest rates may have a material adverse effect on the Company’s financial performance. Our financial results depend substantially on net interest income, which is the difference between the interest income we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Interest-earning assets primarily include loans extended, securities held in our investment portfolio and excess cash held to manage short-term liquidity. We fund our assets using deposits and borrowings. While we offer interest-bearing deposit products, a portion of our deposit balances are from noninterest-bearing products. Overall, the interest rates we receive on our interest-earning assets and pay on our interest-bearing liabilities could be affected by a variety of factors, including market interest rate changes, competition, regulatory requirements and a change in our product mix. Changes in key variable market interest rates such as the Federal Funds, National Prime, LIBOR or Treasury rates generally impact our interest rate spread. Because of the differences in maturities and repricing characteristics of the Company’s interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities. Increases in interest rates may result in a change in the mix of noninterest and interest-bearing deposit accounts. Rising interest rates may cause our funding costs to increase at a faster pace than the yield we earn on our assets, ultimately causing our net interest margin to decrease. Higher interest rates may also result in lower mortgage production income and increased charge-offs in certain segments of the loan portfolio, such as CRE and home equity. In contrast, declining interest rates would increase the Bank’s lending capacity, decrease funding cost, increase prepayments of loans and mortgage related securities, as borrowers refinance to reduce borrowing costs. Accordingly, changes in levels of interest rates could materially and adversely affect our net interest income, net interest margin, cost of deposits, loan origination volume, average loan portfolio balance, asset quality, liquidity and overall profitability.
Reforms to and uncertainty regarding LIBOR may adversely affect our business. On July 27, 2017, the United Kingdom (“U.K.”)’s Financial Conduct Authority (“FCA”), which regulates LIBOR, announced that it will no longer compel banks to submit rates for the calculation of LIBOR after 2021. In June 2017, U.S. Federal Reserve Bank's Alternative Reference Rates Committee (“ARRC”) selected the SOFR as the preferred alternative rate to LIBOR. SOFR differs from LIBOR in two key respects: SOFR is a single overnight rate, while LIBOR includes rates of several tenors; and SOFR is deemed a credit risk-free rate, while LIBOR incorporates an evaluation of credit risk. In addition, the SOFR methodology has not been tested for an extended period of time, which may limit market acceptance of the use of SOFR. The ARRC and other entities intend for the transition to be economically neutral. During 2020, the ARRC has issued updated hardwired fallback language for bilateral business loans and syndicated loans, and a recommended spread methodology for non-consumer cash products, as well as guidance on several matters related to the transition. On October 23, 2020, the International Swaps and Derivatives Association, Inc. (“ISDA”) launched its 2020 IBOR Fallbacks Supplement (“Supplement”) and IBOR Fallbacks Protocol (“Protocol”). The Supplement amended ISDA’s standard definitions for interest rate derivatives to incorporate robust fallbacks for derivatives linked to certain IBORs, with the changes effective on January 25, 2021. From that date, all new cleared and non-cleared derivatives that reference the definitions include the fallbacks. The Protocol enabled market participants to incorporate the revisions into their legacy non-cleared derivatives trades with other counterparties that choose to adhere to the Protocol. The Protocol was open for adherence beginning October 23, 2020 and became effective on the same date as the Supplement, January 25, 2021. The ARRC supports the ISDA Protocol. On November 30, 2020, LIBOR’s administrator, the ICE Benchmark Administration (“IBA”), in coordination with U.K. and U.S. regulators, announced the IBA’s intention to cease publication of the one-week and two-month U.S. dollar (“USD”) LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the remaining USD LIBOR settings immediately following the LIBOR publication on June 30, 2023. Banks are encouraged to cease entering new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021. The Company created a cross-functional team to manage the communication of the Company’s transition plans with both internal and external stakeholders and to ensure that the Company appropriately updates its business processes, analytical tools, information systems and contract language to minimize disruption during and after the LIBOR transition. However, due to the uncertainty surrounding the future of LIBOR, the transition is anticipated to span several reporting periods through the end of 2021 and potentially into 2023 with newly released timing of LIBOR cessation. Since the volume of our products that are indexed to LIBOR is significant, the transition, if not sufficiently planned for and managed by our cross-functional teams, could adversely affect the Company’s financial condition and results of operations. Although implementation of the SOFR benchmark is intended to have minimal economic effect on the parties to a LIBOR-based contract, the transition from LIBOR to a new benchmark rate could result in significant increased systems compliance and legal costs. Inconsistent approaches to a transition from LIBOR to an alternative rate among different market participants and for different financial products may cause market disruption and operational problems, which could adversely affect us, including by exposing us to increased basis risk and resulting costs in connection with remediating these problems, and by creating the possibility of disagreements with counterparties. This transition may also result in our customers challenging the determination of their interest payments or entering into fewer transactions or postponing their financing needs, which could reduce the Company’s revenue and adversely impact our business. In addition, the uncertainty regarding the future of LIBOR as well as the transition from LIBOR to another benchmark rate or rates could have adverse impacts on floating-rate obligations, loans, deposits, derivatives, and other financial instruments that currently use LIBOR as a benchmark rate and, ultimately, adversely affect the Company’s results of operations and financial condition.
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The monetary policies of the federal government and its agencies could have a material adverse effect on our earnings. The Federal Reserve Board regulates the supply of money and credit in the U.S. Its policies determine in large part the cost of funds for lending and investing and also affect the return earned on those loans and investments, both of which in turn affect our net interest margin. They can also materially decrease the value of financial assets we hold. Federal Reserve policies may also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans, or could adversely create asset bubbles which result from prolonged periods of accommodative policy. This, in turn, may result in volatile markets and rapidly declining collateral values. Changes in Federal Reserve policies are beyond our control and difficult to predict. Consequently, the impact of these changes on our business and results of operations is difficult to predict.
The Company is subject to fluctuations in foreign currency exchange rates. The Company’s foreign currency translation exposure relates primarily to its China subsidiary that has its functional currency denominated in Chinese Renminbi (“RMB”). In addition, as the Company continues to expand its businesses in China and Hong Kong, certain transactions are conducted in currencies other than the USD. Although the Company has entered into derivative instruments to offset the impact of the foreign exchange fluctuations, given the volatility of exchange rates, there is no assurance that the Company will be able to effectively manage foreign currency translation risk. Fluctuations in foreign currency exchange rates could have a material unfavorable impact on the Company’s net income, therefore adversely affecting the Company’s business, results of operations and financial condition.
Risks Related to Our Capital Resources and Liquidity
As a regulated entity, we are subject to capital requirements, and a failure to meet these standards could adversely affect our financial condition. The Company and the Bank are subject to certain capital and liquidity rules, including the Basel III Capital Rules, which establish the minimum capital adequacy requirements and may require us to increase our regulatory capital or liquidity targets, increase regulatory capital ratios, or change how we calculate regulatory capital. We may be required to increase our capital levels, even in the absence of actual adverse economic conditions or forecasts, and enhance capital planning based on hypothetical future adverse economic scenarios. As of December 31, 2020, we met the requirements of the Basel III Capital Rules, including the capital conservation buffer. Compliance with these capital requirements may limit capital-intensive operations and increase operational costs, and we may be limited or prohibited from distributing dividends or repurchasing our stock. This could adversely affect our ability to expand or maintain present business levels, which may adversely affect our businesses, results of operations and financial condition. Additional information on the regulatory capital requirements applicable to the Company and the Bank is set forth in Item 1. Business — Supervision and Regulation — Capital Requirements in this Form 10-K.
The Company’s dependence on dividends from the Bank could affect the Company’s liquidity and ability to pay dividends. East West is dependent on the Bank for dividends, distributions and other payments. Our principal source of cash flows, including cash flows to pay dividends to our stockholders and principal and interest on our outstanding debt, is dividends received from the Bank. The ability of the Bank to pay dividends to East West is limited by federal and California law. Subject to the Bank meeting or exceeding regulatory capital requirements, regulatory approval is required under federal law if the total of all dividends declared by the Bank in any calendar year would exceed the sum of the Bank’s net income for that year and its retained earnings for the preceding two years. Federal law also prohibits the Bank from paying dividends that would be greater than its undivided profits, unless the Bank has received prior approval of the Federal Reserve and of at least two-thirds of the shareholders of each class of stock. Likewise, California law imposes its own limitations on capital distributions by California-charted banks that could require the Bank to obtain the approval of the DFPI prior to making a distribution to the Company. In addition, Federal Reserve guidance sets forth the supervisory expectation that bank holding companies will inform and consult with the Federal Reserve in advance of issuing a dividend that exceeds earnings for the quarter and should not pay dividends in a rolling four quarter period in an amount that exceeds net income, net of distributions, for the period. Further description of regulatory requirements applicable to dividends by us and the Bank is set forth in Item 1. Business — Supervision and Regulation — Dividends and Other Transfers of Funds in this Form 10-K.
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The Company is subject to liquidity risk, which could negatively affect the Company’s funding levels. Market conditions or other events could negatively affect the level of or cost of funding, which in turn could affect the Company’s ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, or fund asset growth and new business initiatives at a reasonable cost, in a timely manner and without adverse consequences. Although the Company has implemented strategies to maintain sufficient and diverse sources of funding to accommodate planned, as well as unanticipated changes in assets, liabilities, and off-balance sheet commitments under various economic conditions, a substantial, unexpected or prolonged change in the level or cost of liquidity could have a material adverse effect on the Company’s businesses, results of operations and financial condition. If the cost effectiveness or the availability of supply in the credit markets is reduced for a prolonged period of time, the Company’s funding needs may require the Company to access funding and manage liquidity by other means. These alternatives may include generating client deposits, securitizing or selling loans, and further managing loan growth and investment opportunities. These alternative means of funding may not be available under stressed market conditions or realized in a timely fashion.
Any downgrades in our credit ratings could have a material adverse effect on our liquidity, cost of funding, cash flows, results of operations and financial condition. Credit rating agencies regularly evaluate us, and their ratings are based on a number of factors, including our financial strength, capital adequacy, liquidity, asset quality and ability to generate earnings. Some of these factors are not entirely within our control, including conditions affecting the financial services industry as a whole. Severe downgrades in credit ratings could impact our business and reduce the Company’s profitability in different ways, including a reduction in the Company’s access to capital markets, triggering additional collateral or funding obligations which could negatively affect our liquidity. In addition, our counterparties, as well as our clients, rely on our financial strength and stability and evaluate the risks of doing business with us. If we experience a decline in our credit rating, this could result in a decrease in the number of counterparties and clients who may be willing to transact with us. Our borrowing costs may also be affected by various external factors, including market volatility and concerns or perceptions about the financial services industry. There can be no assurance that we can maintain our credit ratings nor that they will be lowered in the future.
Risks Related to Credit Matters
The Company’s allowance for credit losses level may not be adequate to cover actual losses. In accordance with U.S. GAAP, we maintain an allowance for loan losses to provide for loan defaults and nonperformance, and an allowance for unfunded credit commitments which, when combined, are referred to as the allowance for credit losses. Our allowance for loan losses is based on our evaluation of risks associated with our loans held-for-investment portfolio, including historical loss experience, current economic conditions, reasonable and supportable forecasts of future economic conditions, delinquencies, performing status, the size and composition of the loan portfolio, and concentrations within the portfolio. The allowance estimation process requires subjective and complex judgments, including analysis of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. Current economic conditions in the U.S. and in the international markets could further deteriorate, which could result in, among other things, greater than expected deterioration in credit quality of our loan portfolio or in the value of collateral securing these loans. Our allowance for credit losses may not be adequate to absorb actual credit losses, and future provisions for credit losses could materially and adversely affect our operating results. The amount of future losses is influenced by changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates.
Moreover, we adopted new guidance for estimating credit losses on loans receivable, held-to-maturity debt securities, and unfunded loan commitments effective January 1, 2020. The CECL model significantly changed how entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses that occur over the life of the financial asset. This requires reserves over the life of the loan rather than the loss emergence period used in the prior model. The CECL guidance requires the implementation of new modeling to quantify this estimate by using principles of not only relevant historical experience and current conditions, but also reasonable and supportable forecasts of future events and circumstances, thus incorporating a broad range of estimates and assumptions in developing credit loss estimates, which could result in significant changes to both the timing and amount of credit loss expense and allowance. Adoption of, and efforts to implement this guidance has caused and may in the future cause our allowance for credit losses to change, which could have a material adverse effect on our businesses, financial condition, results of operations and future prospects.
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Additionally, in order to maximize the collection of loan balances, we sometimes modify loan terms when there is a reasonable chance that an appropriate modification would allow the borrower to continue servicing the debt. If such modifications ultimately are less effective at mitigating loan losses than we expect, we may incur losses in excess of the specific amount of allowance for loan losses associated with a modified loan, and this would result in additional provision for loan losses. In addition, we establish a reserve for losses associated with our unfunded credit commitments. The level of the allowance for unfunded credit commitments is determined by following a methodology similar to that used to establish our allowance for loan losses in our loans held-for-investment portfolio. There can be no assurance that our allowance for unfunded credit commitments will be adequate to provide for the actual losses associated with our unfunded credit commitments. An increase in the allowance for unfunded credit commitments in any period may result in a charge to earnings.
We may be subject to increased credit risk and higher credit losses to the extent that our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral. Our credit risk and credit losses can increase if our loans are concentrated in borrowers affected by the same or similar economic conditions in the markets in which we operate or elsewhere, which could result in materially higher credit losses. For example, the Bank has a concentration of real estate loans in California. Potential deterioration in the California real estate market could result in additional loan charge-offs and provision for loan losses, which could have a material adverse effect on the Company’s business, results of operations and financial condition. If any particular industry or market sector were to experience economic difficulties, loan collectability from customers operating in those industries or sectors may differ from what we expected, which could have a material adverse impact on our results of operations and financial condition.
Risks Related to Our Operations
A failure in or breach of our operational or security systems or infrastructure, or those of third parties, could disrupt our businesses, and adversely impact our results of operations, financial condition, cash flows, and liquidity, as well as cause reputational harm. The potential for operational risk exposure exists throughout our organization and from our interactions with third parties. Our operational and security systems, infrastructure, including our computer systems, network infrastructure, data management and internal processes, as well as those of third parties, are integral to our performance. In addition, our ongoing operations rely on our employees and third parties, who may, as a result of human error or malfeasance or failure or breach of third-party systems or infrastructure, expose us to risk. We have taken measures to implement backup systems and safeguards to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to the third parties with whom we interact. In addition, our ability to implement backup systems and other safeguards with respect to third-party systems is more limited than with respect to our own systems. Our financial, accounting, data processing, backup or other operating or security systems and infrastructure may fail to operate properly or may become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control which could adversely affect our ability to process transactions or provide certain services. There could be electrical, telecommunications or other major physical infrastructure outages, natural disasters such as wildfires, disease pandemics, earthquakes, tornadoes, hurricanes and floods, and events arising from local or larger scale political or social matters, including terrorist acts. We continuously update these systems to support our operations and growth, and this entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones. Operational risk exposures could adversely impact our results of operations, financial condition, cash flows, and liquidity, and may result in loss of confidence, significant litigation exposure and harm to our reputation.
23
A cyber-attack, information or security breach, or a technology failure of our systems or of a third party’s systems could adversely affect our ability to conduct business, manage our exposure to risk or expand our businesses. This could also result in the misuse of confidential or proprietary information, increase our costs to maintain and update our operational and security systems and infrastructure, and adversely impact our results of operations, financial condition, cash flows and liquidity, as well as result in reputational harm. The Company offers various internet-based services to its clients, including online banking services. The secure transmission of confidential information over the internet is essential in maintaining our clients’ confidence in the Company’s online services. In addition, our business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact. Cyber security risks, including ransomware and malware attacks, for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunication technologies to conduct financial transactions, especially as more employees are working remotely, and the increased sophistication and activities of organized crime, hackers, terrorists, nation-states and other external parties. Our business rely on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. We rely on digital technologies, computer, database and email systems, software and networks; notwithstanding our defensive systems and processes that are designed to prevent security breaches and periodically test the Company’s security. The Company employs a combination of preventative and detective controls such as firewalls, intrusion detection systems, data loss prevention, anti-malware, endpoint detection and response solutions to safeguard against cyber-attacks. There is no assurance that all of our security measures will be effective, especially as the threat from cyber-attacks is continuous and severe, attacks are becoming more sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures. Failure to mitigate breaches of security, or to comply with frequent imposition of increasingly demanding new and changing industry standards and regulatory requirements, could result in violation of applicable privacy laws, reputational damage, regulatory fines, litigation exposure, increase security compliance costs, affect the Company’s ability to offer and grow the online services, and could have an adverse effect on the Company’s businesses, results of operations and financial condition. We have not experienced any known attacks on our information technology systems that have resulted in any material system failure, incident or security breach to date.
Failure to keep pace with technological change could adversely affect the Company’s businesses. The Company may face risks associated with the ability to utilize information technology systems to support our operations effectively. The financial services industry is continuously undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Company’s businesses and, in turn, the Company’s results of operations and financial condition. In addition, if we do not implement systems effectively or if our outsourcing business partners do not perform their functions properly, there could be an adverse effect on us. There can be no assurance that we will be able to effectively maintain or improve our systems and processes, or utilize outsourced talent, to meet our business needs efficiently. Any such failure could adversely affect our businesses, results of operations, financial condition and reputation.
The actions and soundness of other financial institutions could affect the Company. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company executes transactions with various counterparties in the financial industry, including broker-dealers, commercial banks and investment banks. Defaults by financial services institutions and uncertainty in the financial services industry in general could lead to market-wide liquidity problems and may expose the Company to credit risk. Further, the Company’s credit risk may increase when the underlying collateral held cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to the Company. Any such losses could materially and adversely affect the Company’s businesses, results of operations and financial condition.
The Company’s controls and procedures could fail or be circumvented. Management regularly reviews and updates the Company’s internal controls, reporting controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met. Any failure or circumvention of the Company’s controls and procedures, and any failure to comply with regulations or supervisory expectations related to controls and procedures could adversely affect the Company’s businesses, results of operations and financial condition.
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The Company is dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect the Company’s prospects. Competition for qualified personnel in the banking industry is intense and there is a limited number of qualified persons with knowledge of, and experience in, the regional banking industry, especially in the West Coast market. The process of recruiting personnel with the combination of skills and attributes required to carry out the Company’s strategies is often lengthy. The Company’s success depends, to a significant degree, upon its ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel, as well as upon the continued contributions of its management and personnel. In particular, the Company’s success has been and continues to be highly dependent upon the abilities of certain key executives.
We face strong competition in the financial services industry and we could lose business or suffer margin declines as a result. The Company operates in a highly competitive environment. The Company conducts the majority of its operations in California. Our competitors include commercial banks, savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other regional, national, and global financial institutions. Some of the major competitors include multinational financial service companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates on loans and deposits, customer services, and a range of price and quality of products and services, including new technology-driven products and services. Failure to attract and retain banking customers may adversely impact the Company’s loan and deposit growth.
The Company has engaged in and may continue to engage in further expansion through acquisitions, which could negatively affect the Company’s businesses and earnings. There are risks associated with expanding through acquisitions. These risks include, among others, incorrectly assessing the asset quality of a bank acquired in a particular transaction, encountering greater than anticipated costs in integrating acquired businesses, failing to retain customers or employees, and being unable to profitably deploy assets acquired in the transaction. Additional country or region-specific risks are associated with transactions outside the U.S., including in Greater China. To the extent the Company issues capital stock in connection with additional transactions, these transactions and related stock issuances may have a dilutive effect on earnings per share (“EPS”) and share ownership.
Risks Related to Regulatory, Compliance and Legal Matters
Changes in current and future legislation and regulation may require the Company to change its business practices, increase costs, limit the Company’s ability to make investments and generate revenue, or otherwise adversely affect business operations and/or competitiveness. EWBC is subject to extensive regulation under federal and state laws, as well as supervision and examination by the DFPI, FDIC, Federal Reserve, SEC, CFPB, and other government agencies and self-regulatory organizations. We are also subject to enforcement oversight by the U.S. Department of Justice and state attorneys general. Our overseas operations in Greater China are subject to extensive regulation under the laws of those jurisdictions as well as supervision and examinations by financial regulators for those jurisdictions. Moreover, regulation of the financial services industry continues to undergo major changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies could affect the manner in which EWBC conducts business. In addition, such changes could also subject us to additional costs and may limit the types of financial services and products we offer, and the investments we make.
Given that banks operate in an extensively regulated environment under federal and state law, good standing with our regulators is of fundamental importance to the continuation and growth of our businesses. In the performance of their supervisory and enforcement duties, U.S. federal and state regulators, and non-U.S. regulators have significant discretion and power to initiate enforcement actions for violations of laws and regulations, and unsafe and unsound practices. Further, regulators and bank supervisors continue to exercise qualitative supervision of our industry and specific business operations and related matters. Violations of laws and regulations or deemed deficiencies in risk management or other qualitative practices also may be incorporated into the Company’s bank supervisory ratings. A downgrade in these ratings, or other enforcement actions or supervisory criticisms could limit the Company’s ability to pursue acquisitions or conduct other expansionary activities and require new or additional regulatory approvals before engaging in certain other business activities, as well as result in civil monetary penalties, other sanctions, and damage to our reputation, all of which could adversely affect our business, financial condition, results of operations and future prospects.
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Failure to comply with laws, regulations or policies could result in civil or criminal sanctions by U.S. federal and state, and non-U.S. agencies, the loss of FDIC insurance, the revocation of our banking charter, civil or criminal monetary penalties and/or reputational damage, which could have a material adverse impact on the Company’s businesses, results of operations and financial condition. We continue to adjust to our businesses and operations, capital, policies, procedures and controls to comply with these laws and regulations, final rulemaking, and interpretations from the regulatory authorities. See Item 1. Business — Supervision and Regulation for more information about the regulations to which we are subject.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations. The BSA, the PATRIOT Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective AML program and file suspicious activity reports and currency transaction reports when appropriate. We are also required to ensure our third party vendors adhere to BSA laws and regulations. Financial Crimes Enforcement Network is authorized to implement, administer, and enforce compliance with the BSA and associated regulations. It has the authority to impose significant civil money penalties for violations of those requirements and has been engaging in coordinated enforcement efforts with the federal and state banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and the Internal Revenue Service (“IRS”). Further, we may provide banking services to customers considered to be higher risk customers, which subjects us to greater enforcement risk under the BSA.
We are also required to comply with U.S. economic and trade sanctions administered by OFAC regarding, among other things, the prohibition of transacting business with, and the need to freeze assets of, certain persons and organizations identified as a threat to the national security, foreign policy or economy of the U.S. A violation of any AML or OFAC-related law or regulation could subject us to significant civil and criminal penalties as well as regulatory enforcement actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including any acquisition plans. Any of these violations could have a material adverse effect on our businesses, results of operations, financial condition, reputation and future prospects.
We are subject to significant financial and reputational risk arising from lawsuits and other legal proceedings. We face significant risk from lawsuits and claims brought by consumers, borrowers and counterparties. These actions include claims for monetary damages, penalties and fines, as well as demands for injunctive relief. If these lawsuits or claims, whether founded or unfounded, are not resolved in a favorable manner to us, they could lead to significant financial obligations for the Company, as well as restrictions or changes to how we conduct our businesses. Although we establish accruals for legal matters when and as required by GAAP and certain expenses and liabilities in connection with such matters may or may not be covered by insurance, the amount of loss ultimately incurred in relation to those matters may be substantially higher than the amounts accrued and/or insured. Substantial legal liability could adversely affect our business, results of operations, and financial condition. In addition, we may suffer significant reputational harm as a result of lawsuits and claims, adversely impacting our ability to attract and retain customers and investors. Moreover, it may be difficult to predict the outcome of certain legal proceedings, which may present additional uncertainty to our business prospects.
Risks Related to Accounting and Tax Matters
Changes in accounting standards or changes in how the accounting standards are interpreted or applied could materially impact the Company’s financial statements. The preparation of the Company’s financial statements is based on accounting standards established by the FASB and the SEC. From time to time, these accounting standards may change and such changes may have a material impact on the Company’s financial statements. In addition, the FASB, SEC, banking regulators and the Company’s independent registered public accounting firm may amend or reverse their previous interpretations or positions on how various standards should be applied. These changes may be difficult to predict and could impact how we prepare and report the Company’s financial statements. In some cases, the Company could be required to adopt a new or revised standard retroactively, potentially resulting in restatements to a prior period’s financial statements.
The Company’s consolidated financial statements are based in part on assumptions and estimates which, if incorrect, could cause unexpected losses in the future. Pursuant to GAAP, we are required to use certain assumptions and estimates in preparing our financial statements, including in determining credit loss reserves, reserves related to litigation and the fair value of certain assets and liabilities, among other items. Accounting policies related to these estimates and assumptions are critical because they require management to make subjective and complex judgments about matters that are inherently uncertain. If these estimates and assumptions are incorrect, we may be required to restate prior-period financial statements. For a description of these policies, refer to Note 1 — Summary of Significant Accounting Policies to the Consolidated Financial Statements in this Form 10-K.
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Changes to fiscal policies and tax legislation may adversely affect our business. From time to time, the U.S. government may introduce new fiscal policies and tax laws or make substantial changes to existing tax legislation. These changes could have a material impact on the Company’s businesses, results of operations and financial condition. The Company’s positions or its actions taken prior to such changes, may be compromised by such changes. In addition, the Company’s actions taken in response to, or in reliance upon, such changes in the tax laws may impact our tax position in a manner that may result in adverse financial conditions. The Company also provides for current and deferred taxes in our financial statements, based on our results of operations and financial condition. We may take tax return filing positions for which the final determination of tax is uncertain and our income tax expense could be increased if a federal, state, or local authority were to assess additional taxes that have not been provided for in our consolidated financial statements. There can be no assurance that we will achieve our anticipated effective tax rate. The CARES Act included a number of tax relief provisions for eligible individuals and businesses. It is possible that the U.S. government could further introduce new tax legislation or amend current tax laws that would adversely affect the Company. In addition, the President’s proposed budget, negotiations with Congress over the details of the budget, and the terms of the approved budget could create uncertainty about the U.S. economy, ultimately having an adverse effect on our business.
The Company’s investments in certain tax-advantaged projects may not generate returns as anticipated and may have an adverse impact on the Company’s results of operations. The Company invests in certain tax-advantaged investments that support qualified affordable housing projects, community development and renewable energy resources. The Company’s investments in these projects are designed to generate a return primarily through the realization of federal and state income tax credits, and other tax benefits, over specified time periods. Due diligence review is performed both prior to the initial investment and on an ongoing basis, however, there may be assessments that we failed or were unable to discover or identify in the course of performing due diligence review. The Company is subject to the risk that previously recorded tax credits, which remain subject to recapture by taxing authorities based on compliance features required to be met at the project level, may fail to meet certain government compliance requirements and may not be able to be realized. The possible inability to realize these tax credits and other tax benefits may have a negative impact on the Company’s financial results. The risk of not being able to realize the tax credits and other tax benefits depends on many factors outside the Company’s control, including changes in the applicable tax code and the ability of the projects to be completed.
General Risk Factors
Anti-takeover provisions could negatively impact the Company’s stockholders. Provisions of Delaware and California law and of the Company’s certificate of incorporation, as amended, and bylaws could make it more difficult for a third party to acquire control of the Company or could have the effect of discouraging a third party from attempting to acquire control of the Company. For example, the Company’s certificate of incorporation requires the approval of the holders of at least two-thirds of the outstanding shares of voting stock to approve certain business combinations. The Company is also subject to Section 203 of the Delaware General Corporation Law, which would make it more difficult for another party to acquire the Company without the approval of the Board of Directors. Additionally, the Company’s certificate of incorporation, as amended, authorizes the Board of Directors to issue preferred stock which could be issued as a defensive measure in response to a takeover proposal.
Further, prior approval of the Federal Reserve and the DFPI is required for any person to acquire control of us, and control for these purposes may be presumed to exist when a person owns 10% or more of our outstanding common stock. Federal Reserve approval is also required for a bank holding company to acquire more than 5% of our outstanding common stock. These and other provisions could make it more difficult for a third party to acquire the Company, even if an acquisition might be in the best interest of the stockholders.
Managing reputational risk is important to attracting and maintaining customers, investors and employees. Threats to the Company’s reputation can come from many sources, including unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of the Company’s customers. The Company has policies and procedures in place to protect its reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding the Company’s businesses, employees or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.
The price of the Company’s common stock may be volatile or may decline. The price of the Company’s common stock may fluctuate in response to a number of factors, some of which are outside the Company’s control. These factors include, among other things:
•actual or anticipated quarterly fluctuations in the Company’s results of operations and financial condition;
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•changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts and rating agencies;
•speculation in the press or investment community;
•strategic actions by the Company or its competitors, such as acquisitions or restructurings;
•actions by institutional stockholders;
•addition or departure of key personnel;
•fluctuations in the stock price and operating results of the Company’s competitors;
•general market conditions and, in particular, developments related to market conditions in the financial services industry;
•proposed or adopted regulatory changes or developments;
•cyclical fluctuations;
•trading volume of the Company’s common stock; and
•anticipated or pending investigations, proceedings or litigation that involve or affect the Company.
Industry factors, general economic and political conditions and events, such as cyber or terrorist attacks, economic downturn or recessions, interest rate changes, credit default trends, currency fluctuations, changes to trade policies or public health issues could also cause our stock price to decline regardless of our operating results. A significant decline in the Company’s stock price could result in substantial losses for stockholders.
If the Company’s goodwill was determined to be impaired, it would result in a charge against earnings and thus a reduction in stockholders’ equity. The Company tests goodwill for impairment on an annual basis, or more frequently, if necessary. A significant decline in our expected future cash flows, a material change in interest rates, a significant adverse change in the business climate, slower growth rates, or a significant or sustained decline in the price of the Company’s common stock may necessitate taking charges in the future related to the impairment of goodwill. If the Company determines that a future write-down of goodwill is necessary, the amount of such impairment charge could be significant and could adversely affect earnings as well as capital.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
East West’s corporate headquarters is located at 135 North Los Robles Avenue, Pasadena, California, an eight-story office building that it owns. The Company operates in 116 locations in the U.S. and eight locations in Greater China. In the U.S., the Bank’s corporate headquarters and main administrative offices are located in California, and branches are located in California, Texas, New York, Washington, Georgia, Massachusetts and Nevada. In Greater China, East West’s presence includes full service branches in Hong Kong, Shanghai, Shantou and Shenzhen, and representative offices in Beijing, Chongqing, Guangzhou and Xiamen.
As of December 31, 2020, the Bank owns approximately 154,000 square feet of property at 19 U.S. locations and leases approximately 783,000 square feet in the remaining U.S. locations. Expiration dates for these leases range from 2021 to 2036, exclusive of renewal options. The Bank leases all of its branches and offices in Greater China, totaling approximately 58,000 square feet. Expiration dates for these leases range from 2021 to 2026. All properties occupied by the Bank are used across all business segments and for corporate purposes.
On an ongoing basis, the Company evaluates its current and projected space requirements and, from time to time, it may determine that certain premises or facilities are no longer necessary for its operations. The Company believes that, if necessary, it could secure alternative properties on similar terms without adversely affecting its operations.
ITEM 3. LEGAL PROCEEDINGS
See Note 12 — Commitments, Contingencies and Related Party Transactions — Litigation to the Consolidated Financial Statements in this Form 10-K, which is incorporated herein by reference.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information, Holders of Common Stock and Dividends
The Company’s common stock is traded on the Nasdaq Global Select Market under the symbol “EWBC.” As of January 31, 2021, the Company had 712 stockholders of record holding 141,565,473 shares of the Company’s common stock, not including beneficial owners whose shares are held in record names of brokers or other nominees.
Holders of the Company’s common stock are entitled to receive cash dividends when declared by the Company’s Board of Directors out of legally available funds. The Board of Directors presently intends to continue the policy of paying quarterly cash dividends, however, there can be no assurance as to future dividends because they are dependent on the Company’s future earnings, capital requirements and financial condition.
Securities Authorized for Issuance under Equity Compensation Plans
For information regarding securities authorized for issuance under the Company’s equity compensation plans, see Note 13 — Stock Compensation Plans to the Consolidated Financial Statements and Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters presented elsewhere in this Form 10-K, which are incorporated herein by reference.
Five-Year Stock Performance
The following graph and table compare the Company’s cumulative total return on its common stock with the cumulative total return of the Standard & Poor’s (“S&P”) 500 Index and the Keefe, Bruyette and Woods Nasdaq Regional Banking Index (“KRX”) over the five-year period through December 31, 2020. The S&P 500 Index is utilized as a benchmark against performance and is a commonly referenced U.S. equity benchmark consisting of leading companies from different economic sectors. The KRX is used to align EWBC with those companies of a relatively similar size. This index seeks to reflect the performance of publicly traded U.S. companies that do business as regional banks or thrifts, and is composed of 50 companies. The graph and table below assume that on December 31, 2015, $100 was invested in EWBC’s common stock, the S&P 500 Index and the KRX, and that all dividends were reinvested. Historical stock price performance shown on the graph is not necessarily indicative of future price performance. The information set forth under the heading “Five-Year Stock Performance” shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to the liabilities of Section 18 of the Exchange Act, except to the extent that the Company specifically requests that such information to be treated as soliciting material or specifically to be incorporated by reference into a filing under the Securities Act or the Exchange Act.
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| December 31, | ||||||||||||||||||||||||||||||||||||||
| Index | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | ||||||||||||||||||||||||||||||||
| East West Bancorp, Inc. | $100.00 | $124.90 | $151.60 | $110.20 | $126.10 | $135.50 | ||||||||||||||||||||||||||||||||
| KRX | $100.00 | $139.00 | $141.50 | $116.70 | $144.50 | $131.90 | ||||||||||||||||||||||||||||||||
| S&P 500 Index | $100.00 | $112.00 | $136.40 | $130.40 | $171.50 | $203.00 | ||||||||||||||||||||||||||||||||
Repurchases of Equity Securities by the Issuer and Affiliated Purchasers
On March 3, 2020, the Company’s Board of Directors authorized the repurchase of up to $500.0 million of the Company’s common stock. This $500.0 million repurchase authorization is inclusive of the unused portion of the Company’s $100.0 million stock repurchase authorization previously outstanding in 2013. The share repurchase authorization has no expiration date. In March 2020, the Company repurchased 4,471,682 shares at an average price of $32.64 per share and a total cost of $146.0 million. The Company’s total remaining available share repurchase authorization as of December 31, 2020 was $354.0 million. The Company did not repurchase any shares during 2019 and 2018.
ITEM 6. SELECTED FINANCIAL DATA
Information in response to this Item 6 can be found in Item 7. MD&A — Five-Year Summary of Selected Financial Data, which is incorporated herein by reference.
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EAST WEST BANCORP, INC.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
TABLE OF CONTENTS
| Page | |||||||||||
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Overview
The following discussion provides information about the results of operations, financial condition, liquidity and capital resources of East West Bancorp, Inc. (referred to herein on an unconsolidated basis as “East West” and on a consolidated basis as the “Company,” “we” or “EWBC”), and its subsidiaries, including its subsidiary bank, East West Bank and its subsidiaries (referred to herein as “East West Bank” or the “Bank”). This information is intended to facilitate the understanding and assessment of significant changes and trends related to the Company’s results of operations and financial condition. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the accompanying notes presented elsewhere in this Form 10-K.
Company Overview
East West is a bank holding company incorporated in Delaware on August 26, 1998 and is registered under the BHC Act. The Company commenced business on December 30, 1998 when, pursuant to a reorganization, it acquired all of the voting stock of the Bank, which became its principal asset. The Bank is an independent commercial bank headquartered in California that has a strong focus on the financial service needs of the Asian-American community. Through over 120 locations in the U.S. and Greater China, the Company provides a full range of consumer and commercial products and services through three business segments: Consumer and Business Banking, Commercial Banking, with the remaining operations included in Other. The Company’s principal activity is lending to and accepting deposits from businesses and individuals. The primary source of revenue is net interest income, which is principally derived from the difference between interest earned on loans and debt securities and interest paid on deposits and other funding sources. As of December 31, 2020, the Company had $52.16 billion in assets and approximately 3,200 full-time equivalent employees. For additional information on products and services provided by the Bank, see Item 1. Business — Banking Services.
Corporate Strategy
We are committed to enhancing long-term shareholder value by executing on the fundamentals of growing loans, deposits and revenue, improving profitability, and investing for the future while managing risks, expenses and capital. Our business model is built on customer loyalty and engagement, understanding of our customers’ financial goals, and meeting our customers’ financial needs through our diverse products and services. The Company’s approach is concentrated on seeking out and deepening client relationships that meet our risk/return measures. This focus guides our decision-making across every aspect of our operations: the products we develop, the expertise we cultivate and the infrastructure we build to help our customers conduct businesses. We expect our relationship-focused business model to continue to generate organic growth and to expand our targeted customer bases. On an ongoing basis, we invest in technology to improve the customer user experience, strengthen critical business infrastructure, and streamline core processes, while appropriately managing operating expenses. Our risk management activities are focused on ensuring that the Company identifies and manages risks to maintain safety and soundness while maximizing profitability.
Coronavirus Disease 2019 Global Pandemic
The COVID-19 pandemic has caused significant disruption around the world, as well as economic and financial market deterioration, which did not exist at the beginning of 2020. These economic and operating conditions caused by the COVID-19 pandemic have created financial difficulties for many of the Company’s commercial and consumer customers. As a result, some borrowers may not be able to satisfy their obligations to us. As many of the Company’s loans are secured by real estate, a potential decline in the real estate markets could also negatively impact the Company’s business, financial condition and the credit quality of the Company’s loan portfolio. It has adversely affected, and is likely continue to adversely affect, our business, financial condition and results of operations. We cannot predict at this time the scope and duration of the pandemic as the COVID-19 pandemic has not yet been contained. While there have been various governmental and other responses to slow or control the spread of the COVID-19 pandemic, and to mitigate its adverse impacts, such as stay-at-home orders, restrictions on business activities, economic relief for individuals and businesses, and monetary policy measures, these responses have met varying degrees of success, and it remains uncertain whether these actions will be successful as the pandemic continues. Although effective vaccines have been developed, their distribution is still in the early stages and it is uncertain how long the process will take to complete, nationally or globally.
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Regulatory Developments Relating to the COVID-19 Pandemic
Coronavirus Aid, Relief, and Economic Security Act — The CARES Act was enacted on March 27, 2020 to lessen the economic impact of the COVID-19 pandemic on individuals, businesses and local economies. The CARES Act initiatives included extended unemployment benefits, mortgage forbearance, the SBA PPP and funding and authorization for the MSLP. The Company participated in the Federal Reserve’s MSLP and funded $233.6 million in MSLP loans as of December 31, 2020. The related Main Street special purpose vehicle purchased participations in these loans which amounted to $221.9 million or 95%. The CARES Act also required mortgage servicers to grant, on a borrower’s request, forbearance for up to 180 days (which could be extended for up to another 180 days) on a federally-backed single-family mortgage loan or forbearance up to 30 days (which could be extended for two additional 30-day periods) on a federally-backed multifamily mortgage loan when the borrowers experience financial hardship due to the COVID-19 pandemic.
In response to the continued market disruption and economic impact of the COVID-19 pandemic, President Trump signed into law the CAA on December 27, 2020. The CAA contains a variety of provisions for emergency relief to individuals and business related to the COVID-19 pandemic, including measures to, among other things, provide additional funding to businesses, facilitate emergency capital investments by community development financial institutions, fund rental assistance for certain individuals and extend regulatory relief relating to the adoption of CECL until the earlier of the first day of the fiscal year of the institution that begins after the national emergency termination date or January 1, 2022. The CAA provided additional funding to the PPP, expanded eligibility of businesses for the PPP, extended the PPP to March 31, 2021, and allows eligible borrowers to obtain a second PPP loan (“second draw”) up to a maximum amount of $2 million. Second draw PPP borrowers are eligible for loan forgiveness on the same terms as the first draw borrowers. The CAA also simplified the loan forgiveness process for first and second draw borrowers with PPP loans of $150,000 or less and includes a “hold harmless” provision, which provides that a lender may rely on any certification or documentation submitted by a borrower for a PPP loan and that no enforcement action may be taken against the lender, and the lender will not be subject to any penalties relating to loan origination or forgiveness, if (i) the lender acts in good faith relating to loan origination or forgiveness and (ii) all other applicable statutory and regulatory requirements are satisfied.
Paycheck Protection Program — The PPP provides forgivable loans to businesses in order to keep their employees on the payroll and make certain other eligible payments. The SBA guarantees 100% of the PPP loans made to eligible borrowers, and the entire principal amount and any accrued interest on the loans are eligible to be forgiven if certain conditions are met, at which point the SBA will pay the bank that originated the PPP loan the forgiven amount. The Company is a participant in the PPP. As of December 31, 2020, the Company had approximately 6,200 PPP loans outstanding with balances totaling $1.57 billion, which were recorded in the commercial and industrial (“C&I”) portfolio. Related to the PPP loans made in 2020, as of February 25, 2021, the Company has submitted and received approval from the SBA for forgiveness approximately 2,700 PPP loan applications, totaling $341.9 million. In January 2021, the Company began processing applications under the newly funded PPP, largely second draw PPP loans. Since the start of the second draw PPP through February 25, 2021, the Company has funded over 4,300 new PPP loans, totaling $700.3 million.
Other U.S. Government Facilities and Programs — In connection with our participation in the PPP under the CARES Act as discussed above, the Company participated in the PPPLF. During the second quarter of 2020, the Federal Reserve established the PPPLF to allow eligible lenders to facilitate lending under the SBA’s PPP, taking PPP loans as collateral. The Company drew down $1.44 billion from the Federal Reserve PPPLF and pledged the same amount in PPP loans as collateral during the second quarter of 2020. The Company paid off the outstanding amounts under the PPPLF in full during the fourth quarter of 2020.
Loan Modifications — The CARES Act and related guidance from the federal banking agencies provide financial institutions the option to temporarily suspend requirements under GAAP related to classification of certain loan modifications as TDRs to account for the current and anticipated effects of the COVID-19 pandemic. The CARES Act, as amended by the CAA, specified that COVID-19 related loan modifications executed between March 1, 2020 and the earlier of (i) 60 days after the date of termination of the national emergency declared by the President and (ii) January 1, 2022, on loans that were current as of December 31, 2019 are not TDRs. Additionally, under guidance from the federal banking agencies, other short-term modifications made on a good faith basis in response to the COVID-19 pandemic to borrowers that were current prior to any relief are not TDRs under ASC Subtopic 310-40, “Troubled Debt Restructuring by Creditors.” These modifications include short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. We have granted loan modifications to our customers in the form of maturity extensions, payment deferrals and forbearance. For a summary of the loans that we have modified in response to the COVID-19 pandemic, please refer to Item 7. MD&A — Risk Management — Credit Risk Management in this Form 10-K.
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Regulatory Capital — The CARES Act requires PPP loans to be assigned a zero percent risk weight under the federal banking agencies’ risk-based capital rules. Additionally, under an interim final rule of the federal banking agencies, PPP loans that an institution pledges as collateral to the PPPLF may be deducted from the institution’s average total consolidated assets for purposes of the Tier 1 leverage ratio.
Federal Reserve Requirements — On March 26, 2020, the Federal Reserve reduced reserve requirement ratios to zero percent, eliminating the reserve requirement for all depository institutions, an action that provides liquidity in the banking system to support lending to households and businesses, in response to the economic stress stemming from the COVID-19 pandemic.
Our Response to the COVID-19 Pandemic
In response to the pandemic, the Company has implemented protocols and processes to execute its business continuity plans to help protect its employees and support its customers. The Company is managing its response to the COVID-19 pandemic according to its Enterprise Business Continuity Policy, which invokes centralized management of the crisis event and the integration of its response. The CEO and key members of the Company’s management team meet regularly with senior executives to help drive decisions, communication and consistency of response across all businesses and functions. In addition, we have implemented measures to assist our employees and customers as discussed below:
•Employees:
The majority of the Company’s employees are able to work from home. The Company continues to evaluate its continuity plans and work-from-home strategy to best protect the health and safety of its employees. For employees with jobs that are required to be performed on-site, we have taken significant actions to ensure employee safety by providing personal protection equipment, adopting social distancing measures, placing visual safety reminders related to social distancing, implementing an enhanced cleaning program, installing plexiglass panels, and requiring temperature screenings and the wearing of masks for all employees.
•Customers:
We assisted our commercial, consumer and small business clients affected by the COVID-19 pandemic through payment deferrals, suspension of foreclosures on certain residential mortgage loans, and participation in the SBA PPP and the MSLP. We intend to evaluate participation in additional new government-sponsored programs, as they are established. In addition, the Company continues to make a wide range of banking services accessible to customers through mobile and other digital channels to reduce the need for in-person branch visits.
Impact on our Financial Position and Results of Operations — Our financial position and results of operations are sensitive to the ability of our loan customers to meet loan obligations, the availability of our workforce and the decline in the value of assets held by us. While its effects continue to materialize, the COVID-19 pandemic has resulted in a significant decrease in commercial activity throughout our operating footprint. This decrease in commercial activity has caused and may continue to cause our customers to be unable to meet existing payment or other obligations to us. The greatest impact of the COVID-19 pandemic on our financial condition has been in the increase of the provision for credit losses and the allowance for loan losses. We recorded approximately $210.7 million of provision for credit losses during 2020, bringing our allowance for loan losses to $620.0 million as of December 31, 2020, with an allowance for loan losses to loans held-for-investment ratio of 1.61%. Despite the impact of the increased provision for credit losses, we maintained solid profitability for the full year of 2020, earning 1.16% on return on average assets (“ROA”) and 11.17% on return on average equity (“ROE”). Our capital ratios are strong, and we remain well-positioned from a liquidity perspective, enabling us to weather adverse economic scenarios while continuing to support our customers and invest in our business.
For additional information, see Item 7. MD&A — Risk Management — Credit Risk Management and — Liquidity Risk Management, and — Balance Sheet Analysis — Regulatory Capital and Ratios in this Form 10-K. Further discussion of the potential impacts on our business from the COVID-19 pandemic is provided under Part I, Item 1A — Risk Factors in this Form 10-K.
Accounting Standards Update 2016-13 Adoption
On January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments — Credit Losses, which establishes a single allowance framework for all financial assets carried at amortized cost, and for certain off-balance sheet exposures. Replacing the prior incurred loss model, this framework requires that management estimate credit losses over the full remaining expected life of a loan, and consider expected future changes in macroeconomic conditions. The adoption of CECL on January 1, 2020 increased the allowance for loan losses by $125.2 million, and the allowance for unfunded credit commitments by $10.5 million, and an after-tax decrease to retained earnings of $98.0 million.
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Five-Year Summary of Selected Financial Data
| ($ and shares in thousands, except per share, ratio and headcount data) | 2020 | 2019 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||
| Summary of operations: | ||||||||||||||||||||||||||||||||
Net interest income before provision for credit losses (1) | $ | 1,377,193 | $ | 1,467,813 | $ | 1,386,508 | $ | 1,185,069 | $ | 1,032,638 | ||||||||||||||||||||||
Noninterest income (2) | 235,547 | 222,245 | 217,433 | 263,654 | 186,921 | |||||||||||||||||||||||||||
| Total revenue | 1,612,740 | 1,690,058 | 1,603,941 | 1,448,723 | 1,219,559 | |||||||||||||||||||||||||||
| Provision for credit losses | 210,653 | 98,685 | 64,255 | 46,266 | 27,479 | |||||||||||||||||||||||||||
Noninterest expense (3) | 716,322 | 747,456 | 720,990 | 667,357 | 619,892 | |||||||||||||||||||||||||||
| Income before income taxes | 685,765 | 843,917 | 818,696 | 735,100 | 572,188 | |||||||||||||||||||||||||||
Income tax expense (4) | 117,968 | 169,882 | 114,995 | 229,476 | 140,511 | |||||||||||||||||||||||||||
Net income (1)(2)(3)(4) | $ | 567,797 | $ | 674,035 | $ | 703,701 | $ | 505,624 | $ | 431,677 | ||||||||||||||||||||||
| Per common share: | ||||||||||||||||||||||||||||||||
| Basic earnings | $ | 3.99 | $ | 4.63 | $ | 4.86 | $ | 3.50 | $ | 3.00 | ||||||||||||||||||||||
| Diluted earnings | $ | 3.97 | $ | 4.61 | $ | 4.81 | $ | 3.47 | $ | 2.97 | ||||||||||||||||||||||
| Dividends declared | $ | 1.10 | $ | 1.06 | $ | 0.86 | $ | 0.80 | $ | 0.80 | ||||||||||||||||||||||
| Book value | $ | 37.22 | $ | 34.46 | $ | 30.52 | $ | 26.58 | $ | 23.78 | ||||||||||||||||||||||
Non-GAAP tangible common equity per share (5) | $ | 33.85 | $ | 31.15 | $ | 27.15 | $ | 23.13 | $ | 20.27 | ||||||||||||||||||||||
| Weighted-average number of shares outstanding: | ||||||||||||||||||||||||||||||||
| Basic | 142,336 | 145,497 | 144,862 | 144,444 | 144,087 | |||||||||||||||||||||||||||
| Diluted | 142,991 | 146,179 | 146,169 | 145,913 | 145,172 | |||||||||||||||||||||||||||
| Common shares outstanding at period-end | 141,565 | 145,625 | 144,961 | 144,543 | 144,167 | |||||||||||||||||||||||||||
| Performance metrics: | ||||||||||||||||||||||||||||||||
| ROA | 1.16 | % | 1.59 | % | 1.83 | % | 1.41 | % | 1.30 | % | ||||||||||||||||||||||
| ROE | 11.17 | % | 14.16 | % | 17.04 | % | 13.71 | % | 13.06 | % | ||||||||||||||||||||||
Return on average non-GAAP tangible equity (5) | 12.42 | % | 15.88 | % | 19.48 | % | 16.03 | % | 15.62 | % | ||||||||||||||||||||||
| Total average equity to total average assets | 10.38 | % | 11.21 | % | 10.72 | % | 10.30 | % | 9.97 | % | ||||||||||||||||||||||
| Common dividend payout ratio | 27.97 | % | 23.04 | % | 17.90 | % | 23.14 | % | 27.01 | % | ||||||||||||||||||||||
| Net interest margin | 2.98 | % | 3.64 | % | 3.78 | % | 3.48 | % | 3.30 | % | ||||||||||||||||||||||
Efficiency ratio (6) | 44.42 | % | 44.23 | % | 44.95 | % | 46.07 | % | 50.83 | % | ||||||||||||||||||||||
Non-GAAP efficiency ratio (5) | 39.30 | % | 38.14 | % | 39.39 | % | 41.26 | % | 44.04 | % | ||||||||||||||||||||||
| At year end: | ||||||||||||||||||||||||||||||||
| Total assets | $ | 52,156,913 | $ | 44,196,096 | $ | 41,042,356 | $ | 37,121,563 | $ | 34,788,840 | ||||||||||||||||||||||
Total loans (7) | $ | 38,392,743 | $ | 34,778,973 | $ | 32,385,464 | $ | 29,053,935 | $ | 25,526,215 | ||||||||||||||||||||||
| AFS debt securities | $ | 5,544,658 | $ | 3,317,214 | $ | 2,741,847 | $ | 3,016,752 | $ | 3,335,795 | ||||||||||||||||||||||
| Total deposits | $ | 44,862,752 | $ | 37,324,259 | $ | 35,439,628 | $ | 31,615,063 | $ | 29,890,983 | ||||||||||||||||||||||
| Long-term debt and finance lease liabilities | $ | 151,739 | $ | 152,270 | $ | 146,835 | $ | 171,577 | $ | 186,327 | ||||||||||||||||||||||
| FHLB advances | $ | 652,612 | $ | 745,915 | $ | 326,172 | $ | 323,891 | $ | 321,643 | ||||||||||||||||||||||
Stockholders’ equity (8) | $ | 5,269,175 | $ | 5,017,617 | $ | 4,423,974 | $ | 3,841,951 | $ | 3,427,741 | ||||||||||||||||||||||
Non-GAAP tangible common equity (5) | $ | 4,791,579 | $ | 4,535,841 | $ | 3,936,062 | $ | 3,343,693 | $ | 2,922,638 | ||||||||||||||||||||||
| Head count (full-time equivalent) | 3,214 | 3,294 | 3,196 | 2,933 | 2,838 | |||||||||||||||||||||||||||
| EWBC capital ratios: | ||||||||||||||||||||||||||||||||
| CET1 capital | 12.7 | % | 12.9 | % | 12.2 | % | 11.4 | % | 10.9 | % | ||||||||||||||||||||||
| Tier 1 capital | 12.7 | % | 12.9 | % | 12.2 | % | 11.4 | % | 10.9 | % | ||||||||||||||||||||||
| Total capital | 14.3 | % | 14.4 | % | 13.7 | % | 12.9 | % | 12.4 | % | ||||||||||||||||||||||
| Tier 1 leverage capital | 9.4 | % | 10.3 | % | 9.9 | % | 9.2 | % | 8.7 | % | ||||||||||||||||||||||
Total stockholders’ equity to total assets | 10.1 | % | 11.4 | % | 10.8 | % | 10.3 | % | 9.9 | % | ||||||||||||||||||||||
Non-GAAP tangible common equity to tangible assets (5) | 9.3 | % | 10.4 | % | 9.7 | % | 9.1 | % | 8.5 | % | ||||||||||||||||||||||
(1)2020 includes $43.3 million of interest income related to PPP loans.
(2)2018 includes $31.5 million of gain recognized from the sale of the Desert Community Bank (“DCB”) branches. 2017 includes $71.7 million and $3.8 million of gains recognized from the sales of a commercial property in California and EWIS’s insurance brokerage business, respectively.
(3)2020 includes $10.7 million of recovery related to DC Solar and affiliates (“DC Solar”) tax credit investments, of which $1.1 million was recorded as an impairment recovery. 2020 also includes $8.7 million in extinguishment costs related to assets sold under repurchase agreements’ (“repurchase agreements”). 2019 includes $7.0 million in impairment charge related to DC Solar, of which $1.6 million was subsequently recovered.
(4)2020 includes $5.1 million of tax expense to record an uncertain tax position related to DC Solar. 2019 includes $30.1 million of additional tax expense to reverse certain previously claimed tax credits related to DC Solar. 2017 includes an additional $41.7 million in income tax expense recognized due to the enactment of the Tax Cuts and Jobs Act of 2017.
(5)For a discussion of non-GAAP tangible common equity per share, return on average non-GAAP tangible equity, non-GAAP efficiency ratio, non-GAAP tangible common equity and total non-GAAP tangible common equity to tangible assets, refer to Item 7. MD&A — Reconciliation of GAAP to Non-GAAP Financial Measures in this Form 10-K.
(6)The efficiency ratio is noninterest expense divided by total revenue.
(7)Includes $1.57 billion of PPP loans as of December 31, 2020.
(8)On January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments using the modified retrospective approach. The Company recorded $125.2 million increase to allowance for loan losses and $98.0 million after-tax decrease to opening retained earnings as of January 1, 2020.
35
Our MD&A reviews the financial condition and results of operations of the Company for 2020 and 2019. Some tables include additional periods to comply with disclosure requirements or to illustrate trends in greater depth. When reading the discussion in the MD&A, readers should also refer to the consolidated financial statements and related notes in this Form 10-K. The page locations of specific sections that we refer to are presented in the table of contents. To review our financial condition and results of operations for 2018 and a comparison between 2018 and 2019 results, see Item 7. MD&A of our 2019 Form 10-K filed with the SEC on February 27, 2020.
Financial Review
Noteworthy items about the Company’s performance for 2020 included:
•Earnings: 2020 net income was $567.8 million, or $3.97 per diluted share, compared with 2019 net income of $674.0 million, or $4.61 per diluted share, a decrease of $106.2 million or 16%. The decrease primarily came from a higher provision for credit losses and lower net interest income, partially offset by a decrease in income tax expense.
•Adjusted Earnings: 2020 non-GAAP net income was $565.2 million, or $3.95 per diluted share, a decrease of 20% from 2019 non-GAAP net income of $707.9 million, or $4.84 per diluted share. Non-GAAP adjustments in 2020 and 2019 exclude the impacts of the impairment, recoveries and income tax items related to the Company’s investment in DC Solar. For 2020, DC Solar-related adjustments consisted of $10.7 million in recoveries, $3.0 million of income tax expense related to the recoveries, and $5.1 million of income tax expense booked for an uncertain tax position. For 2019, DC Solar-related adjustments consisted of $7.0 million in impairment charge, $1.6 million in recovery, $1.6 million of income tax expense related to the impairment and recovery, and $30.1 million of income tax expense booked for the reversal of certain previously claimed tax credits. For additional detail, refer to the reconciliations of non-GAAP measures presented under Item 7. MD&A — Reconciliation of GAAP to Non-GAAP Financial Measures in this Form 10-K.
•Revenue: Revenue, or the sum of net interest income before provision for credit losses and noninterest income, was $1.61 billion in 2020, compared with $1.69 billion in 2019, a decrease of $77.3 million or 5%. This decrease was primarily due to lower net interest income, partially offset by an increase in noninterest income.
•Net Interest Income and Net Interest Margin: 2020 net interest income was $1.38 billion, a decrease of $90.6 million or 6%, compared with 2019 net interest income of $1.47 billion. 2020 net interest margin was 2.98%, a decrease of 66 basis points from 3.64% for 2019. The decreases in the net interest income and net interest margin reflected significantly lower interest rates year-over-year, including a 150 basis points reduction to the target federal funds rate in March 2020.
•Provision for credit losses: 2020 provision for credit losses was $210.7 million, an increase of $112.0 million or 113%, compared with $98.7 million for 2019. The year-over-year increase in the provision for credit losses reflected the deteriorating macroeconomic conditions and outlook due to the COVID-19 pandemic. Provision expense in the first half of 2020 was $176.3 million, compared with $34.4 million in the second half of 2020.
•Tax: 2020 income tax expense was $118.0 million and the effective income tax rate was 17.2%, compared with income tax expense of $169.9 million and an effective tax rate of 20.1%, for 2019. 2020 income tax expense included $8.1 million of income tax expense related to DC Solar tax credit investments; $5.1 million due to an uncertain tax position and $3.0 million of tax expense for $10.7 million of recoveries included in Amortization of tax credit and other investments. 2019 income tax expense included $30.1 million for the reversal of certain previously claimed tax credits related to DC Solar and $1.6 million of income tax benefit related to an impairment and recovery related to DC Solar.
•Profitability: 2020 ROA was 1.16%, compared with 1.59% for 2019. 2020 ROE was 11.17%, compared with 14.16% for 2019. Adjusted for the non-recurring items related to DC Solar in 2020 and 2019, 2020 non-GAAP ROA was 1.16%, compared with 1.67% for 2019. 2020 non-GAAP ROE was 11.12%, compared with 14.87% for 2019. For additional detail, refer to the reconciliations of non-GAAP measures presented under Item 7. MD&A — Reconciliation of GAAP to Non-GAAP Financial Measures in this Form 10-K.
•Loans: Total loans were $38.39 billion as of December 31, 2020, an increase of $3.61 billion or 10% from $34.78 billion as of December 31, 2019. Loan growth was well-diversified across each of the Company’s major loan portfolios of C&I, driven by PPP loan funding, single-family residential and CRE.
•Deposits: Total deposits were $44.86 billion as of December 31, 2020, an increase of $7.54 billion or 20% from $37.32 billion as of December 31, 2019. Growth was primarily driven by noninterest-bearing demand deposits and money market accounts, partially offset by a decrease in time deposits.
36
•Allowance for Loan Losses: The allowance for loan losses was $620.0 million, or 1.61% of loans held-for-investment, as of December 31, 2020, compared with $358.3 million, or 1.03% of loans held-for-investment, as of December 31, 2019. On January 1, 2020, the allowance for loan losses increased by $125.2 million, reflecting the adoption of ASU 2016-13. Between January 2 and December 31, 2020, the allowance for loan losses increased by $136.5 million, primarily reflecting the negative impact of the COVID-19 pandemic and a deterioration of the macroeconomic forecast for the first half of 2020.
•Asset Quality Metrics: Nonperforming assets were $234.9 million or 0.45% of total assets, as of December 31, 2020, an increase of $113.4 million or 93% from $121.5 million or 0.27% of total assets, as of December 31, 2019. For 2020, net charge-offs were $63.2 million or 0.17% of average loans held-for-investment, compared with net charge-offs of $52.8 million or 0.16% of average loans held-for-investment for 2019.
•Capital Levels: Our capital levels are strong. As of December 31, 2020, all of the Company’s and the Bank’s regulatory capital ratios were well above the required well-capitalized levels. See Item 7. MD&A — Balance Sheet Analysis — Regulatory Capital and Ratios in this Form 10-K for more information regarding capital.
•Capital Return: The annual cash dividend on common stock was $1.10 per share in 2020, compared with $1.055 per share in 2019. The Company returned $158.2 million and $155.1 million in cash dividends to stockholders during 2020 and 2019, respectively. On March 3, 2020, the Company’s Board of Directors authorized a stock repurchase program to buy back up to $500.0 million of the Company’s common stock. During the first quarter of 2020, the Company repurchased 4,471,682 shares at an average price of $32.64 per share and a total cost of $146.0 million. As of December 31, 2020, $354.0 million remains available under the outstanding authorization.
Results of Operations
Net Interest Income
The Company’s primary source of revenue is net interest income, which is the interest income earned on interest-earning assets less interest expense paid on interest-bearing liabilities. Net interest margin is the ratio of net interest income to average interest-earning assets. Net interest income and net interest margin are impacted by several factors, including changes in average balances and the composition of interest-earning assets and funding sources, market interest rate fluctuations and the slope of the yield curve, repricing characteristics and maturity of interest-earning assets and interest-bearing liabilities, volume of noninterest-bearing sources of funds and asset quality.
37
Net interest income for 2020 was $1.38 billion, a decrease of $90.6 million or 6%, compared with $1.47 billion in 2019. The decrease in net interest income for 2020 was due to lower interest-earning asset yields, reflecting significantly lower benchmark interest rates in 2020, partially offset by a lower cost of funds. Net interest margin for 2020 was 2.98%, a decrease of 66 basis points from 3.64% in 2019.
Average interest-earning assets were $46.24 billion in 2020, an increase of $5.92 billion or 15% from $40.32 billion in 2019. This was primarily due to loan growth, as well as increases of $1.19 billion in average interest-bearing cash and deposits with banks, and $1.17 billion in average AFS debt securities. Average loans were $36.80 billion in 2020, an increase of $3.43 billion or 10% from $33.37 billion in 2019.
The yield on average interest-earning assets for 2020 was 3.45%, a decrease of 122 basis points from 4.67% in 2019. The year-over-year yield compression reflected the lower average loan yield, as well as yield compression for all other earning asset categories, in response to the low interest rate environment. The average loan yield for 2020 was 3.98%, a decrease of 117 basis points from 5.15% in 2019. The year-over-year yield compression reflected materially lower benchmark interest rates, including a 150 basis points reduction to the target federal funds rate in March 2020. Approximately 65% and 64% of loans held-for-investment were variable-rate or hybrid loans in their adjustable rate period as of December 31, 2020 and 2019, respectively.
Deposits are an important source of funds and impact both net interest income and net interest margin. Average total deposits were $40.76 billion in 2020, an increase of $4.71 billion or 13% from $36.05 billion in 2019. Average noninterest-bearing demand deposits were $13.82 billion in 2020, an increase of $3.32 billion or 32% from $10.50 billion in 2019. Average interest-bearing deposits were $26.94 billion in 2020, an increase of $1.39 billion or 5% from $25.55 billion in 2019. Due to the strong growth in average noninterest-bearing deposits, the share of noninterest-bearing demand deposits increased to 34% of average total deposits in 2020, compared with 29% in 2019.
The average cost of funds in 2020 was 0.51%, a decrease of 61 basis points from 1.12% in 2019. The decrease in the average cost of funds primarily reflected a 150 basis points reduction to the target federal funds rate in March 2020. The average cost of interest-bearing deposits decreased 78 basis points to 0.69% in 2020, from 1.47% in 2019. Other sources of funding included in the calculation of the average cost of funds primarily consist of long-term debt, FHLB advances, repurchase agreements, and short-term borrowings.
The Company utilizes various tools to manage interest rate risk. Refer to the “Interest Rate Risk Management” section of Item 7. MD&A — Risk Management — Market Risk Management for details.
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The following table presents the interest spread, net interest margin, average balances, interest income and expense, and the average yield/rate by asset and liability component in 2020, 2019 and 2018:
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | ||||||||||||||||||||||||||||||||||||||||||||||||
| ASSETS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Interest-bearing cash and deposits with banks | $ | 4,236,430 | $ | 25,175 | 0.59 | % | $ | 3,050,954 | $ | 66,518 | 2.18 | % | $ | 2,609,463 | $ | 54,700 | 2.10 | % | ||||||||||||||||||||||||||||||||||||||
Assets purchased under resale agreements (“resale agreements”) (1) | 1,101,434 | 21,389 | 1.94 | % | 969,384 | 28,061 | 2.89 | % | 1,020,822 | 29,432 | 2.88 | % | ||||||||||||||||||||||||||||||||||||||||||||
AFS debt securities (2)(3) | 4,023,668 | 82,553 | 2.05 | % | 2,850,476 | 67,838 | 2.38 | % | 2,773,152 | 60,911 | 2.20 | % | ||||||||||||||||||||||||||||||||||||||||||||
Loans (4)(5) | 36,799,017 | 1,464,382 | 3.98 | % | 33,373,136 | 1,717,415 | 5.15 | % | 30,230,014 | 1,503,514 | 4.97 | % | ||||||||||||||||||||||||||||||||||||||||||||
Restricted equity securities | 79,160 | 1,543 | 1.95 | % | 76,854 | 2,468 | 3.21 | % | 73,691 | 3,146 | 4.27 | % | ||||||||||||||||||||||||||||||||||||||||||||
Total interest-earning assets | $ | 46,239,709 | $ | 1,595,042 | 3.45 | % | $ | 40,320,804 | $ | 1,882,300 | 4.67 | % | $ | 36,707,142 | $ | 1,651,703 | 4.50 | % | ||||||||||||||||||||||||||||||||||||||
| Noninterest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cash and due from banks | 528,406 | 471,060 | 445,768 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses | (577,560) | (330,125) | (298,600) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other assets | 2,747,238 | 2,023,146 | 1,688,259 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 48,937,793 | $ | 42,484,885 | $ | 38,542,569 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Checking deposits (6) | $ | 5,357,934 | $ | 24,213 | 0.45 | % | $ | 5,244,867 | $ | 58,168 | 1.11 | % | $ | 4,477,793 | $ | 34,657 | 0.77 | % | ||||||||||||||||||||||||||||||||||||||
Money market deposits (6) | 9,881,284 | 42,720 | 0.43 | % | 8,220,236 | 111,081 | 1.35 | % | 7,985,526 | 83,696 | 1.05 | % | ||||||||||||||||||||||||||||||||||||||||||||
Saving deposits (6) | 2,234,913 | 6,398 | 0.29 | % | 2,118,060 | 9,626 | 0.45 | % | 2,245,644 | 8,621 | 0.38 | % | ||||||||||||||||||||||||||||||||||||||||||||
Time deposits (6) | 9,465,608 | 111,411 | 1.18 | % | 9,961,289 | 196,927 | 1.98 | % | 7,431,749 | 107,778 | 1.45 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Short-term borrowings | 108,398 | 1,504 | 1.39 | % | 44,881 | 1,763 | 3.93 | % | 32,222 | 1,398 | 4.34 | % | ||||||||||||||||||||||||||||||||||||||||||||
| FHLB advances | 664,370 | 13,792 | 2.08 | % | 592,257 | 16,697 | 2.82 | % | 327,435 | 10,447 | 3.19 | % | ||||||||||||||||||||||||||||||||||||||||||||
Repurchase agreements (1) | 350,849 | 11,766 | 3.35 | % | 74,926 | 13,582 | 18.13 | % | 50,000 | 12,110 | 24.22 | % | ||||||||||||||||||||||||||||||||||||||||||||
Long-term debt and finance lease liabilities | 734,921 | 6,045 | 0.82 | % | 152,445 | 6,643 | 4.36 | % | 159,185 | 6,488 | 4.08 | % | ||||||||||||||||||||||||||||||||||||||||||||
Total interest-bearing liabilities | $ | 28,798,277 | $ | 217,849 | 0.76 | % | $ | 26,408,961 | $ | 414,487 | 1.57 | % | $ | 22,709,554 | $ | 265,195 | 1.17 | % | ||||||||||||||||||||||||||||||||||||||
Noninterest-bearing liabilities and stockholders’ equity: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Demand deposits (6) | 13,823,152 | 10,502,618 | 11,089,537 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Accrued expenses and other liabilities | 1,234,178 | 812,461 | 612,656 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Stockholders’ equity | 5,082,186 | 4,760,845 | 4,130,822 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 48,937,793 | $ | 42,484,885 | $ | 38,542,569 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest rate spread | 2.69 | % | 3.10 | % | 3.33 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income and net interest margin | $ | 1,377,193 | 2.98 | % | $ | 1,467,813 | 3.64 | % | $ | 1,386,508 | 3.78 | % | ||||||||||||||||||||||||||||||||||||||||||||
(1)Average balances of resale and repurchase agreements are reported net, pursuant to ASC 210-20-45-11, Balance Sheet Offsetting: Repurchase and Reverse Repurchase Agreements. The weighted-average yields of gross resale agreements were 1.94%, 2.66% and 2.63% for 2020, 2019 and 2018, respectively. The weighted-average interest rates of gross repurchase agreements were 3.25%, 4.74% and 4.46% for 2020, 2019 and 2018, respectively.
(2)Yields on tax-exempt securities are not presented on a tax-equivalent basis.
(3)Includes the amortization of premiums on debt securities of $33.9 million, $10.9 million and $16.1 million for 2020, 2019 and 2018, respectively.
(4)Average balances include nonperforming loans and loans held-for-sale.
(5)Loans include the accretion of net deferred loan fees, unearned fees and amortization of premiums, which totaled $52.4 million, $36.8 million and $39.2 million for 2020, 2019 and 2018, respectively.
(6)Average balance of deposits for 2018 includes average deposits held-for-sale related to the sale of DCB branches.
39
The following table summarizes the extent to which changes in (1) interest rates; and (2) average interest-earning assets and average interest-bearing liabilities affected the Company’s net interest income for the periods presented. The total change for each category of interest-earning assets and interest-bearing liabilities is segmented into changes attributable to variations in volume and yield/rate. Changes that are not solely due to either volume or yield/rate are allocated proportionally based on the absolute value of the change related to average volume and average rate.
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||||||||
| 2020 vs. 2019 | 2019 vs. 2018 | |||||||||||||||||||||||||||||||||||||
| Total Change | Changes Due to | Total Change | Changes Due to | |||||||||||||||||||||||||||||||||||
| Volume | Yield/Rate | Volume | Yield/Rate | |||||||||||||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||||||||||||||||
| Interest-bearing cash and deposits with banks | $ | (41,343) | $ | 19,300 | $ | (60,643) | $ | 11,818 | $ | 9,554 | $ | 2,264 | ||||||||||||||||||||||||||
| Resale agreements | (6,672) | 3,454 | (10,126) | (1,371) | (1,489) | 118 | ||||||||||||||||||||||||||||||||
| AFS debt securities | 14,715 | 25,037 | (10,322) | 6,927 | 1,734 | 5,193 | ||||||||||||||||||||||||||||||||
| Loans | (253,033) | 163,842 | (416,875) | 213,901 | 160,392 | 53,509 | ||||||||||||||||||||||||||||||||
| Restricted equity securities | (925) | 72 | (997) | (678) | 130 | (808) | ||||||||||||||||||||||||||||||||
| Total interest and dividend income | $ | (287,258) | $ | 211,705 | $ | (498,963) | $ | 230,597 | $ | 170,321 | $ | 60,276 | ||||||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||
| Checking deposits | $ | (33,955) | $ | 1,228 | $ | (35,183) | $ | 23,511 | $ | 6,666 | $ | 16,845 | ||||||||||||||||||||||||||
| Money market deposits | (68,361) | 18,949 | (87,310) | 27,385 | 2,526 | 24,859 | ||||||||||||||||||||||||||||||||
| Saving deposits | (3,228) | 506 | (3,734) | 1,005 | (511) | 1,516 | ||||||||||||||||||||||||||||||||
| Time deposits | (85,516) | (9,365) | (76,151) | 89,149 | 43,130 | 46,019 | ||||||||||||||||||||||||||||||||
| Short-term borrowings | (259) | 1,387 | (1,646) | 365 | 507 | (142) | ||||||||||||||||||||||||||||||||
| FHLB advances | (2,905) | 1,864 | (4,769) | 6,250 | 7,590 | (1,340) | ||||||||||||||||||||||||||||||||
| Repurchase agreements | (1,816) | 16,640 | (18,456) | 1,472 | 5,028 | (3,556) | ||||||||||||||||||||||||||||||||
| Long-term debt and finance lease liabilities | (598) | 8,397 | (8,995) | 155 | (282) | 437 | ||||||||||||||||||||||||||||||||
| Total interest expense | $ | (196,638) | $ | 39,606 | $ | (236,244) | $ | 149,292 | $ | 64,654 | $ | 84,638 | ||||||||||||||||||||||||||
| Change in net interest income | $ | (90,620) | $ | 172,099 | $ | (262,719) | $ | 81,305 | $ | 105,667 | $ | (24,362) | ||||||||||||||||||||||||||
Noninterest Income
The following table presents the components of noninterest income for the periods indicated:
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||
| Change from 2019 | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | 2018 | ||||||||||||||||||||||||||||
| Lending fees | $ | 74,842 | $ | 63,670 | $ | 11,172 | 18 | % | $ | 59,758 | ||||||||||||||||||||||
| Deposit account fees | 48,148 | 38,648 | 9,500 | 25 | % | 39,176 | ||||||||||||||||||||||||||
| Interest rate contracts and other derivative income | 31,685 | 39,865 | (8,180) | (21) | % | 18,980 | ||||||||||||||||||||||||||
| Foreign exchange income | 22,370 | 26,398 | (4,028) | (15) | % | 21,259 | ||||||||||||||||||||||||||
| Wealth management fees | 17,494 | 16,547 | 947 | 6 | % | 13,624 | ||||||||||||||||||||||||||
| Net gains on sales of loans | 4,501 | 4,035 | 466 | 12 | % | 6,590 | ||||||||||||||||||||||||||
| Gains on sales of AFS debt securities | 12,299 | 3,930 | 8,369 | 213 | % | 2,535 | ||||||||||||||||||||||||||
| Net gain on sale of business | — | — | — | — | % | 31,470 | ||||||||||||||||||||||||||
| Other investment income | 10,641 | 18,117 | (7,476) | (41) | % | 7,731 | ||||||||||||||||||||||||||
| Other income | 13,567 | 11,035 | 2,532 | 23 | % | 16,310 | ||||||||||||||||||||||||||
| Total noninterest income | $ | 235,547 | $ | 222,245 | $ | 13,302 | 6 | % | $ | 217,433 | ||||||||||||||||||||||
Noninterest income comprised 15% and 13% of total revenue in 2020 and 2019, respectively. 2020 noninterest income was $235.5 million, an increase of $13.3 million or 6%, compared with $222.2 million in 2019. This increase was primarily due to increases in lending fees, deposit account fees and gains on sales of AFS debt securities, partially offset by decreases in interest rate contracts and other derivative income, and other investment income.
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Lending fees were $74.8 million in 2020, an increase of $11.1 million or 18%, compared with $63.7 million in 2019. This increase was primarily due to valuation gains on warrants received as part of lending relationships and the subsequent exercise of warrants during the fourth quarter of 2020.
Deposit account fees were $48.1 million in 2020, an increase of $9.5 million or 25%, compared with $38.6 million in 2019. This increase was primarily due to an increase in customer-driven transactions.
Interest rate contracts and other derivative income was $31.7 million in 2020, a decrease of $8.2 million or 21%, compared with $39.9 million in 2019. This decrease was primarily due to the impact of negative credit valuation adjustments, which reflected higher loss probabilities for borrowers impacted by the COVID-19 pandemic, as well as a decline in customer interest rate swap transactions.
Gains on sales of AFS debt securities were $12.3 million in 2020, an increase of $8.4 million or 213%, compared with $3.9 million in 2019. This increase primarily reflected gains recorded from $131.6 million in sales of municipal bonds during the second quarter of 2020.
Other investment income was $10.6 million in 2020, a decrease of $7.5 million or 41%, compared with $18.1 million in 2019. This decrease was due to reduced earnings from CRA tax credit investments accounted for under the equity method, and decreased distributions from investments in qualified affordable housing partnerships.
Noninterest Expense
The following table presents the components of noninterest expense for the periods indicated:
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||
| Change from 2019 | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | 2018 | ||||||||||||||||||||||||||||
| Compensation and employee benefits | $ | 404,071 | $ | 401,700 | $ | 2,371 | 1 | % | $ | 379,622 | ||||||||||||||||||||||
| Occupancy and equipment expense | 66,489 | 69,730 | (3,241) | (5) | % | 68,896 | ||||||||||||||||||||||||||
| Deposit insurance premiums and regulatory assessments | 15,128 | 12,928 | 2,200 | 17 | % | 21,211 | ||||||||||||||||||||||||||
| Deposit account expense | 13,530 | 14,175 | (645) | (5) | % | 11,244 | ||||||||||||||||||||||||||
| Data processing | 16,603 | 13,533 | 3,070 | 23 | % | 13,177 | ||||||||||||||||||||||||||
| Computer software expense | 29,033 | 26,471 | 2,562 | 10 | % | 22,286 | ||||||||||||||||||||||||||
| Consulting expense | 5,391 | 9,846 | (4,455) | (45) | % | 11,579 | ||||||||||||||||||||||||||
| Legal expense | 7,766 | 8,441 | (675) | (8) | % | 8,781 | ||||||||||||||||||||||||||
| Other operating expense | 79,489 | 92,249 | (12,760) | (14) | % | 88,042 | ||||||||||||||||||||||||||
| Amortization of tax credit and other investments | 70,082 | 98,383 | (28,301) | (29) | % | 96,152 | ||||||||||||||||||||||||||
| Repurchase agreements’ extinguishment cost | 8,740 | — | 8,740 | 100 | % | — | ||||||||||||||||||||||||||
| Total noninterest expense | $ | 716,322 | $ | 747,456 | $ | (31,134) | (4) | % | $ | 720,990 | ||||||||||||||||||||||
Efficiency ratio (1) | 44.42 | % | 44.23 | % | 44.95 | % | ||||||||||||||||||||||||||
(1)Refer to Item 7. MD&A — Reconciliation of GAAP to Non-GAAP Financial Measures in this Form 10-K for the detailed calculation of GAAP and non-GAAP efficiency ratios.
2020 noninterest expense was $716.3 million, a decrease of $31.2 million or 4%, compared with $747.5 million in 2019. This decrease was primarily due to decreases in amortization of tax credit and other investments, and other operating expense, partially offset by repurchase agreements’ extinguishment cost.
Amortization of tax credit and other investments was $70.1 million in 2020, a decrease of $28.3 million or 29%, compared with $98.4 million in 2019. This year-over-year change was primarily due to the recognition pattern of production and renewable energy tax credit investments placed in service; $10.7 million of recoveries recorded in the fourth quarter of 2020 related to DC Solar tax credit investments, and lower OTTI charges. In 2020, there were $5.2 million of OTTI charges related to three historic tax credit investments and a CRA investment. In comparison, during 2019, there were $7.6 million of OTTI charges related to five historic tax credit investments and a CRA investment, as well as $5.4 million of net OTTI charges related to DC Solar tax credit investments.
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Other operating expense primarily consists of telecommunications and postage, loan related expenses, marketing, other real estate owned expense (“OREO”), charitable contributions, travel, and other miscellaneous expense categories. Other operating expense was $79.5 million in 2020, a decrease of $12.7 million or 14%, compared with $92.2 million in 2019. This decrease was largely driven by lower travel and marketing expenses, partially offset by a write-down on OREO.
In the second quarter of 2020, the Company prepaid $150.0 million of repurchase agreements and incurred a debt extinguishment cost of $8.7 million. No such expense was incurred in 2019.
Efficiency ratio, calculated as noninterest expense divided by total revenue, was 44.42% and 44.23% in 2020 and 2019, respectively. Non-GAAP efficiency ratio, adjusted for the amortization of tax credit and other investments, the amortization of core deposit intangibles, and repurchase agreements’ extinguishment cost (where applicable), was 39.30% in 2020, an increase of 116 basis points from 38.14% in 2019. For additional detail, see the reconciliations of non-GAAP measures presented under Item 7. MD&A — Reconciliation of GAAP to Non-GAAP Financial Measures in this Form 10-K.
Income Taxes
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Income before income taxes | $ | 685,765 | $ | 843,917 | $ | 818,696 | ||||||||||||||
| Income tax expense | $ | 117,968 | $ | 169,882 | $ | 114,995 | ||||||||||||||
| Effective tax rate | 17.2 | % | 20.1 | % | 14.0 | % | ||||||||||||||
2020 income tax expense was $118.0 million, and the effective tax rate was 17.2%, compared with 2019 income tax expense of $169.9 million, and an effective tax rate of 20.1%. 2020 income tax expense included $5.1 million in uncertain tax position related to the Company’s investment in DC Solar. The higher effective tax rate in 2019 was primarily due to $30.1 million of additional income tax expense recorded to reverse certain previously claimed tax credits related to the Company’s investment in DC Solar.
Management regularly reviews the Company’s tax positions and deferred tax balances. Factors considered in this analysis include the Company’s ability to generate future taxable income, implement tax-planning strategies (as defined in ASC 740, Income Taxes) and utilize taxable income from prior carryback years (if such carryback is permitted under the applicable tax law), as well as future reversals of existing taxable temporary differences. The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized and settled. Net deferred tax assets increased $57.3 million or 53.8% to $163.8 million as of December 31, 2020, compared with $106.5 million as of December 31, 2019. This increase was mainly due to an increase in allowance for credit losses due to the Company’s CECL adoption, partially offset by an increase in deferred tax liabilities arising from net unrealized loss on securities. For additional details on the components of net deferred tax assets, see Note 11 — Income Taxes to the Consolidated Financial Statements in this Form 10-K.
A valuation allowance is used, as needed, to reduce the deferred tax assets to the amount that is more-likely-than-not to be realized. To determine whether a valuation allowance is needed, the Company considers evidence such as the Company’s ability to generate future taxable income, implement tax-planning strategies (as defined in ASC 740, Income Taxes), and utilize taxable income from prior carryback years (if such carryback is permitted under the applicable tax law), as well as future reversals of existing taxable temporary differences. The Company expects to have sufficient taxable income in future years to fully realize its deferred tax assets. The Company also performed an overall assessment by weighing all positive evidence against all negative evidence, and concluded that it is more-likely-than-not that all of the benefits of the deferred tax assets will be realized, with the exception of the deferred tax assets related to certain state net operating losses (“NOL”) carryforwards. As of December 31, 2020, management released $21 thousand of valuation allowance provided as of December 31, 2019, which related to the state NOL carryforwards. No additional valuation allowance was recorded as of December 31, 2020. For additional details on the components of net deferred tax assets, see Note 11 — Income Taxes to the Consolidated Financial Statements in this Form 10-K.
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Impact of Investment in DC Solar Tax Credit Funds
The Company invested in four solar energy tax credit funds in the years 2014, 2015, 2017 and 2018 as a limited member. These tax credit funds engaged in the acquisition and leasing of mobile solar generators through DC Solar entities. The Company’s investments in the DC Solar tax credit funds qualified for federal energy tax credit under Section 48 of the Internal Revenue Code of 1986, as amended. The Company also received a “should” level legal opinion from an external law firm supporting the legal structure of the investments for tax credit purposes. These investments were recorded in Investments in tax credit and other investments, net on the Consolidated Balance Sheet and were accounted for under the equity method of accounting. DC Solar had its assets frozen in December 2018 and filed for bankruptcy protection in February 2019. In February 2019, an affidavit from the Federal Bureau of Investigation special agent stated that DC Solar was operating a fraudulent “Ponzi-like scheme” and that the majority of the mobile solar generators sold to investors and managed by DC Solar, as well as the majority of the related lease revenues claimed to have been received by DC Solar might not have existed. In January 2020, the owners of DC Solar pleaded guilty to charges of conspiracy to commit wire fraud and money laundering in a Ponzi scheme related to DC Solar.
During 2019, the Company fully wrote off the remainder of its tax credit investments related to DC Solar, recorded a $7.0 million OTTI charge and a subsequent $1.6 million recovery. During 2020, the Company further recorded $10.7 million in recoveries, of which $1.1 million is recorded as an impairment recovery. The recoveries were recorded in Amortization of tax credit and other investments, net on the Consolidated Statement of Income. There were no balances in Accrued expenses and other liabilities — Unfunded commitments related to DC Solar as of December 31, 2020 and 2019. More discussion on the Company’s impairment evaluation and monitoring process of tax credit investments is provided in Note 2 — Fair Value Measurement and Fair Value of Financial Instruments to the Consolidated Financial Statements in this Form 10-K.
ASC 740-10-25-6 states in part, that an entity shall initially recognize the financial statement effects of a tax position when it is more-likely-than-not, based on the technical merits, that the position will be sustained upon examination. The term “more-likely-than-not” means a likelihood of more than 50 percent; the terms “examined” and “upon examination” include resolution of the related appeals or litigation processes, if any. The level of evidence that is necessary and appropriate to support the technical merits of a tax position is subject to judgment and depends on available information as of the balance sheet date. The Company received a “should” level legal opinion from an external law firm supporting the legal structure of these investments for tax credit purposes. A subsequent measurement of a tax position is based on management’s best judgment given the facts, circumstances and information available at the latest quarterly reporting date. A change in judgment that results in a subsequent derecognition or change in measurement of a tax position is recognized as a discrete item in the period in which the change occurs.
Investors in DC Solar funds, including the Company, received tax credits for making renewable energy investments. Between 2014 and 2018, the Company had invested in four DC Solar energy tax credit funds and claimed tax credits of approximately $53.9 million, partially reduced by a deferred tax liability of $5.7 million related to the 50% tax basis reduction, for a net impact of $48.2 million to the Consolidated Financial Statements.
In 2019, the Company, in coordination with other fund investors, engaged an unaffiliated third-party inventory firm to investigate the actual number of mobile solar generators in existence. Based on the inventory report, none of the mobile service generators that had been purchased by the Company’s 2017 and 2018 tax credit funds were found. On the other hand, a vast majority of the mobile solar generators purchased by the Company’s 2014 and 2015 tax credit funds were found. In 2019, the Company reversed $33.6 million out of $53.9 million in previously claimed tax credits, and $3.5 million out of $5.7 million deferred tax liability, resulting in $30.1 million of additional income tax expense. Based on management’s best judgments regarding the future settlement of the related tax positions with the IRS, the Company recorded $5.1 million in uncertain tax position related to its investments in DC Solar in 2020. The Company’s investigation related to this matter is ongoing. For additional information on the risks surrounding the Company’s investments in tax-advantaged projects, see Item 1A. Risk Factors in this Form 10-K.
Operating Segment Results
The Company organizes its operations into three reportable operating segments: (1) Consumer and Business Banking; (2) Commercial Banking; and (3) Other. These segments are defined by the type of customers served and the related products and services provided. The segments reflect how financial information is currently evaluated by management. For additional description of the Company’s internal management reporting process, including the segment cost allocation methodology, see Note 18 — Business Segments to the Consolidated Financial Statements in this Form 10-K.
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Segment net interest income represents the difference between actual interest earned on assets and interest incurred on liabilities of the segment, adjusted for funding charges or credits through the Company’s internal funds transfer pricing (“FTP”) process. The process was effective in the current market conditions as of December 31, 2020.
The following tables present the results by operating segment for the periods indicated:
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Consumer and Business Banking | Commercial Banking | Other | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ($ in thousands) | 2020 | 2019 | 2018 | 2020 | 2019 | 2018 | 2020 | 2019 | 2018 | |||||||||||||||||||||||||||||||||||||||||||||||
| Total revenue | $ | 597,944 | $ | 754,471 | $ | 812,822 | $ | 845,651 | $ | 786,035 | $ | 715,937 | $ | 169,145 | $ | 149,552 | $ | 75,182 | ||||||||||||||||||||||||||||||||||||||
| Provision for credit losses | 3,885 | 14,178 | 9,364 | 206,768 | 84,507 | 54,891 | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||
| Noninterest expense | 331,750 | 343,001 | 341,396 | 266,923 | 263,064 | 237,520 | 117,649 | 141,391 | 142,074 | |||||||||||||||||||||||||||||||||||||||||||||||
| Segment income (loss) before income taxes | 262,309 | 397,292 | 462,062 | 371,960 | 438,464 | 423,526 | 51,496 | 8,161 | (66,892) | |||||||||||||||||||||||||||||||||||||||||||||||
| Segment net income | $ | 187,931 | $ | 284,161 | $ | 330,683 | $ | 266,342 | $ | 313,833 | $ | 303,553 | $ | 113,524 | $ | 76,041 | $ | 69,465 | ||||||||||||||||||||||||||||||||||||||
Consumer and Business Banking
The Consumer and Business Banking segment primarily provides financial products and services to consumer and commercial customers through the Company’s domestic branch network. This segment offers consumer and commercial deposits, mortgage and home equity loans, and other products and services. It also originates commercial loans for small- and medium-sized enterprises. Other products and services provided by this segment include wealth management, treasury management and foreign exchange services. The integration of digital channels and our brick and mortar channels has been a priority for the Bank. The Company is developing a digital consumer banking platform to enhance the customer user experience and offer a full suite of banking services. Customer adoption of the digital banking application is in progress, and has contributed to growth in segment fee income and deposit growth in 2020.
The following table presents additional financial information for the Consumer and Business Banking segment for the periods indicated:
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||
| Change from 2019 | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | 2018 | ||||||||||||||||||||||||||||
| Net interest income before provision for credit losses | $ | 530,829 | $ | 696,551 | $ | (165,722) | (24) | % | $ | 727,215 | ||||||||||||||||||||||
| Noninterest income | 67,115 | 57,920 | 9,195 | 16 | % | 85,607 | ||||||||||||||||||||||||||
| Total revenue | 597,944 | 754,471 | (156,527) | (21) | % | 812,822 | ||||||||||||||||||||||||||
| Provision for credit losses | 3,885 | 14,178 | (10,293) | (73) | % | 9,364 | ||||||||||||||||||||||||||
| Noninterest expense | 331,750 | 343,001 | (11,251) | (3) | % | 341,396 | ||||||||||||||||||||||||||
| Segment income before income taxes | 262,309 | 397,292 | (134,983) | (34) | % | 462,062 | ||||||||||||||||||||||||||
| Segment net income | $ | 187,931 | $ | 284,161 | $ | (96,230) | (34) | % | $ | 330,683 | ||||||||||||||||||||||
| Average loans | $ | 12,056,987 | $ | 10,647,814 | $ | 1,409,173 | 13 | % | $ | 9,469,764 | ||||||||||||||||||||||
| Average deposits | $ | 27,201,737 | $ | 25,124,827 | $ | 2,076,910 | 8 | % | $ | 24,700,474 | ||||||||||||||||||||||
Segment net income decreased $96.2 million, or 34%, to $187.9 million in 2020 compared with 2019, primarily due to lower net interest income before provision for credit losses.
Net interest income before provision for credit losses decreased $165.7 million, or 24%, to $530.8 million in 2020, primarily reflecting a lower credit assigned to deposits under the FTP system in a near-zero interest environment. Noninterest income increased $9.2 million, or 16%, to $67.1 million in 2020, primarily driven by higher deposit account fees due to higher customer-driven transactions.
The provision for credit losses decreased $10.3 million, to $3.9 million in 2020, primarily driven by the methodology change to credit loss estimates under CECL. The loan portfolio in the Consumer and Business Banking segment is predominantly made up of residential mortgage loans, with a long history of low loan losses.
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Noninterest expense decreased $11.3 million, or 3%, to $331.8 million in 2020, primarily due to lower allocated corporate overhead expense.
Commercial Banking
The Commercial Banking segment primarily generates commercial loans and deposits. Commercial loan products include commercial business loans and lines of credit, trade finance loans and letters of credit, CRE loans, construction and land lending, affordable housing loans and letters of credit, asset-based lending, and equipment financing. Commercial deposit products and other financial services include treasury management, foreign exchange services, and interest rate and commodity risk hedging.
The following table present additional financial information for Commercial Banking for the periods indicated:
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||
| Change from 2019 | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | 2018 | ||||||||||||||||||||||||||||
| Net interest income before provision for credit losses | $ | 706,286 | $ | 651,413 | $ | 54,873 | 8 | % | $ | 605,650 | ||||||||||||||||||||||
| Noninterest income | 139,365 | 134,622 | 4,743 | 4 | % | 110,287 | ||||||||||||||||||||||||||
| Total revenue | 845,651 | 786,035 | 59,616 | 8 | % | 715,937 | ||||||||||||||||||||||||||
| Provision for credit losses | 206,768 | 84,507 | 122,261 | 145 | % | 54,891 | ||||||||||||||||||||||||||
| Noninterest expense | 266,923 | 263,064 | 3,859 | 1 | % | 237,520 | ||||||||||||||||||||||||||
| Segment income before income taxes | 371,960 | 438,464 | (66,504) | (15) | % | 423,526 | ||||||||||||||||||||||||||
| Segment net income | $ | 266,342 | $ | 313,833 | $ | (47,491) | (15) | % | $ | 303,553 | ||||||||||||||||||||||
| Average loans | $ | 24,742,030 | $ | 22,725,322 | $ | 2,016,708 | 9 | % | $ | 20,760,250 | ||||||||||||||||||||||
| Average deposits | $ | 10,811,020 | $ | 8,591,285 | $ | 2,219,735 | 26 | % | $ | 6,897,424 | ||||||||||||||||||||||
Segment net income decreased $47.5 million, or 15%, to $266.3 million in 2020 compared with 2019, reflecting a higher provision for credit losses, partially offset by higher net interest income before provision for credit losses.
Net interest income before provision for credit losses increased $54.9 million, or 8%, to $706.3 million in 2020, primarily driven by lower FTP charges assessed for loans, partially offset by lower interest income earned on loans due to the lower interest rate environment. Noninterest income increased $4.7 million, or 4%, to $139.4 million in 2020, primarily driven by higher lending fees, partially offset by lower interest rate contracts and other derivative income.
The provision for credit losses increased $122.3 million, to $206.8 million in 2020, primarily due to deteriorating macroeconomic conditions and outlook in the first half of 2020, as a result of the COVID-19 pandemic. The loan portfolio in the Commercial Banking segment primarily consists of commercial and CRE loans, the loss estimates for which are highly sensitive to changes in the macroeconomic conditions.
Noninterest expense increased $3.9 million in 2020, primarily due to a write-down on OREO.
Other
Centralized functions, including the corporate treasury activities of the Company and eliminations of inter-segment amounts, have been aggregated and included in the Other segment, which provides broad administrative support to the two core segments, namely the Consumer and Business Banking and the Commercial Banking segments.
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The following table presents additional financial information for Other for the periods indicated:
| ($ in thousands) | Year Ended December 31, | |||||||||||||||||||||||||||||||
| Change from 2019 | ||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | 2018 | ||||||||||||||||||||||||||||
| Net interest income before provision for credit losses | $ | 140,078 | $ | 119,849 | $ | 20,229 | 17 | % | $ | 53,643 | ||||||||||||||||||||||
| Noninterest income | 29,067 | 29,703 | (636) | (2) | % | 21,539 | ||||||||||||||||||||||||||
| Total revenue | 169,145 | 149,552 | 19,593 | 13 | % | 75,182 | ||||||||||||||||||||||||||
| Noninterest expense | 117,649 | 141,391 | (23,742) | (17) | % | 142,074 | ||||||||||||||||||||||||||
| Segment income (loss) before income taxes | 51,496 | 8,161 | 43,335 | 531 | % | (66,892) | ||||||||||||||||||||||||||
| Segment net income | $ | 113,524 | $ | 76,041 | $ | 37,483 | 49 | % | $ | 69,465 | ||||||||||||||||||||||
| Average deposits | $ | 2,750,134 | $ | 2,330,958 | $ | 419,176 | 18 | % | $ | 1,632,351 | ||||||||||||||||||||||
Segment net income increased $37.5 million, or 49%, to $113.5 million in 2020 compared with 2019, primarily driven by lower noninterest expense and higher net interest income before provision for credit losses.
Net interest income before provision for credit losses increased $20.2 million, or 17%, to $140.1 million in 2020, primarily driven by lower deposit costs, partially offset by lower interest income on investments. Noninterest income remained relatively flat year-over-year.
Noninterest expense decreased $23.7 million, or 17%, to $117.6 million in 2020, reflecting lower amortization of tax credit and other investments.
The income tax expense or benefit in the Other segment consists of the remaining unallocated income tax expense or benefit after allocating income tax expense to the two core segments. Income tax expense is allocated to the Consumer and Business Banking and the Commercial Banking segments based on statutory income tax rates, applied to segment income before income taxes.
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Balance Sheet Analysis
The following table presents a discussion of the significant changes between December 31, 2020 and 2019:
Selected Consolidated Balance Sheet Data
| ($ in thousands) | December 31, | Change | ||||||||||||||||||||||||
| 2020 | 2019 | $ | % | |||||||||||||||||||||||
| ASSETS | ||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 4,017,971 | $ | 3,261,149 | $ | 756,822 | 23 | % | ||||||||||||||||||
| Interest-bearing deposits with banks | 809,728 | 196,161 | 613,567 | 313 | % | |||||||||||||||||||||
| Resale agreements | 1,460,000 | 860,000 | 600,000 | 70 | % | |||||||||||||||||||||
| AFS debt securities, at fair value (amortized cost of $5,470,523 in 2020 and $3,320,648 in 2019) | 5,544,658 | 3,317,214 | 2,227,444 | 67 | % | |||||||||||||||||||||
| Restricted equity securities, at cost | 83,046 | 78,580 | 4,466 | 6 | % | |||||||||||||||||||||
| Loans held-for-sale | 1,788 | 434 | 1,354 | 312 | % | |||||||||||||||||||||
Loans held-for-investment (net of allowance (1) for loan losses of $619,983 in 2020 and $358,287 in 2019) | 37,770,972 | 34,420,252 | 3,350,720 | 10 | % | |||||||||||||||||||||
Investments in qualified affordable housing partnerships, net | 213,555 | 207,037 | 6,518 | 3 | % | |||||||||||||||||||||
Investments in tax credit and other investments, net | 266,525 | 254,140 | 12,385 | 5 | % | |||||||||||||||||||||
Premises and equipment | 103,251 | 118,364 | (15,113) | (13) | % | |||||||||||||||||||||
| Goodwill | 465,697 | 465,697 | — | — | % | |||||||||||||||||||||
| Operating lease right-of-use assets | 95,460 | 99,973 | (4,513) | (5) | % | |||||||||||||||||||||
| Other assets | 1,324,262 | 917,095 | 407,167 | 44 | % | |||||||||||||||||||||
| TOTAL | $ | 52,156,913 | $ | 44,196,096 | $ | 7,960,817 | 18 | % | ||||||||||||||||||
| LIABILITIES | ||||||||||||||||||||||||||
| Noninterest-bearing | $ | 16,298,301 | $ | 11,080,036 | $ | 5,218,265 | 47 | % | ||||||||||||||||||
| Interest-bearing | 28,564,451 | 26,244,223 | 2,320,228 | 9 | % | |||||||||||||||||||||
| Total deposits | 44,862,752 | 37,324,259 | 7,538,493 | 20 | % | |||||||||||||||||||||
| Short-term borrowings | 21,009 | 28,669 | (7,660) | (27) | % | |||||||||||||||||||||
| FHLB advances | 652,612 | 745,915 | (93,303) | (13) | % | |||||||||||||||||||||
| Repurchase agreements | 300,000 | 200,000 | 100,000 | 50 | % | |||||||||||||||||||||
| Long-term debt and finance lease liabilities | 151,739 | 152,270 | (531) | 0 | % | |||||||||||||||||||||
| Operating lease liabilities | 102,830 | 108,083 | (5,253) | (5) | % | |||||||||||||||||||||
| Accrued expenses and other liabilities | 796,796 | 619,283 | 177,513 | 29 | % | |||||||||||||||||||||
| Total liabilities | 46,887,738 | 39,178,479 | 7,709,259 | 20 | % | |||||||||||||||||||||
STOCKHOLDERS’ EQUITY (1) | 5,269,175 | 5,017,617 | 251,558 | 5 | % | |||||||||||||||||||||
| TOTAL | $ | 52,156,913 | $ | 44,196,096 | $ | 7,960,817 | 18 | % | ||||||||||||||||||
(1)On January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments using the modified retrospective approach. The Company recorded $125.2 million increase to allowance for loan losses and $98.0 million after-tax decrease to opening retained earnings as of January 1, 2020.
As of December 31, 2020, total assets were $52.16 billion, an increase of $7.96 billion or 18% from $44.20 billion as of December 31, 2019, primarily due to loan growth, and an increase in purchases of AFS debt securities. The loan growth came from C&I lending, driven by originations of PPP loans, single-family residential and CRE.
As of December 31, 2020, total liabilities were $46.89 billion, an increase of $7.71 billion or 20% from $39.18 billion as of December 31, 2019, primarily due to deposit growth, driven by strong growth in noninterest-bearing deposits.
As of December 31, 2020, total stockholders’ equity was $5.27 billion, an increase of $251.6 million or 5% from $5.02 billion as of December 31, 2019, primarily due to $567.8 million in 2020 net income, partially offset by cash dividends declared on common stock and common stock repurchases.
Debt Securities
The Company maintains a portfolio of high quality and liquid debt securities with relatively short durations to minimize overall interest rate and liquidity risks. The Company’s debt securities provide:
•interest income for earnings and yield enhancement;
•availability for funding needs arising during the normal course of business;
47
•the ability to execute interest rate risk management strategies in response to changes in economic or market conditions; and
•collateral to support pledging agreements as required and/or to enhance the Company’s borrowing capacity.
Available-for-Sale Debt Securities
Debt securities classified as AFS are carried at their fair value with the corresponding changes in fair value recorded in Accumulated other comprehensive income (loss), net of tax, as a component of Stockholders’ equity on the Consolidated Balance Sheet.
The following table presents the distribution of the Company’s AFS debt securities portfolio by fair value and percentage of fair value as of December 31, 2020 and 2019, and by credit ratings as of December 31, 2020:
| ($ in thousands) | December 31, | Ratings (2) | ||||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | As of December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Fair Value | % of Total | Fair Value | % of Total | AAA/AA | A | BBB | No Rating | |||||||||||||||||||||||||||||||||||||||||||
| AFS debt securities: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury securities | $ | 50,761 | 1 | % | $ | 176,422 | 5 | % | 100 | % | — | % | — | % | — | % | ||||||||||||||||||||||||||||||||||
| U.S. government agency and U.S. government-sponsored enterprise debt securities | 814,319 | 15 | % | 581,245 | 18 | % | 100 | % | — | % | — | % | — | % | ||||||||||||||||||||||||||||||||||||
| U.S. government agency and U.S. government-sponsored enterprise mortgage-backed securities | 2,814,664 | 51 | % | 1,607,368 | 48 | % | 100 | % | — | % | — | % | — | % | ||||||||||||||||||||||||||||||||||||
| Municipal securities | 396,073 | 7 | % | 102,302 | 3 | % | 91 | % | 5 | % | — | % | 4 | % | ||||||||||||||||||||||||||||||||||||
| Non-agency mortgage-backed securities | 529,617 | 10 | % | 135,098 | 4 | % | 89 | % | — | % | — | % | 11 | % | ||||||||||||||||||||||||||||||||||||
| Corporate debt securities | 405,968 | 7 | % | 11,149 | — | % | — | % | 30 | % | 70 | % | — | % | ||||||||||||||||||||||||||||||||||||
Foreign government bonds (1) | 182,531 | 3 | % | 354,172 | 11 | % | 17 | % | 83 | % | — | % | — | % | ||||||||||||||||||||||||||||||||||||
Asset-backed securities (1) | 63,231 | 1 | % | 64,752 | 2 | % | 100 | % | — | % | — | % | — | % | ||||||||||||||||||||||||||||||||||||
CLOs (1) | 287,494 | 5 | % | 284,706 | 9 | % | 92 | % | 8 | % | — | % | — | % | ||||||||||||||||||||||||||||||||||||
| Total AFS debt securities | $ | 5,544,658 | 100 | % | $ | 3,317,214 | 100 | % | 88 | % | 6 | % | 5 | % | 1 | % | ||||||||||||||||||||||||||||||||||
(1)There were no securities of a single non-governmental agency issuer that exceeded 10% of stockholder’s equity as of both December 31, 2020 and December 31, 2019.
(2)Primarily based upon the lowest of the credit ratings issued by S&P, Moody’s Investors Service (“Moody’s”) or Fitch Ratings (“Fitch”). Rating percentages are allocated based on fair value.
The fair value of AFS debt securities totaled $5.54 billion as of December 31, 2020, an increase of $2.23 billion or 67% from $3.32 billion as of December 31, 2019. The largest net change came from U.S. government agency and U.S. government-sponsored enterprise mortgage-backed securities, which increased $1.21 billion, followed by corporate debt securities, which increased $394.8 million, and non-agency mortgage-backed securities, which increased $394.5 million.
The Company’s debt securities portfolio had an effective duration of 4.2 years as of December 31, 2020 which increased from 3.1 years as of December 31, 2019, primarily due to an increase in the target duration of securities purchases to achieve enhancement in portfolio yield. As of December 31, 2020, 88% of the carrying value of the Company’s debt securities portfolio was rated “AA-” or “Aa3” or higher by nationally recognized credit rating agencies, compared with 97% as of December 31, 2019. The decrease in higher-rated securities was primarily due to the strategic growth in non-agency securities within the portfolio mix. Credit ratings of BBB- or higher by S&P and Fitch, or Baa3 or higher by Moody’s, are considered investment grade.
The Company’s AFS debt securities are carried at fair value with noncredit-related unrealized gains and losses, net of tax, reported in Other comprehensive income (loss) on the Consolidated Statement of Comprehensive Income. Pre-tax net unrealized gain on AFS debt securities was $74.1 million as of December 31, 2020, a net improvement of $77.6 million from pre-tax net unrealized losses of $3.4 million as of December 31, 2019. This change was primarily due to a decrease in benchmark interest rates as of December 31, 2020. Gross unrealized losses on AFS debt securities totaled $22.5 million as of December 31, 2020, compared with $23.2 million as of December 31, 2019. As of December 31, 2020, the Company had no intention to sell securities with unrealized losses and believed it is more-likely-than-not that it would not be required to sell such securities before recovery of their amortized costs.
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Of the securities with gross unrealized losses, substantially all were rated investment grade as of both December 31, 2020 and 2019, as classified based upon the lowest of the credit ratings issued by S&P, Moody’s, or Fitch. The Company believes that the gross unrealized losses were due to non-credit related factors and the gross unrealized losses were primarily attributable to yield curve movement and widened spreads. The Company believes that the credit support levels of the AFS debt securities are strong and, based on current assessments and macroeconomic forecasts, expects that full contractual cash flows will be received, even if near term credit performance is impacted by the COVID-19 pandemic.
If a credit loss exists, the Company records an impairment related to credit losses through the allowance for credit losses with a corresponding Provision for credit losses on the Consolidated Statement of Income. There were no credit losses recognized in earnings for 2020 and no OTTI credit losses were recognized in earnings for 2019. The Company assesses individual securities for credit losses for each reporting period. For additional information of the Company’s accounting policies, valuation and composition, see Note 1 — Summary of Significant Accounting Policies, Note 2 — Fair Value Measurement and Fair Value of Financial Instruments, and Note 4 — Securities to the Consolidated Financial Statements in this Form 10-K.
49
The following table presents the weighted-average yields and contractual maturity distribution, excluding periodic principal payments, of the Company’s AFS debt securities as of December 31, 2020 and 2019. Actual maturities of certain securities can differ from contractual maturities as the borrowers have the right to prepay obligations with or without prepayment penalties. In addition, factors such as prepayments and interest rates may affect the yields on the carrying values of these securities.
| ($ in thousands) | December 31, | |||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||||||||||||||||
| Amortized Cost | Fair Value | Yield (1) | Amortized Cost | Fair Value | Yield (1) | |||||||||||||||||||||||||||||||||
| AFS debt securities: | ||||||||||||||||||||||||||||||||||||||
| U.S. Treasury securities: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | $ | 50,310 | $ | 50,761 | 1.26 | % | $ | — | $ | — | — | % | ||||||||||||||||||||||||||
Maturing after one year through five years | — | — | — | % | 177,215 | 176,422 | 1.33 | % | ||||||||||||||||||||||||||||||
Total | 50,310 | 50,761 | 1.26 | % | 177,215 | 176,422 | 1.33 | % | ||||||||||||||||||||||||||||||
| U.S. government agency and U.S. government-sponsored enterprise debt securities: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | 640,153 | 640,366 | 1.78 | % | 328,628 | 326,341 | 2.62 | % | ||||||||||||||||||||||||||||||
Maturing after one year through five years | 118,053 | 122,012 | 2.38 | % | 158,490 | 156,431 | 2.69 | % | ||||||||||||||||||||||||||||||
Maturing after five years through ten years | 11,091 | 11,697 | 2.54 | % | 44,908 | 45,189 | 2.38 | % | ||||||||||||||||||||||||||||||
Maturing after ten years | 37,517 | 40,244 | 2.74 | % | 52,249 | 53,284 | 2.78 | % | ||||||||||||||||||||||||||||||
Total | 806,814 | 814,319 | 1.92 | % | 584,275 | 581,245 | 2.63 | % | ||||||||||||||||||||||||||||||
| U.S. government agency and U.S. government-sponsored enterprise mortgage-backed securities: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | 4,185 | 4,232 | 3.46 | % | 112 | 113 | 2.72 | % | ||||||||||||||||||||||||||||||
Maturing after one year through five years | 21,566 | 22,668 | 2.72 | % | 23,144 | 23,289 | 2.29 | % | ||||||||||||||||||||||||||||||
Maturing after five years through ten years | 216,332 | 222,905 | 2.17 | % | 85,970 | 88,261 | 2.72 | % | ||||||||||||||||||||||||||||||
Maturing after ten years | 2,517,644 | 2,564,859 | 2.11 | % | 1,489,035 | 1,495,705 | 2.66 | % | ||||||||||||||||||||||||||||||
Total | 2,759,727 | 2,814,664 | 2.12 | % | 1,598,261 | 1,607,368 | 2.66 | % | ||||||||||||||||||||||||||||||
Municipal securities (2): | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | 18,663 | 18,868 | 3.04 | % | 37,136 | 37,291 | 2.67 | % | ||||||||||||||||||||||||||||||
Maturing after one year through five years | 36,000 | 37,716 | 2.89 | % | 18,699 | 18,948 | 2.52 | % | ||||||||||||||||||||||||||||||
Maturing after five years through ten years | 230,851 | 239,883 | 2.07 | % | 12,151 | 12,451 | 3.15 | % | ||||||||||||||||||||||||||||||
Maturing after ten years | 97,059 | 99,606 | 2.08 | % | 33,635 | 33,612 | 2.63 | % | ||||||||||||||||||||||||||||||
Total | 382,573 | 396,073 | 2.20 | % | 101,621 | 102,302 | 2.69 | % | ||||||||||||||||||||||||||||||
| Non-agency mortgage-backed securities: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | 7,920 | 7,920 | 0.63 | % | — | — | — | % | ||||||||||||||||||||||||||||||
Maturing after one year through five years | 49,704 | 49,870 | 3.80 | % | 7,920 | 7,914 | 3.78 | % | ||||||||||||||||||||||||||||||
Maturing after five years through ten years | 21,332 | 21,376 | 1.50 | % | — | — | — | % | ||||||||||||||||||||||||||||||
Maturing after ten years | 444,529 | 450,451 | 2.48 | % | 125,519 | 127,184 | 3.21 | % | ||||||||||||||||||||||||||||||
Total | 523,485 | 529,617 | 2.48 | % | 133,439 | 135,098 | 3.24 | % | ||||||||||||||||||||||||||||||
| Corporate debt securities: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | 126,250 | 124,846 | 1.71 | % | 1,250 | 1,262 | 5.20 | % | ||||||||||||||||||||||||||||||
Maturing after one year through five years | 276,073 | 277,103 | 3.56 | % | 10,000 | 9,887 | 4.00 | % | ||||||||||||||||||||||||||||||
Maturing after five years through ten years | 4,000 | 4,019 | 4.50 | % | — | — | — | % | ||||||||||||||||||||||||||||||
Total | 406,323 | 405,968 | 2.99 | % | 11,250 | 11,149 | 4.13 | % | ||||||||||||||||||||||||||||||
| Foreign government bonds: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | 45,681 | 45,655 | 0.85 | % | 354,481 | 354,172 | 2.22 | % | ||||||||||||||||||||||||||||||
Maturing after one year through five years | 138,147 | 136,876 | 2.41 | % | — | — | — | % | ||||||||||||||||||||||||||||||
Total | 183,828 | 182,531 | 2.02 | % | 354,481 | 354,172 | 2.22 | % | ||||||||||||||||||||||||||||||
| Asset-backed securities: | ||||||||||||||||||||||||||||||||||||||
Maturing after ten years | 63,463 | 63,231 | 0.85 | % | 66,106 | 64,752 | 2.65 | % | ||||||||||||||||||||||||||||||
| CLOs: | ||||||||||||||||||||||||||||||||||||||
Maturing after ten years | 294,000 | 287,494 | 1.34 | % | 294,000 | 284,706 | 3.08 | % | ||||||||||||||||||||||||||||||
| Total AFS debt securities | $ | 5,470,523 | $ | 5,544,658 | 2.13 | % | $ | 3,320,648 | $ | 3,317,214 | 2.60 | % | ||||||||||||||||||||||||||
| Total aggregated by maturities: | ||||||||||||||||||||||||||||||||||||||
Maturing in one year or less | $ | 893,162 | $ | 892,648 | 1.72 | % | $ | 721,607 | $ | 719,179 | 2.43 | % | ||||||||||||||||||||||||||
Maturing after one year through five years | 639,543 | 646,245 | 3.05 | % | 395,468 | 392,891 | 2.11 | % | ||||||||||||||||||||||||||||||
Maturing after five years through ten years | 483,606 | 499,880 | 2.12 | % | 143,029 | 145,901 | 2.65 | % | ||||||||||||||||||||||||||||||
Maturing after ten years | 3,454,212 | 3,505,885 | 2.08 | % | 2,060,544 | 2,059,243 | 2.76 | % | ||||||||||||||||||||||||||||||
| Total AFS debt securities | $ | 5,470,523 | $ | 5,544,658 | 2.13 | % | $ | 3,320,648 | $ | 3,317,214 | 2.60 | % | ||||||||||||||||||||||||||
(1)Weighted-average yields are computed based on amortized cost balances.
(2)Yields on tax-exempt securities are not presented on a tax-equivalent basis.
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Loan Portfolio
The Company offers a broad range of financial products designed to meet the credit needs of its borrowers. The Company’s loan portfolio segments include commercial loans, which consist of C&I, CRE, multifamily residential, and construction and land loans; and consumer loans, which consist of single-family residential, home equity lines of credit (“HELOCs”) and other consumer loans. Total net loans, including loans held-for-sale, were $37.77 billion as of December 31, 2020, an increase of $3.35 billion or 10% from $34.42 billion as of December 31, 2019. This was primarily driven by increases of $1.48 billion or 12% in C&I loans, driven by PPP loan growth; $1.08 billion or 15% in single-family residential loans and $896.2 million or 9% in CRE loans. The composition of the loan portfolio as of December 31, 2020 was similar to the composition as of December 31, 2019.
The following table presents the composition of the Company’s total loan portfolio by loan type as of the periods indicated:
| ($ in thousands) | December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2017 | 2016 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Amount (1) | % | Amount (1) | % | Amount (1) | % | Amount (1) | % | Amount (1) | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
C&I (2) | $ | 13,631,726 | 36 | % | $ | 12,150,931 | 35 | % | $ | 12,056,970 | 37 | % | $ | 10,697,231 | 37 | % | $ | 9,640,563 | 38 | % | ||||||||||||||||||||||||||||||||||||||||||
| CRE: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| CRE | 11,174,611 | 29 | % | 10,278,448 | 30 | % | 9,260,199 | 28 | % | 8,758,818 | 31 | % | 7,890,368 | 31 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Multifamily residential | 3,033,998 | 8 | % | 2,856,374 | 8 | % | 2,470,668 | 8 | % | 2,094,255 | 7 | % | 1,711,680 | 6 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Construction and land | 599,692 | 2 | % | 628,499 | 2 | % | 538,794 | 2 | % | 659,697 | 2 | % | 674,754 | 3 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Total CRE | 14,808,301 | 39 | % | 13,763,321 | 40 | % | 12,269,661 | 38 | % | 11,512,770 | 40 | % | 10,276,802 | 40 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Total commercial | 28,440,027 | 75 | % | 25,914,252 | 75 | % | 24,326,631 | 75 | % | 22,210,001 | 77 | % | 19,917,365 | 78 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Consumer: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||