Despite continued growth, I’m not ready to write a check to East West Bancorp (EWBC) just yet

A bank I was quite neutral about was East West Bancorp (NASDAQ:EWBC). For those unfamiliar with the institution, it is a fairly large player in the financial space with a market capitalization starting at this writing $10.69 billion. Even though there are plenty of other banks that are bigger than this one, this is one of the biggest ones we’ve looked at. And as you can imagine, an institution of this magnitude has a significant reach. And the expansion extends not only to parts of the US, such as California, Texas and New York, but also to parts of Asia, such as China and Singapore.

From an asset quality perspective, East West Bancorp is a fairly robust institution. In addition, at least relative to earnings, the company is quite attractively priced. But at a price to reserve and price to book basis, shares are slightly higher. Recently, top and bottom performance has been a bit disappointing. This is despite the fact that non-interest income at the bank has increased. And when you add on top of how the stock prices are on a book basis, I don’t think I’m ready to upgrade it from “hold” I had it when I last wrote about it in December 2023 to a “buy” yet.

The growth continues

When it comes to the balance sheet, East West Bancorp is an interesting and growing business. At the end of 2023, for example, the bank had $56.09 billion in deposits on its books. They have grown since then, reaching $60 billion in the second quarter of fiscal 2024. That wasn’t the only part of the balance sheet that expanded. The value of loans, for example, increased from $51.54 billion to $52.10 billion. And an even more impressive growth can be seen when we look at securities. They amounted to 9.14 billion dollars last year. But today, they amount to $11.86 billion. And the company accomplished this while seeing only a modest drop in cash from $4.62 billion to $4.39 billion.

While it would have been nice to see the cash grow as well, you can’t have everything perfect. And the good news is that this cash balance has declined in part because management has made paying down debt a priority. At the end of last year, the total debt in the institution’s accounts amounted to 4.65 billion dollars. But by the end of the most recent quarter, that number had dropped significantly to $3.54 billion. This is still far from where the debt used to be. At the end of 2022, for example, the company had just $452.4 million in debt on its books. But because of the banking crisis, many banks have decided to increase the amount of debt they have to shore up their balance sheets with fresh cash. And for a company that still has a fairly high exposure to uninsured deposits at 42%, maintaining adequate liquidity is important to avoid the perception of trouble should times turn tough again.

When it comes to the income statement, the picture was disappointing across the board. In the most recent quarter, net interest income was $516.2 million. That’s down from the $540.7 million reported a year earlier. A rise in interest-bearing liabilities, as well as a slight contraction in the company’s net interest margin from 3.34% to 3.27%, can be blamed for much of this. But even when you look at the first half of this year compared to the same period last year, the drop from $1.12 billion to $1.06 billion, which was driven not only by an increase in interest-bearing liabilities , but also by a decrease in the net interest margin. from 3.55% to 3.27%, it becomes clear that this is part of a recent trend.

Fortunately, while net interest income has come under pressure, non-interest income at the bank has been growing. For the first half of this year, the company reported non-interest income of $163.7 million. That’s up quite a bit from the $138.6 million reported a year earlier. Higher fee income, which was largely attributed to an increase in the wealth management fees the company charges, as well as an increase in deposit account fees and loan fees, can be held responsible for much of this improvement. But that wasn’t enough to prevent net interest income from falling from $634.5 million last year to $573.3 million this year. And even in the most recent quarter, the $288.2 million reported by management was slightly below the $312 million seen in the same period in 2023.

Based on observed 2023 results, the company’s stock looks reasonably priced at a price-to-earnings multiple of 9.2. But if we annualize the data for 2024, we get a slightly higher reading of 10.2. I usually prefer banks to be somewhere between 6x and 10x earnings, so this candidate is right at the high end of the range. In the chart above, you can see how this compares against five peer banks. Four of the five trade at price-to-earnings multiples that are higher than East West Bancorp trades for. Of course, we can also value an institution like this against book value and tangible book value. And in the chart below, that’s exactly what we did. Based on the reserve price, three of the five companies we collected were trading less than it is. And that number drops to two out of five when we use the tangible book value approach.

All of this places East West Bancorp more or less in the middle of the competition. But some investors might argue that high asset quality justifies a premium. And it’s true that, at least on a relative basis, East West Bancorp has asset quality near the high end of the spectrum. In the chart below, we’ve compared it to five firms using the return on assets for each institution. And of all the companies, our candidate came out on top. In the following chart, we’ve done the same thing using return on equity. And in this scenario, the 16.40% the company boasts puts it higher than four out of five competitors.

Take away

Institutions like this are hard for me to place. There are some very positive things about East West Bancorp that investors should be aware of. Debt is coming down and most other parts of the balance sheet have improved. The stock isn’t ridiculously priced, though it’s certainly nowhere near the cheap end of the spectrum (except on price-to-earnings). And the asset quality seems to be quite high. We also have a large exposure to uninsured deposits, which makes me a little uneasy. When you add all of this up, you end up with a company that should probably be teetering between a “walk” and a “buy.” But the value investor in me insists on having a more than sufficient margin of safety. And that’s not something we seem to have in this case. So, out of an abundance of caution, I think keeping the company rated as a “hold” makes the most sense at this point.