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East West Bancorp: strong growth at high market price (EWBC)

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Earnings for East West Bancorp, Inc. (NASDAQ: EWBC) are likely to rise this year, primarily due to expected strong loan growth. In addition, the combination of a large portfolio of variable rate loans and rigid deposit costs will increase net interest income in a rising interest rate environment. On the other hand, provision charges will likely increase due to strong loan growth, which will limit net income growth. Overall, I expect the company to report earnings of $6.28 per share in 2022, compared to expected earnings of $6.16 per share in 2021. The year-end target price suggests a slight drop from the current market price. Accordingly, I adopt a neutral rating on East West Bancorp.

Loan growth should continue to hover in the high single-digit range

East West Bancorp has experienced high single digit loan growth in recent years. The company will most likely succeed in maintaining this historical trend in 2022 due to the strong economy. East West Bancorp is very well diversified geographically as it operates in California, Georgia, Massachusetts, Nevada, Texas, New York and Washington. As a result, economic parameters for the whole country are a good indicator of loan demand. The sharp improvement in the jobless rate bodes well for consumer lending, while an expansionary PMI bodes well for business lending. The following charts show recent trends in these economic measures.

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Additionally, management mentioned on the conference call that they are taking steps to continue attracting new customers. These measures include investments in people and technology and the expansion of product offerings. On the other hand, the upcoming cancellation of the remaining Paycheck Protection Program (“PPP”) loans will limit loan growth. According to the details given in the earnings presentation, outstanding PPP loans represented approximately 2.0% of total loans at the end of the last quarter.

Given these factors, I expect loans to grow by 8.2% in 2022. During this time, deposits will likely grow at the same rate as loans. The following table shows my balance sheet estimates.

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Good mixes of loans and deposits to increase income in a situation of monetary tightening

Non-interest bearing deposits represented approximately 43% of total deposits at the end of September 2021. These deposits will make the average cost of deposits stable on the upside in a rising interest rate environment. Additionally, variable rate loans accounted for approximately 65% ​​of total loans at the end of last quarter, as mentioned in the presentation. These loans will ensure that the average loan yield will be repriced upwards soon after an increase in interest rates.

However, the overall asset mix is ​​not well positioned to benefit from higher rates. The loan-to-deposit ratio fell to 75% at the end of September 2021, from 84% at the end of December 2020 and 92% at the end of December 2019. As I expect deposits to grow at the same rate as loans, the It is unlikely that the loan-to-deposit ratio will improve anytime soon. Due to the sub-optimal asset mix, net interest income is only moderately sensitive to rate changes. According to management’s interest rate sensitivity analysis, a 100 basis point increase in the interest rate can only increase net interest income by 3%. The following table from the 10-Q filing shows the results of the interest rate sensitivity analysis.

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Given the factors mentioned above, I expect the net interest margin to increase by only two basis points in 2022.

Loan growth to drive loan loss provisioning

East West Bancorp reported significant net releases of provisions in the first nine months of 2021. Further releases of reserves are likely as the level of provisioning is quite high compared to actual loan losses. Provisions represented 1.38% of total loans at the end of September 2021, while net write-offs represented only 0.13% of average loans in the third quarter of 2021, as mentioned in the presentation. As the provisions were more than 10 times actual loan losses, they appear excessive.

Moreover, East West Bancorp’s books do not face much threat from the Chinese economy and US-China relations. Exposure to China is limited as assets in the region represented only 3% of total consolidated assets at the end of the last quarter, as mentioned in the 10-Q file.

High single-digit loan growth is likely to be the main driver of provisioning this year. Overall, I expect provisioning to remain below the historical average in 2022. I expect provisioning to be 0.09% of total loans in 2022, down from 0.19 % of total loans from 2016 to 2019.

Expected earnings of $6.28 per share in 2022

Strong single-digit loan growth and modest spread expansion will likely boost earnings this year. On the other hand, a higher provision charge will likely limit earnings growth. Overall, I expect the company to report earnings of $6.28 per share in 2022. For the last quarter of 2021, I expect the company to report earnings of $1.58 $ per share, which will bring annual earnings to $6.16 per share. . East West Bancorp is expected to announce fourth quarter results on January 27, 2022. The following table shows my income statement estimates.

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Actual earnings may differ materially from estimates due to risks and uncertainties related to the COVID-19 pandemic, particularly the Omicron variant.

Current market price above the target price for the coming year

East West Bancorp offers a dividend yield of just 1.5% at the current quarterly dividend rate of $0.33 per share. Earnings and dividend estimates suggest a payout ratio of 21% for 2022, which is in line with the 2016-2019 average of 23%. Therefore, I do not expect an increase in the level of dividends even though there is plenty of room for higher dividends.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value East West Bancorp. The stock has traded at an average P/TB ratio of 1.84 in the past, as shown below.

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Multiplying the average P/TB multiple by the expected tangible book value per share of $42.7 yields a target price of $78.5 for the end of 2022. This price target implies a decline of 9.6% compared to the closing price on January 7. The following table shows the sensitivity of the target price to the P/TB ratio.

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The stock has traded at an average P/E ratio of around 12.3x in the past, as shown below.

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Multiplying the average P/E multiple with the expected earnings per share of $6.28 yields a target price of $77.1 for the end of 2022. This price target implies an 11.1% decline from at the closing price on January 7. The following table shows the sensitivity of the target price to the P/E ratio.

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Equal weighting of the target prices from the two valuation methods yields a combined target price of $77.8, implying a 10.4% decline from the current market price. Adding the forward dividend yield gives an expected total return of minus 8.8%. Therefore, I adopt a neutral rating on East West Bancorp. I want to buy this stock at a market price at least 15% below the current level.