Will the recent positive trend continue leading up to its next earnings release, or is East West Bancorp due for a pullback? Before we dive into how investors and analysts have reacted as of late, let’s take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
East West Bancorp’s fourth-quarter 2020 earnings per share of $1.15 outpaced the Zacks Consensus Estimate of $1.03. However, the figure is down 10.9% from the prior-year quarter. Results included adjustments related to DC Solar tax credit investments.
Results reflect rise in non-interest income and lower expenses. Also, the company witnessed a rise in loan and deposits balance during the quarter. However, decline in net interest income, mainly due to lower interest rates, was a major undermining factor. Also, provisions increased during the quarter.
Adjusted net income was $161.5 million or $1.13 per share, down from $187.1 million or $1.28 per share in the year-ago quarter.
In 2020, earnings of $3.97 per share beat the consensus estimate of $3.85 but was down 13.9% year over year. Adjusted net income was $565.2 million or $3.95 per share, down from $707.9 million or $4.84 per share in 2019.
Net revenues for the quarter were $416.4 million, down 4.1% year over year. However, the figure beat the Zacks Consensus Estimate of $389.8 million.
In 2020, net revenues declined 4.6% to $1.61 billion. However, the top line surpassed the consensus estimate of $1.58 billion.
Net interest income came in at $346.6 million, down 5.9% year over year. Net interest margin also contracted 70 basis points (bps) to 2.77%.
Non-interest income was $69.8 million, up 6.1%. This rise mainly resulted from higher deposit account fees, foreign exchange income and other income.
Non-interest expenses declined 8.9% to $178.7 million. The fall was primarily due to lower amortization of tax credit and other investments, legal expenses and consulting expenses.
Efficiency ratio was 42.90%, down from 45.20% recorded in the prior year quarter. A fall in the efficiency ratio indicates improvement in profitability.
As of Dec 31, 2020, net loans were $37.8 billion, up 2.6% sequentially. Total deposits increased 7.6% to $44.9 billion.
Annualized quarterly net charge-offs were 0.20% of average loans held for investment, up 10 bps year over year.
As of Dec 31, 2020, non-performing assets were $234.9 million, surging 93.3%. Also, provision for credit losses was $24.3 million, up 31% from the prior-year quarter.
As of Dec 31, 2020, common equity Tier 1 capital ratio was 12.7% as of Dec 31, 2020, down from 12.9% as of Dec 31, 2019. Total risk-based capital ratio was 14.3%, down from 14.4%.
At the end of the fourth quarter, return on average assets was 1.24%, down from 1.68% as of Dec 31, 2019. Further, as of Dec 31, 2020, return on average tangible equity was 13.77%, down from the 16.61%.
Management assumes no change in interest rates. Adjusted NII is projected to grow in line with loan growth and exclude paycheck protection program (PPP) income. Loans are expected to grow 6-8% range.
Adjusted non-interest expenses (excluding (ex. tax credit investment & core deposit intangible amortization) are anticipated to rise 3-5%.
Provision for credit losses is likely to be between $70 million and $80 million.
Effective tax rate is expected to be roughly 15%, including the impact of tax credit investments.
How Have Estimates Been Moving Since Then?
It turns out, fresh estimates have trended upward during the past month. The consensus estimate has shifted 20% due to these changes.
Currently, East West Bancorp has a poor Growth Score of F, however its Momentum Score is doing a bit better with a D. Charting a somewhat similar path, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.
Overall, the stock has an aggregate VGM Score of F. If you aren’t focused on one strategy, this score is the one you should be interested in.
Estimates have been trending upward for the stock, and the magnitude of these revisions looks promising. It comes with little surprise East West Bancorp has a Zacks Rank #2 (Buy). We expect an above average return from the stock in the next few months.
PASADENA, Calif.–(BUSINESS WIRE)–East West Bancorp, Inc. (“East West” or the “Company”) (Nasdaq: EWBC), parent company of East West Bank, the financial bridge between the United States and Greater China, will release fourth quarter and full year 2020 financial results before the market opens on Thursday, January 28, 2021.
Conference Call Information
Management will discuss fourth quarter and full year 2020 financial results with the public on Thursday, January 28, 2021 at 8:30 A.M. Pacific Time/ 11:30 A.M. Eastern Time via conference call. The public and investment community are invited to listen as management discusses fourth quarter and full year results and operating developments.
Within the U.S.
Within the U.S.
Replay Access Code
Replay will be available from January 28, 2021 at 11:30 A.M. Pacific Time/ 2:30 P.M. Eastern Time until February 28, 2021.
Information for the conference call and replay are provided on the Investor Relations page at www.eastwestbank.com/investors.
About East West
East West Bancorp, Inc. is a publicly owned company with total assets of $50.4 billion and is traded on the Nasdaq Global Select Market under the symbol “EWBC”. The Company’s wholly-owned subsidiary, East West Bank, is one of the largest independent banks headquartered in California, operating over 125 locations in the United States and Greater China. U.S. markets include California, Georgia, Massachusetts, Nevada, New York, Texas and Washington. 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. For more information on East West, visit the Company’s website at www.eastwestbank.com.
Will the recent positive trend continue leading up to its next earnings release, or is East West Bancorp due for a pullback? Before we dive into how investors and analysts have reacted as of late, let’s take a quick look at the most recent earnings report in order to get a better handle on the important drivers.
East West Bancorp’s third-quarter 2020 earnings per share of $1.12 surpassed the Zacks Consensus Estimate of 94 cents. However, the figure is down 4.3% from the prior-year quarter.
The results reflect lower provisions and operating expenses. Further, improving loan and deposit balances strengthen the balance sheet. However, lower net interest and non-interest income, and shrinking margins remain headwinds.
Net income was $159.5 million, down 6.9% from the year-ago quarter.
Total revenues were $373.7 million, down 11.3% year over year. Moreover, the figure missed the Zacks Consensus Estimate of $398 million.
NII came in at $324.1 million, which fell 12.4% year over year. NIM also contracted 87 basis points year over year to 2.72%.
Non-interest income was $49.6 million, down 3.7% from the year-ago quarter. This decline mainly resulted from a decrease in net gains on sale of loans, foreign-exchange income and other investment income. The downside was partially offset by an increase in lending fees, deposit account fees and other income.
Non-interest expenses declined 5.1% from the prior-year quarter to $167.7 million. The fall was largely due to lower amortization, occupancy and legal expenses.
Efficiency ratio was 44.86%, up from the prior year’s 41.93%. A rise in the efficiency ratio indicates deterioration in profitability.
As of Sep 30, 2020, net loans were $36.8 billion, up marginally sequentially. Total deposits increased 2.5% from the end of the first quarter to $41.7 billion.
Annualized quarterly net charge-offs were 0.26% of average loans held for investment, unchanged from the end of the prior-year quarter.
As of Sep 30, 2020, non-performing assets were $260 million, surging 93.2% year over year. However, provision for credit losses was $10 million, tanking 73.9% from the prior-year quarter’s $38.3 million.
Common equity Tier 1 capital ratio was 12.8% as of Sep 30, 2020, unchanged from Sep 30, 2019. Total risk-based capital ratio was 14.5%, up from 14.2% as of the same date.
At the end of the third quarter, return on average assets was 1.26%, down from 1.58% as of Sep 30, 2019. Further, as of Sep 30, 2020, return on average tangible equity was 13.88%, down from the 15.75% witnessed in the corresponding period of 2019.
The company expects GAAP NII to grow 3-5%. Further, GAAP NIM is expected to be in the range of 275 to 285, including Paycheck Protection Program (PPP) income. Both NII and NIM are expected to be driven by a fall in deposit costs and the partial repayment of Paycheck Protection Program Liquidity Facility (PPPLF) ahead of PPP loan forgiveness.
Amortization of tax credit and other investments is anticipated to be nearly $20 million.
Further, the company expects to recognize a deferred fee and interest income of $15 million from PPP loans.
The company projects similar pace of residential mortgage origination as witnessed in the first three quarters of 2020.
Effective tax rate is likely to be close to the full year rate of 15%.
How Have Estimates Been Moving Since Then?
It turns out, fresh estimates have trended downward during the past month.
At this time, East West Bancorp has a poor Growth Score of F, however its Momentum Score is doing a lot better with a C. Charting a somewhat similar path, the stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.
Overall, the stock has an aggregate VGM Score of C. If you aren’t focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, East West Bancorp has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
East West Bancorp, Inc. (NASDAQ:EWBC) Q3 2020 Results Earnings Conference Call October 22, 2020 11:30 AM ET
Julianna Balicka – Director, Strategy & Corporate Development
Dominic Ng – Chairman & CEO
Irene Oh – CFO
Conference Call Participants
Ebrahim Poonawala – Bank of America
Ken Zerbe – Morgan Stanley
Jared Shaw – Wells Fargo
Chris McGratty – KBW
Dave Rochester – Compass Point
Gary Tenner – D.A. Davidson
Matthew Clark – Piper Sandler
David Chiaverini – Wedbush Securities
Brock Vandervliet – UBS
Good day, and welcome to the East West Bancorp’s Third Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Julianna Balicka. Please go ahead.
Thank you, Sarah. Good morning and thank you everyone for joining us to review the financial results of East West Bancorp for the third quarter of 2020. With me on this conference call today are Dominic Ng, our Chairman and Chief Executive Officer; and Irene Oh, our Chief Financial Officer.
We would like to caution you that during the course of the call, management may make projections or other forward-looking statements regarding events or future financial performance of the company within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties.
For a more detailed description of the Risk Factors that could affect the company’s operating results, please refer to our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year-ended December 31, 2019.
In addition, some of the numbers referenced on this call pertain to adjusted numbers. Please refer to our third quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures.
During the course of this call, we will be referencing a slide deck that is available as part of the webcast and on the Investor Relations website. As a reminder, today’s call is being recorded, and will also be available in replay format on our Investor Relations website.
I will now turn the call over to Dominic.
Thank you, Julianna. Good morning and thank you everyone for joining us for our third quarter 2020 earnings call. I would begin with the review of our financial condition and results on slide 3 of this presentation.
This morning we reported third quarter 2020 net income of $160 million a $1.10 per share up 61% from second quarter net income of $99 million or $0.70 per share. Our third quarter return of average assets was 1.26%, return on average equity was 12.5% and return on average tangible equity was 13.9%. Our profitability rebound from the trough of the second quarter as provision for credit losses declined. Deposit growth this quarter was very healthy but especially strong growth in non-interest bearing demand account which grew 28% annualized quarter-over-quarter based on period end balances and 22% annualized based on average balances. As of September 30, we reached a record $41.7 billion in deposits including a record $14.9 billion in demand deposit account. We generate a positive loan growth also in the third quarter reaching a record $37.4 billion in loans as of September 30, 2020 despite a challenging backdrop of slow economic activity due to the COVID-19 pandemic.
The biggest driver for the quarter-over-quarter increases in net income was a reduction in the provision for credit losses which was $10 million in the third quarter compared to $102 million in the second quarter. In the first half of the year we recorded $176 million in provision for credit losses compared to net charge-offs of $20 million substantially including our reserve level based on an improved macro economic outlook we modestly decreased our allowance for loan losses as of September 30. Overall credit continues to be very manageable as demonstrated by net charge-offs at annualized 26 basis points of average loans. Also in the third quarter we earned $219 million of pre-tax, pre-provision income on total revenue of $374 million.
Our pre-tax, pre-provision profitability ratio was 1.74%. The steep decline in interest rates this year has impacted our revenue. However, at the downward reprising of our earning assets to benchmark rate is largely complete and we continue to reduce the cost of funds as maturing CDs reprise lower. We anticipate that our pre-tax pre-provision income and profitability will stabilize going forward. Importantly our efficiency remains industry-leading and it’s the key durable to maintaining above averages pre-tax pre-provision probability. Efficiency ratio in the third quarter was 41.3%.
Moving to slide 4 for summary review of our balance sheet. Our balance sheet is strong. We have high levels of liquidity and capital as of September 30, 2020 with crossover than $50 billion in assets milestone and in the quarters at $50.4 billion. This translates to an organic compound annual growth rate of 10% over the past five years. Quarter-over-quarter total loans of $37.4 billion increased $208 million or 2% length quarter annualized. Total deposits of $41.7 billion increased $1 billion or 10% annualized.
Our deposit growth combination of on boarding new clients, expanding existing relationships and our clients maintaining high levels of liquidity. We believe the momentum of strong deposit growth can be sustained post pandemic. Due to our deposit growth this quarter our loan to deposit ratio as of September 30 was 89.8% compared to 91.5% as of June 30.
Now turning to slide 5. You can see that East West capital ratios are strong and growing and are some of the highest amount regional banks particularly for the common and tier one equity. Our book value and tangible equity per share were both up 3% from the prior quarter and on tangible equity to tangible assets ratio increased to 9.3%. You can see from the charge of that all out capital ratios increased quarter-over-quarter. East West board of directors has declared fourth quarter 2020 dividends for the company’s common stock. The common stock cash dividend of $27.5 is payable on November 16, 2020 to stockholders of record on November 2, 2020.
Moving on to a discussion about loan portfolios beginning with slide 6. C&I loans excluding PPP were $11.5 billion as of September 30 or 31% of the total loans. Total C&I commitment excluding PPP were $16.3 billion as of September 30 a quarter-over-quarter to increase of 5% annualized.
Month-over-month growth of loans outstanding turned positive in September reversing a trend of negative monthly growth since March. Overall C&I loans outstanding excluding PPP decreased by $144 million between June 30 and September 30, a decrease of 5% annualized compared to a decrease of 29% annualized in the second quarter.
Moving to slide 7, as a September 30 our total commercial real estate portfolio was $14.7 billion or 39% of the total loans. Total commercial real estate loans grew $171 million or 5% annualized from June 30. The portfolio is well balanced across the major property types of retail, multi-family, office, industrial and hotel. Our exposure to construction and land loan remain low at 1.5% of total loans.
You can see on slide 8 that the weighted average loan to value of our total commercial real estate portfolio is 51% more than the average loan size of only $2.4 million. Nearly 90% of our commercial real estate loans have an LTV of 65% or lower. In the chart on the right you can see that the weighted average loan to value of our loans by property type range from 49% to 53%.
On slides 9 and 10, we provide additional details regarding our single-family residential loans and home equity lines. Combined residential mortgage and other consumer loans make up 25% of our total loans. As of September 30, a single family residential portfolio was $7.8 billion up by $126 million or 7% annualized from June 30. In the third quarter we originated $768 million of residential mortgage loans consistent with the pace from the first half of 2020 and up by 19% year-over-year from the third quarter of last year. We expect a similar pace of origination for the fourth quarter.
The average loan size in our residential mortgage portfolio is only 386,000 and the weighted average loan to value is 53% again 90% of our residential mortgage loans have an LTV loan to value of 60% or less. On to slide 10. September 30 we had $1.5 billion of home equity lines outstanding plus $1.6 billion in undisbursed commitments translating into a utilization rate of 48% unchanged from last quarter. Equity lines outstanding increased $52 million quarter-over-quarter or 14% annualized and total commitment increased 11% annualized. The average size of our home equity commitment is 367,000 and the weighted average combined LTV is only 48%. 97% of our home equity have an LTV, loan to value of under 60%.
I will now turn the call over to Irene for a more detailed discussion of our asset quality and income.
Thank you Dominic. I will start by discussing loans on COVID-19 related deferrals on slide 11. As of October 20, loans on full payment deferral were 1.9% of total loans including loans on partial payment referral suddenly were modifications of principal and interest payment to interest only, loans on deferral total 3.4%. Overall 55% of commercial loans on deferral are still making partial payments. Quarter-over-quarter loans on COVID-19 related deferral decreased close to 50% between June 30 and September 30 and decreased a further 20% month to date in October. The largest improvement was in residential mortgage deferrals which decreased by 79% since June 30 reflecting the resiliency of the East West customer base.
Similar to the second quarter the deferral rate on C&I loans continued to be very low. Commercial real estate loans on deferral have also decreased down to 6.6% as of October 20 comprised of 3.8% on partial payments and 2.8% on full payment deferral largely reflecting the longer COVID-19 impact on cash flows for certain properties.
Turning to slide 12 for review of our allowance for loan losses and slide 13 for a review of our other asset quality metrics. Our allowance for loan losses was $618 million as of September 30 or 1.65% of loans held for investment modestly down from $632 million or 1.7% of loans as of June 30. Since January 1 post-season our allowance increased $135 million and the coverage ratio increased by 26 basis points from 139. The current macroeconomic forecast has improved projecting less severe economic conditions compared to June 30. This in turn decreased the expected lifetime losses for the loan portfolio.
The forecast driven reduction to the allowance was partially offset by increased qualitative reserves for oil and gas and commercial real estate loans. The allowance coverage of our oil and gas portfolio was 10% as of September 30, up for 9% as of June 30. Net charge-offs for the second quarter were just under $25 million and the net charge-off ratio was 26 basis points of average loans annualized. Charge-offs in the third quarter were primarily from oil and gas loans which accounted for $22 million or 91% of net charge-offs while charge-offs from other loan classes remain at low cost. Reflecting these drivers and assumptions we recorded a 10 million provision for credit losses during the third quarter of 2020 compared to $102 million in the second quarter.
Turning the slide 13. On this page we detail out the components of criticized assets. Criticized loans were 3.9% of total loans as of September 30 totaling $1.5 billion. The largest concentration within criticized loans by either industry or property type remains oil and gas. Other criticized C&I loans are diversified by industry and the criticized commercial real estate loans are likewise largely diversified by property type.
Special mentioned loans were 1.9% of totals as of September 30 in the amount of $723 million up from 1.5 of total loans as of June 30; an increase of 26%. The quarter-over-quarter increase in specialty loans was largely due to inflows from commercial real estate. As of September 30, 10.5% of oil gas loans, 2.8% of all other C&I loans and 2.1% of commercial real estate loans were graded special mention.
Classified loans were two percent of total loans as of September 30 in the amount of $758 million compared to 1.8% as of June 30, an increase of 11%. The quarter-over-quarter increase in classified loans was largely driven by downgrades of oil and gas loans followed by downgrades of all other C&I loans. As of September 30, 23.5% of oil and gas loans, 2% of all other C&I and 1.6% of commercial real estate loans were classified.
Non-performing assets were 52 basis points of total assets as of September 30 in the amount of $260 million compared to 41 basis points as of June 30 an increase of 29%. The quarter-over-quarter increase in non-performing assets was primarily due to net inflows of previously classified oil and gas loans to non-accrual status.
Lastly accruing loans 30 to 89 days past due were $85 million or 23 basis points of total loans as of September 30, a quarter-over-quarter improvement of 25% from $113 million or 30 basis points of total loans as of June 30. As you can see in our credit quality metrics outside of oil and gas asset quality is holding across our other loan portfolios.
In terms of oil and gas I’d like to note that we continue to reduce our exposures through pay downs, workouts and charge-offs. Oil and gas loans outstanding are down 8% quarter-over-quarter and down 12% year-to-date. Including undispersed commitments total oil and gas commitments are down 8% quarter-over-quarter and down 17% year-to-date. In terms of hedges in place for our EMP borrowers 52% of their planned 2021 oil production is hedged and 59% of their planned 2021 gas production is hedged.
And now moving to a discussion of our income statement on page 14. This slide summarizes the key line items of the income statement which I will discuss in more detail on the following slides. Amortization of tax credit and other investments was $12 million in the third quarter compared to $25 million in the second quarter. The quarter-over-quarter change reflects timing of tax credit investments and we expect this number to be approximately $20 million in the fourth quarter.
The effective tax rate for the third quarter was 90% up from 12% in the second quarter of 2020. The quarter-over-quarter increase in the tax rate reflects the increase in pre-tax income. Third quarter income before taxes was $196 million; a 75% increase from $112 million in the second quarter as we increased our estimate for the full year effective tax rate to 15%. The 19% effective tax rate for the third quarter includes the trough to the higher full year effective tax rate. The effective tax rate in the fourth quarter should be close to the full year effective tax rate of 15%.
I’ll now review the key drivers of our net interest income and net interest margin on slides 15 through 18 starting with average balance sheet growth. Third quarter average loans of $37.2 billion grew quarter-over-quarter. Growth in commercial real estate, residential mortgage and PPP loans was offset by a decrease in C&I loans. Third quarter average deposits of $41.2 billion grew 13% linked quarter annualized driven by strong growth in demand and checking accounts offset by a reduction in high cost time deposits. Average non-interest bearing deposit accounts grew 22% linked quarter annualized and made up 35% of total deposits in the third quarter or from 34% in the second quarter and 29% in the year ago quarter.
With a strong deposit growth in excess of loan growth the average loan to deposit ratio decreased to 90% in the third quarter down from 93% in the second quarter. Excluding PPP loans where we match funded 75% with the PPLF the average loan to deposit ratio was 86% in the third quarter. Accordingly average interest bearing cash and deposits with banks increased by $1.5 billion in the third quarter and made up 10% of average earning assets up from 8% in the second quarter. This growth in lower yielding assets was a headwind to the net interest margin this quarter.
We’ve continued to deploy excess liquidity until available for sale securities but given the low interest rates and the flat curve attractive opportunities are limited. In the current environment we are comfortable in managing the balance sheet with a higher level liquidity and recognize that when loan growth accelerates as it is starting to this headwind to the net interest margin will largely self-care.
On slide 16 you can see that third quarter 2020 net interest income of $324 million decreased by $20 million or 6% linked quarter and a net interest margin of $272 compressed by 32 basis points from the prior quarter. However, excluding the impact of PPP loans and the PPLF third quarter adjusted net interest income of $318 million declined by 2% or $5 million quarter-over-quarter exhibiting relative stability. Third quarter adjusted net interest margin of 277 compressed by 19 basis points from second quarter.
PPP loan interest and deferred fee income was $6.5 million in the third quarter down from $21 million in the second quarter. The quarter-over-quarter fluctuation is due to changes we made to our estimate for expected forgiveness of PPP loans by the SBA resulting in reduced deferred fee accretion for the third quarter. The quarter-over-quarter change in net interest margin breaks down as follows. Negative 14 basis points from lower loan yields. Negative 6 basis points from lower other earning asset yields. Negative 12 basis points from excess liquidity with higher balances of interest bearing cash and deposits with banks as well as a negative 13 basis points of negative impact from less PPP income partially offset by 12 basis points from a lower cost of deposits and one basis point from a lower cost of borrowing.
Headwinds engine have been deposit growth in excessive loan growth a lack of attractive redeployment yields for excess liquidity. But we see several tailwinds that should improve the NIM and the net interest income going forward. For the fourth quarter of 2020 we anticipate that our GAAP net interest income will grow by 3% to 5% and that our GAAP net interest margin will range from 275 to 285 including PPP income. The drivers for our net interest income and NIM outlook are as follows. First, continued reduction in deposit costs from the repricing of maturing CDs. We have 1.4 billion in CDs at a weighted average interest rate of 145 maturing in the fourth quarter and another 1.3 billion at a weighted average interest rate of 126 in Q1 of 2021.
Second partial repayment of the PPPLF ahead of PPP loan forgiveness for our customers; a process that we have already begun. Month to date in October we’ve repaid $524 million. Also we expect to recognize $15 million of PPP loan deferred fee and interest income in the fourth quarter and thirdly general stability for low yields as downward repricing of variable rate loans has largely run its course.
Now turning to slide 17. Third quarter average loan yields of 360 contracted by 38 basis points from last quarter reflecting downward pricing of variable rate loans to benchmark interest rates as well as the reduced fee income accredited on PPP loans. Excluding the impact of PPP, the third quarter adjusted loan yield of 370 contracted by 20 basis points quarter-over-quarter. In the second quarter the quarter-over-quarter contraction and the average loan yield excluding the impact of PPP was 81 basis points. 65% of East West loan portfolio is variable rate and by now these loans have largely repriced. Nearly 90% of variable rate loans we have are linked to benchmark interest rates with a duration of three months or less.
In the upper right quadrant we’ve laid out a new chart showing our average loan yields by portfolio. As you can see our single family residential mortgage product is a lease rate sensitive portfolio and continues to carry attractive yields. To organically reduce asset sensitivity we have been growing fixed rate loans notably in single family. Year-over-year fixed-rate loans excluding PPP increased by 30%.
Turning to slide 18. Against the backdrop of maturely lower interest rates declines in earning asset yields have been partially offset by decreases in the cost of funds. Our average cost of deposits for the third quarter dropped to 33 basis points down from 47 basis points in the second quarter and an improvement of 14 basis points. The spot rate of total deposits as of September 30 was 29 basis points. Our third quarter average cost of interest bearing deposits dropped to 50 basis points down from 71 basis points in the second quarter; an improvement of 19 basis points. The spot rate of interest bearing deposits as of September 30 was 46 basis points.
In the lower left quadrant we present our third quarter 2020 cost of deposit by deposit category compared to the cost of deposits in the third quarter of 2015 which was the last full quarter under a zero interest rate policy before the fed raised rates in December 2015. At that time the average cost of deposits was 28 basis points and the average cost of interest bearing deposits was 40 basis points. We included this chart in the deck as we believe it provides additional context of the repricing lever within our cost of deposits. You can clearly see that our CD book has not fully repriced down to historic Zurich levels.
We expect to continue to reduce our average cost of CDs maturing CDs over the next six months reprice lower, bringing the total cost of deposits down further. The rate paid on originations or renewals of domestic CDs in the third quarter of 2020 was 43 basis points and the retention rate of branch CDs has been an excellent 92%. Quarter-to-date rates paid on our CD originations and renewals have been lower than in the third quarter. Also as of yesterday the spot rate for our cost of interest bearing deposits is down to 42 basis points and for our total cost of deposits it’s down 27 basis points.
Moving on to fee income on slide 19. Total non-interest income in the third quarter was $50 million compared $59 million in the second quarter. Fee income and net gains on sales of loans was $48 million in the third quarter down by $4 million or 8% quarter-over-quarter. Lending fees of $19 million decreased by $3 million largely reflecting valuation changes for warrants received as part of lending relationships. Third quarter lending fees included $4 million from an increase in the valuation of warrants in comparison second quarter included $8 million from an increase in the valuation of warrants. Included in lending fees are customer driven letters of credit fees which increase quarter-over-quarter in parallel with increased customer activity.
Reflecting an increase in the number of customer accounts in customer driven transactions deposit account fees and wealth management fees increased quarter-over-quarter. Foreign exchange fees decreased quarter-over-quarter due to downward revaluations of FX denominated balance sheet items partially offset by an increase in customer driven trend.
Moving on to slide 20, third quarter non-interest expense was $168 million a decrease of 11% linked quarter. Excluding amortization of tax credits and other investments and core deposit intangible amortization adjusted non-interest expense was $154 million in the third quarter; an increase of only 1 % quarter-over-quarter and a decrease of 3% year-over-year. I would also note that excluding the impact of PPP loan origination costs deferred in the second quarter, third quarter compensation expense of $100 million decreased 4% quarter-over-quarter for $104 million in the second quarter. In the second quarter $7 million of compensation expense associated with PPP loan originations was deferred.
The quarter-over-quarter increase in computer software expense reflects amortization of previously capitalized investment spend. Our third quarter adjusted efficiency ratio was 41.3%. Over the past five quarters our efficiency ratio has ranged from 37.7% to 41.3%. As an organization we remain committed to controlling expenses across the board in order to support our strong profitability.
With that I will now turn the call back to Dominic Ng for closing remarks.
Thank you Irene. Well in summary our net interest margin is stabilizing. Our loan growth is positive. We remain disciplined about efficiency and credit remains manageable. Business activity for our customer is picking up and we are looking forward to helping them rebuild and expand into the future. Here I would like to thank all of our associates for the dedication during these unprecedented times and wish everyone continued good health.
I will now open up the call to questions. Operator?
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Ebrahim Poonawala with Bank of America. Please go ahead.
Good morning Ebrahim.
If we could just start with credit Dominic when we look at the provisioning level I think assuming that the macro doesn’t deteriorate from here. Just talk to us in terms of your comfort around the portfolio one like what do you expect with the rest of the deferrals that are still outstanding as we get towards the end of the year? What percentage of those do you expect to go into non-accrual versus go back to paying and what have you learned about the portfolio in the last six months to give us comfort that we’re not going to have negative credit surprises in 2021?
Well we’ve been actually looking at our credit portfolio sector by sector and within the C&I also in commercial real estate in C&I with all the different industry vertical each vertical gap review loan by loan. CRE we break it down by for the hotel, office building, multi-family and then region by region and obviously our single family mortgage is hardly have any problem and has always been for many years. So we’ve done all of that kind of review and we as of today feel pretty good about where we are today. We think our reserve is definitely adequate and in terms of our risk rating classification and so forth and we feel that we are very much current in terms of the classification.
From the deferral point of view as you can see from June 30 to September 30 and all the way even we showed that the deferral as of two days ago it continued to show great progress and we, at this point, do not see a lot of concern about surprises.
Got it. And just in terms of capital I think Dominic you mentioned on CET1 even on tangible equity you have one of the stronger capital levels. You were conservative coming into the cycle not buying back stocks. Just talk to us in terms of how you think about capital allocation maybe not in the next couple of months but as we look into the first half of next year and I guess a desire to buy back stock on if it stays where it is?
Well we have board meetings every two months, two and a half months or so. So this is always like I would say that a standing agender. So we update the information, financial condition and balance sheet and also the mainly the economic outlook with the board members and then with those information we deliver it and then we have discussion of whether we take any kind of action. So at this stage right now I would say that and we’re still in that pandemic environment. We are not going to be looking into buying back stock. On the other hand comes 2021 things can change dramatically in terms of economic outlook and then we will do whatever is right accordingly in the based on the circumstances at that point.
Our next question comes from Ken Zerbe with Morgan Stanley. Please go ahead.
All right. Great. Thanks. I guess maybe just looking for a little more detail on the NPA increase I know you said I was driven by oil and gas I guess the concern that we would have is does it continue right I mean obviously you still have a sizable portfolio it is running off but is the worries it doesn’t continue and slash do you have to build reserves for the additional portfolio as it deteriorates? Thanks.
Yes Ken that’s a great question. When we look at the increase in non-accrual loans and also charge-offs really over the course of last year and beyond that really a lot of that has come from the oil and gas portfolio and we have also increased the reserves let’s say a quarter-over-quarter 9% to 10%. So when I look at it from the perspective of where the loss content is I do think it’s still in our portfolio in oil and gas. I would say though when these loans were previously classified they are identified and one thing that is positive is that we’re not seeing an ongoing kind of downward deterioration into classified assets.
Yes. I would say, Ken let me just add maybe add on to what Irene just shared is that would there be likelihood of more potential charge of losses from the oil and gas portfolio. Definitely. There is that probability. The difference is that we feel very confident because we only have so many loans in our own portfolio and it’s twinkling down and there are just so many loans in there and we have looked at every one of them and we continue to classify them in the right bucket and the macroeconomic condition as of today is actually more positive than a few months ago. We all recall you know back in late March and early April the crude oil prices had just dropped to a level that is unheard of but it’s been pretty much stabilized at that $40 per barrel and then the gas price actually have gone up quite nicely.
And then keep in mind also that our portfolio as Irene shared earlier I mean substantial percentage of these loans are properly hedged even going into 2021. So it’s not like these are the loans that on a daily basis they are going one by one going into trouble. I think what we experience in terms of the charge off somewhat relative to peers in that industry and everyone get the link from the oil and gas business. So from our perspective is that this is a portfolio that is getting smaller and smaller and we have substantial reserve provide for it and we feel confident that we can manage that and in addition to it we have plenty of profits and income to offset against these losses and still come up with a decent return of equity and return of asset.
Yes and this is a long-term plan just to keep running it off because I guess it’s just hard for us to see how this segment generates positive risk adjust to returns given every few years it almost feels like there’s a problem and losses spike. I’m talking positive risk adjusted returns over like a multi-year period.
We are managing it down and then we started managing it downs last year and then we continue the managing down, but the environment keep changing who knows what’s going to happen from the demand around the world or United States or even a technological advancement that changed the dynamic that we have no ability to project. I mean as a bank we basically facilitate financing with a very-very focus of risk management. If we feel that this is going to be an industry going forward that we can manage the risk very effectively there is no reason why we’re not into this segment. I think it’s all get back down to we will be always very prudent to watch what’s going on in the future and do the right thing accordingly.
Our next question comes from Jared Shaw with Wells Fargo. Please go ahead.
Hi good morning.
Good morning Jared.
Looking at the expense side in the efficiency side do you think given the broader low rate environment we can get back to a sub 40% efficiency ratio or will that really depend on seeing some broader rate improvement or is there anything you can do on the expense side to help accelerate that?
Yes Jared I will take that call, a question. I think the largest variable for that would be on the revenue side. As we talked about earlier in our prepared remarks we do feel strongly fourth quarter and beyond that that revenue that interest margin NIM will increase. I think we have a long history of proven ability to control the expenses and that’s something that we feel confident in this type of environment that we’ll be able to continue to do so. While still making the appropriate investments that we need to support our growing business.
Okay. Thanks and then shifting a little bit to the CRE portfolio and the growth you saw this quarter I guess how much of that was refining I guess somebody else’s loan and what gives you, how are you getting comfort putting on new CRE product now and is that translating into better terms and conditions and pricing or I guess maybe your thoughts around what you’re seeing and doing on the CRE side?
In terms of with CRE loans that we originated most of the, I mean almost all of them are with customers that we’ve been doing business for a long time and these customers have very strong financial and balance sheet and that we feel comfortable and then obviously these are the properties that are less impacted negatively by the pandemic and that’s what we originated. These new loans; some of them are not refi some of them are just also taking shares from other banks and so forth. The pricing is getting better than slightly better than it was I would say six nine months ago obviously CRE pricing was extremely competitive last year. It’s no longer as a competitive so we will be, I would say that originating CRE along with a slightly better pricing go forward.
In terms of volume of CRE loans I would think that in 2021 and we probably may not have as nice of a robust growth of CRE origination like we did in 2019. So you would expect that 2021 the growth rate will be tempered somewhat because of the lack of great quality asset to be financed, but we will continue to look and then I looked at it is that East West is a not a giant institution it’s not that difficult for us to keep looking and finding gems, hide around the bushes and then just make up enough to show positive growth rate.
Our next question comes from Chris McGratty with KBW. Please go ahead.
Great. Thanks for the question. I want to ask about everyone’s favorite topic and taxes given the market’s expectations that there could be a tax rate increase next year could you walk us through the potential sensitivity on the tax line and also the amortization line given that you guys have been a little bit more proactive in managing your taxes over the years?
Yes. Chris so when we look at the changes that might happen from a corporate tax rate 21% to 27% of that at this point in time although you know there are a lot of moving parts we think if that happens the impact test will be about 4% on the rest of it with the amortization once we have this call in January to talk about fourth quarter we can give you a little bit more details on that along with that if that happens I will add at this point in time we have about $20 million of DTAs that would reverse as well.
Got it and then assuming this status quo just for modeling purposes I think you said for the fourth quarter amortization of $20 million that would bring it to around 75 for the year all else equal is that the right math for next year 15% tax rate and 75 or so on the amortization?
So we’ll talk about that in January.
Got it. Thanks.
Our next question comes from Dave Rochester with Compass Point. Please go ahead.
Hey good morning guys.
Hey on credit you talked about the reserve release a bit. I was just wondering if you could maybe just give a little bit more detail on your comfort level reducing that reserve on your CRE book at this point where there’s still uncertainty in the economy and how the remaining deferrals in that book are going to pan out. This quarter we saw other banks building that reserve in that particular bucket. So just wondering what your thoughts were for this quarter and then if you could talk about how much stimulus that you have baked into your outlook at this point that would be great?
Okay. So if we look at kind of the breakdowns of our allowance the amount of reserve that we have set aside for our real estate loans is just over $200 million. So on income producing real estate and also multi-family. So ultimately I would say right now deferrals what we’re seeing in the portfolio our customers we’re very comfortable with that allowance level depending on what happens with the forecast we’ll look and see as far as is a level appropriate. For our allowance calculation we rely on Moody’s and the economic forecast there to kind of tailor to our portfolio. We do use a multi-scenario approach baseline S1 and S3 because of S3 is a more severe adverse scenario overall I will share that the reserve the quantitative reserve that we set aside is higher than the baseline.
Okay. And then how much stimulus is baked into your overall outlook at this point? What do you guys assume for government, additional government stimulus?
Yes so in and I think I will just break it down with the scenario so baseline did assume 1.5 trillion — assumed none. So as I mentioned the overall quantitative reserve that we have is higher than the baseline.
Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead.
Thanks. Good morning. A lot of questions have been answered but I was curious on your comments on pre-paying the PPP I think you said $524 million month to date in terms of the liquidity facility. How much of that do you expect to exit by year end?
So we paid off the $453 million. We will evaluate and see as far as, excuse me $423 million we’ll evaluate and see if we’ll pay off more. I think more than the $523 is expected depending on how much and the timing of that we’ll look and see as far as the liquidity that we have and then also the pace of the forgiveness of the PPP loans which has started for us.
Okay and then just in terms of overall balance sheet you talked about kind of holding some of that liquidity you have in anticipation of longer improving. Do you have any and also continuing expectations over our liquidity flows given the amount of excess funding in system right now.
I know it was a great question especially in this quarter. What we’ve done especially as the deposit flow have continued and I think we’ve gone a little bit more comfortable reinvesting some of that into securities and also with our securities book, at that securities book.
We have extended out the duration a little bit. So, I think if you look at the month of September not quarter-to-date, and the average yields in the portfolio it is up a little bit close to 2%. If you look at duration, you have 630, we’re about 2.0 2.6 and we are at about 38 as of 09.30.
The next question comes from Matthew Clark with Piper Sandler. Please go ahead.
Hi, good morning. Maybe first on increase in special mention, like you touched on the fact that the commercial real-estate migrated a little bit. Can you give us more some specific examples of what migrated this quarter?
Yes. And Matthew, when we look at kind of the migration into special mentioned during the quarter, it was really to a certain extent throughout the portfolio of share, that regardless of whether a customer is on deferral, we’re making sure that the grading is appropriate if necessarily we are downgrading these loans.
So, some of the loans we downgraded were loans that were on deferral but across the board I would say in different kind of asset classes, office, multifamily and also retail.
Okay. And then, just on the deferrals, the C&I x energy has been sort of muted the date. Can you give us a sense for why that I sand what your customers are doing at this point. Whether or not that might increase in the future?
It doesn’t look like that at this point-in-time, I think we shared about this last quarter as well. We did initially as an accommodation for our customers, helped them with a one month, we called it a skip of pay. Certainly I think that helped us kind of reach out and have those conversations with our customers on the C&I front.
I think the request and kind of conversations that we’ve had, the request for deferrals, and the conversations we have with our customers around our cash flows that has generally been relatively positive.
And next question comes from David Chiaverini with Wedbush Securities. Please go ahead.
Hi, thanks. A couple of questions. The first one on loan growth. You hit on a couple of the categories already about CRE expecting loan growths next year versus this year in single-family residential, you mentioned about similar trend going forward.
But on C&I, if we exclude PPP, what type of growth are you expecting in that loan category?
Well, for 2021, what we do plan to provide guidance at the next earnings release, I mean at this point that will be too early for us in the right in the midst of this upcoming presidential election with that mystery about when the vaccine will be available, all sort of things that are happening right now.
I just feel that it will be much better for us to have the gross guidance to provide to you in January. And but at the mean time or I can share as of today is to have, in the second quarter April, May and June, we spent a lot of time focusing on PPP, skip of payment deferral.
We took a lot of time, number one thing is to focus in on keeping our employees in great health and thank goodness as of today we do not have one employee actually who went to a hospital for COVID-19.
And so, all of us are in very good health. We’re going to continue to stay vigilant to keep everyone in good health so they will can take care of customers. I mean, that’s number one thing that we’re focusing on.
And then PPP kept us very busy. And now we’re doing PPP, we’re also looking into potential deferral and so forth. Some customers just get confused, they don’t really need, they didn’t need a deferral, they just thought they have to get a deferral. So, there’s a lot of conversation going on back then.
So, not until sometime in the third quarter, when these kind of issues all settled, in our frontline relationship managers and branch managers have start I mean really reaching out and then looking for new business. Then good news is that as we highlighted in our talked earlier that in the latter part of September we start nearly booking some nice C&I loans.
And we start seeing growth in C&I. and actually many of these loans that we originated, our brand new customers are I think that to a some degree we’re fortunate by being active helping our customers and even non-customers or PPP other type of matters that banking related caused some of these very good prospects too decided to move their banking relationship.
And some of our banks at East West. So, we’re picking up some new business. So, that’s part of it. Other three weeks of October, we also continue to bring in new business of some other banks and that has been very helpful for us. And we hope this trend will continue.
Now, given the fact that we are still in the midst of pandemic. And that could be a lot of commercial business that are out there aggressively, putting capital investment and growth and other than the one that who happened to be in the business that the pandemic helped them.
For those who were in some other traditional business, the pandemic may not help them. I think their utilization rate for their line of credit would probably contingent to say a little bit lower. So, we don’t expect that many of the existing customers going to have a strong push to draw down the line dramatically higher to cause a substantial growth there.
But we are getting new customers that supplement the growth. So, all-in-all, I think at this point we feel that fourth quarter looking more positive from a C&I side. And by the way it’s not just coming from one particular industry or one particular geographic region, it’s pretty much across the board for East West bank.
Several industry verticals even our entertainment business have grown nicely back, our digital media business are grown coming back strong and so our clean energy this project finance you know, those type of business are all coming back stronger than before.
So, we hope this trend will continue and in 2021 but for the detail also are providing some sort of a forecast for both on the lending side or put it to the fourth quarter 2021, well in January 2021.
Well that’s helpful, thanks for that. And then, shifting gears to fee income. You mentioned about how customer transaction activity increased in the third quarter, curious as to what the outlook is for the fourth quarter of that customer transaction activity.
That momentum continued into the fourth quarter or we should expect either stabilization or rebound. Just curious as to your thoughts there.
Yes. As you can see it the fee income side, for customer related banking transaction type of fee income had all picked up. So, if you look at for example like deposit account fees, that has a lot to do with this new banking relationship that I talked about earlier and some of the existing customers expanding the relationship with us.
That combination of two result in us generating even stronger cash management fee income. Keep in mind of we talked about for the last few years about investing in the internal infrastructure and COVID enhancement technology improvement, all of those cost that we put in are generating tangible results.
Or rebuilt a cash management system that can manage us accommodate but actually will offer great services to many of the more sophisticated larger sized business. We now can just comfortably move the banking relationship from large banks to East West Bank because we have the capability to handle the cash management needs.
So, that result in more fee income for us and larger the DDA account deposits. And we see that trend as very positive that we are able to do all of that but well a lot of us are still working at home under the pandemic.
So, what we’re looking forward to is to continue to keep pushing and or working with existing customers, expanding and deepening the banking relationship and also for the new customers on the outside. So, I looked at from the cash management, wealth management, and even trade finance.
We have a 9% pickup in terms of business. So, all now I looked at it is that we just continue to focusing on making sure that we took good care of our clients and then hopefully we’ll get more new business through this referral from our good clients and so forth.
And then one step at a time and then getting more meaningful or fee income coming to the bank in 2021.
The next question comes from Brock Vandervliet with UBS. Please go ahead.
Hi, thanks. Hi Dominic, you’ve talked a lot in the past about the political environment released a bit in the past about it. It’s obviously been pretty fraught between the U.S. and China. As we look at potentially at buy it and win.
How do you think this could potentially change your business?
We are always sort of like an organization does, very nimble in terms of adjusting comfortably with whatever their political environment that is out there. To recall, four years ago or the U.S. government policy has been very much of lot of to about bring in investments from China and also investing in China and so forth.
And for the last couple of years due to presidential election and the political ladder heads had turned hostile and that had changed the dynamic dramatically.
And we looked at even with the trade war in place for the last few years with the terror, as you have seen so far we have such a big trade finance portfolio, import export business and then also with greater China exposure, is that at the end of the day we hardly have any losses.
Now, the business slowed down a bit because we’d be more cautious temporary and then also of course because of the pandemic, actually China shutdown force a few months. And so, that had effect the growth aspect. But in terms of then the risk aspect, we manage very well and have almost no losses.
So, with that in mind I would say that looking forward, Joe Biden had made it very clear about his foreign policy, now which is to get back instead of American gold loan and against the world and American is going to work with allies and is going to take leadership back into United Nation, WHO, WTO, et cetera and U.S. and then get back into the front seat.
Then I am 100% sure when U.S. wanted to get back into the front seat and engaging with the allies and China will be more than delighted to step back to stick a second or third or four seat, and do collaborate with the United States for climate change and all the other activities that all the nations around the world need to work together.
So, I would expect that if that happens, there’s no question to whether it’s Republican Party or Democrat, at the end of the day U.S. will compete with China economically. And I think is the right thing to do to commit to compete. There’s nothing wrong to compete.
But on the other hand I’d think that I have also strong confidence that there’s going to be a lot more business exchange between U.S. and China. Just reflect back for the last few months, allies doesn’t get a whole lot of news coverage but JPMorgan said the bank Morgan Stanley all increase their stake in the joint venture in China are taking majority ownership.
Bedrock, and Joe Lieberman and a few others in the front management business are giving new licenses, insurance company giving new life license. Everyday American Express giving new license; Parker opening more stores; Starbuck opening more stores; in fact U.S. business have never stopped.
Never stopped in our expanding into China. And the Chinese government also have never stopped pulling them in and giving them even more business opportunities that had ever been given before.
In fact, just last week a Senior Minister in China are talking about additional intellectual protection right for foreign direct investments in China. So, on a day-to-day basis for people like us that constantly watching what’s happening between U.S. and China and actually do look at regulation instead of just mainstream media news.
We are seeing China in making at aggressive effort to continue to open up the market and letting foreign investors to take on the majority ownership or floor ownership in multiple different industries. Renting license that they never planned before and then changing the laws sort of intellectual property protection and also penalizing company that force transfer of technology and so forth.
All of the things that we’ve been hearing many times from a U.S. trade representative Lighthizer, all of those things that we’ve been hearing were making these changes to it. Now they are not broadcasting all over the world but that they are making the changes and this could then whether from U.S. or from Europe are directly benefitting from it.
So, in East West position is that, well most of those are irrelevant to us to a certain degree because we’re not going there to get some big invest capital investments and then get certain license for certain type of new business.
Our position is that the cross border business still strong and China has emerged from the pandemic to back to business as usual. Many of my colleagues in Shanghai and Shenzhen will go out to movie theaters having dinner with their friends or even have to wear masks. So, I’m happy for them.
So, they are doing business. And we absolutely are there doing business also. We look at Hong Kong. Hong Kong, the stock exchange is going to overpass U.S. in terms of IPO listing. Because companies are all going there lining up Unicorn after Unicorn, lining up in Hong Kong or in Shanghai Stock Exchange, Shenzhen Stock Exchange.
Through this IPO, there’s going to be a lot more new billionaires to billionaires and they all need to make investments. They all need to have their personal wealth management. And they are buying properties around the world, U.S. still one of them but prefer places for either risk investments or other investments.
So, we do feel comfortable that business is going to be there. So, we have not ability to predict what the outcome is for their election coming on November 3rd on one way or the other. One thing I can guarantee everyone, East West know how to adjust and adapt and find way to thrive under whatever circumstances.
Thanks, Dominic. Looking forward to a better backdrop there. Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Dominic Ng and closing remarks.
Thank you, again. And thank you, for joining us in this call. And we are looking forward to speaking with all of you in January. Bye.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.