Form 10-K EAST WEST BANCORP INC For: Dec 31
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
December 31, 2021
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization)
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(Address of principal executive offices) (Zip Code)
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Securities registered pursuant to Section 12(b) of the Act:
|Title of each class||Trading Symbol(s)||Name of each exchange on which registered|
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 ☐
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.
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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).
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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.
|☒||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
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The aggregate market value of the registrant’s common stock held by non-affiliates was approximately $
10,090,038,515 (based on the June 30, 2021 closing price of Common Stock of $71.69 per share). As of January 31, 2022, 141,908,514 shares of East West Bancorp, Inc. Common Stock were outstanding.
DOCUMENT INCORPORATED BY REFERENCE
EAST WEST BANCORP, INC.
2021 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
This Annual Report on Form 10-K (“this Form 10-K”) contains forward-looking statements that are intended to be covered by the safe harbor provision for such statements provided by the Private Securities Litigation Reform Act of 1995. In addition, the Company may make forward-looking statements in other documents that it files with, or furnishes to, the United States (“U.S.”) Securities and Exchange Commission (“SEC”) and management may make forward-looking statements to analysts, investors, media members and others. Forward-looking statements are those that do not relate to 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. These statements relate to the Company’s financial condition, results of operations, plans, objectives, future performance and/or business. They usually can be identified by the use of forward-looking language, such as “anticipates,” “assumes,” “believes,” “can,” “continues,” “could,” “estimates,” “expects,” “forecasts,” “goal,” “intends to,” “likely,” “may,” “might,” “objective,” “plans,” “potential,” “projects,” “target,” “trend,” “remains,” “should,” “will,” “would,” or similar expressions, 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 this Form 10-K. 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 include, but are not limited to:
•changes in the global economy, including an economic slowdown or market disruption, level of inflation, interest rate environment, housing prices, employment levels, rate of growth and general business conditions;
•the impact of any future federal government shutdown and uncertainty regarding the federal government’s debt limit;
•changes in local, regional and global business, economic and political conditions, and geopolitical events;
•the economic, financial, reputational and other impacts of the ongoing COVID-19 global pandemic, including variants thereof, and any other pandemic, epidemic or health-related crisis, as well as a deterioration of asset quality and an increase in credit losses due to the COVID-19 global pandemic;
•changes in laws or the regulatory environment, including regulatory reform initiatives and policies of the U.S. Department of Treasury, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (“FDIC”), the SEC, the Consumer Financial Protection Bureau (“CFPB”) and the California Department of Financial Protection and Innovation (“DFPI”) - Division of Financial Institutions;
•the changes and effects thereof in trade, monetary and fiscal policies and laws, including the ongoing trade, economic and political disputes between the U.S. and the People’s Republic of China and the monetary policies of the Federal Reserve;
•changes in the commercial and consumer real estate markets;
•changes in consumer or commercial spending, and savings and borrowing habits, patterns and behaviors;
•fluctuations in the Company’s stock price;
•impact from potential changes to income tax laws and regulations, federal spending and economic stimulus programs;
•the Company’s ability to compete effectively against financial institutions in its banking markets and other entities, including as a result of emerging technologies;
•the soundness of other financial institutions;
•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;
•impact of the benchmark interest rate reform in the U.S. including the transition away from U.S. dollar (“USD”) London Interbank Offered Rate (“LIBOR”) to alternative reference rates;
•impact of communications or technology disruption, failure in, or breach of, the Company’s operational or security systems or infrastructure, or those of third party vendors with which 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 operations due to political developments, disease pandemics, wars, civil unrest, terrorism or other hostilities that may disrupt or increase volatility in securities or otherwise affect business and 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, penalties and other negative consequences from regulatory violations, legal actions, and 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;
•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;
•changes in the equity and debt securities markets;
•fluctuations in foreign currency exchange rates;
•impact of increased focus on social, environmental and sustainability matters, which may affect the Company’s operations as well as those of its customers and the economy more broadly;
•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, declines in asset values and/or recognition of allowance for credit losses on securities held in the Company’s available-for-sale (“AFS”) debt securities portfolio; and
•impact of climate change, natural or man-made disasters or calamities, such as wildfires, droughts and earthquakes, all of which are particularly common in California, or other events that may directly or indirectly result in a negative impact on the Company’s financial performance.
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.
ITEM 1. BUSINESS
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 (“East West Bank” or 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 China. In the U.S., the Bank’s corporate headquarters and main administrative offices are located in California; its branches and offices are located in California, Texas, New York, Washington, Georgia, Massachusetts, Nevada and Illinois. The Bank has a banking subsidiary based in China - East West Bank (China) Limited.
As of December 31, 2021, the Company had $60.87 billion in total assets, $41.15 billion in total net loans, $53.35 billion in total deposits, and $5.84 billion in total stockholders’ equity.
We are committed to enhancing long-term stockholder value by 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 our customers’ financial goals, and meeting our customers’ financial needs through our diverse products and services. The Bank’s strategy focuses on seeking out and deepening client relationships that meet our risk/return parameters. This 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 their businesses. We expect our relationship-focused business model to continue to generate organic growth from existing customers and to expand our targeted customer bases. We constantly invest in technology to improve the customer user experience, strengthen critical business infrastructure, and streamline core processes, while properly managing operating expenses. Our risk management activities are focused on ensuring that the Bank identifies and manages risks to sustain safety and soundness while maximizing profitability.
Uniquely among U.S.-based regional banks, East West has a commercial business operating license in China, allowing the bank to open branches, make loans and collect deposits in the country. The Bank continues to develop its international banking presence with its network of overseas branches and representative offices that includes four full-service branches in China, located in Hong Kong, Shanghai, Shantou and Shenzhen. The Bank also has five offices in 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 its branches and offices, the Bank focuses on growing its cross-border client base between the U.S. and China, helps U.S.-based businesses expand in China, and helps companies based in China pursue business opportunities in the U.S.
The Bank believes that its customers benefit from the Bank’s understanding of the China market through its physical presence, corporate and organizational ties in 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 Asian business opportunities and Asian American communities, provides the Bank with a competitive advantage. The Bank utilizes its presence in China to identify and build corporate relationships, which the Bank may leverage to create business opportunities in California and other U.S. markets.
As of December 31, 2021, 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 China/Asia. The Bank also has a strong focus on the Asian American community. Through its network of over 120 banking locations in the U.S. and 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 ten 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 lending, construction finance, working capital lines of credit, trade finance, letters of credit, commercial business lending, affordable housing lending, asset-based lending, asset-backed finance, project finance, equipment financing and loan syndications. The Bank also provides financing services to clients in need of a financial bridge to facilitate their business transactions between the U.S. and China. Additionally, to support the business needs of its customers, the Bank offers various derivative contracts such as interest rate, energy commodity and foreign exchange contracts.
The integration of digital channels and brick and mortar channels has been 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 have developed mobile and online banking platforms, which we are continually enhancing to enrich our customer user experience and we offer a full suite of banking services tailored to our customers’ unique needs. The omnichannel banking service approach increases efficiency and deepens customer relationships.
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”) — Results of Operation — Operating Segment Results and Note 17 — Business Segments to the Consolidated Financial Statements in this Form 10-K.
The Bank operates in a highly competitive environment. The Company faces intense competition from domestic and foreign lending institutions, numerous other financial services providers and other entities, including as a result of emerging technologies. 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 Asian 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 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.
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 most significant contributors to our success. Our key human capital objectives are to attract, develop and retain quality talent, who reflect our values and enable us to serve our customers. To achieve these objectives, our human resource programs have been designed based on our core values and the attributes we seek to foster, which include absolute integrity, customer orientation, creativity, respect, teamwork, expertise, and selflessness. We use these core values to better service our customers and prepare our employees for leadership positions and to advance their careers. We are committed to promoting diversity in employment and advancement.
As of December 31, 2021, we had approximately 3,100 full-time equivalent employees, of which nearly 200 were located in China and Hong Kong. None of our employees are subject to a collective bargaining agreement. The Company’s compensation and employee benefits expense was $433.7 million and $404.1 million, or 54% and 56% of total noninterest expense in 2021 and 2020, respectively.
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. As of December 31, 2021, the Bank had grown to be the largest FDIC-insured, minority-operated depository institution headquartered in the United States, serving communities with diverse ethnicities and socio-economic backgrounds in eight states across the nation. Our operations are concentrated in areas that include larger numbers of immigrants and minorities. We proudly offer home loans and other products and services that support low-to-moderate income, minority and immigrant communities. We also 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. Our focus on basic, fair-priced products and alternative credit criteria supports the underbanked, which is part of our founding mission. 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 ten other languages.
Promoting diversity and inclusion in our workforce and executive leadership is critical to our continued growth and success. Our commitment to diversity is reflected in the composition of our employees. As of December 31, 2021, 74% of the Company’s employees were Asian or Asian-American, 15% were other minorities and 11% were Caucasian. Approximately 62% of our employees were women. At the managerial level, 74% of our managers were Asian or Asian-American, 12% were other minorities and 57% of our managers were women.
To put our diversity in context, minorities made up only 32% of the FDIC-regulated institutions’ workforce, and 12% of their managers, according to the most recently available FDIC survey data from 2019. For us, 89% of the Bank’s workforce and 86% of its managers were minorities. The composition of our Board of Directors further exemplifies our commitment to diversity. Of our eight directors as of December 31, 2021, six were minorities, representing four ethnic groups, and three were women.
Talent Acquisition, Development and Promotion
An experienced and well qualified work force is essential to delivering high quality and reliable banking services to our customers and to managing the Company in a safe and sound manner. We endeavor to attract, develop, and retain diverse, motivated talent as part of our ongoing commitment to building a stronger workforce to serve our customers and communities. Our compensation and benefits program provides both short-term and long-term awards, incentivizing performance, and aligning employee and stockholder interests. Employee compensation packages include a competitive base salary and, subject to Company and individual performance, may include an annual incentive bonus. In addition, employees at certain levels are eligible to receive equity awards tied to the value of the Company’s stock. We sponsor a 401(k) plan for U.S. employees and provide a Company matching contribution, and maintain other defined contribution retirement plans for countries outside of the U.S. As of December 31, 2021, approximately 2,700 or 94% of employees participated in our 401(k) plan. 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 stockholders, 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 us.
The focus on leadership development and promoting from within is a critical part of our succession planning for key roles throughout the organization and fostering organizational stability. We also recognize the importance of employee development and career growth in achieving personal fulfillment for our employees, which is the key for fostering retention and one of the Company’s strategic objectives. We provide a variety of resources to help all employees grow in their current roles and build new skills for future advancement, such as tuition reimbursement. We provide training in many areas and encourage continuing education for all employees. Our corporate culture is a distinguishing factor in our work and collaboration every day, which has been incorporated into the fabric of what we do in all of our routines through our interactions and activities with customers, other external stakeholders, and internal teams and associates.
Health, Safety and Wellness
We are committed to supporting our employees’ well-being by offering flexible and competitive benefits. Comprehensive health insurance coverage (medical, dental and vision) is offered to employees working at least 30 hours or more each week. We offer paid time off, life insurance, disability insurance, parental leave, wellness and benefits programs designed to assist employees in maintaining a healthy work-life balance. We apply a consistent approach towards employee policies, opportunities, benefits, and protections to all employees regardless of their locations, except if there are contradictions between individual state laws. As an example of our consistent approach, we applied the state of California’s work-from-home reimbursement policy nationwide during the COVID-19 pandemic, even in states without similar requirements.
In addition, we are committed to making positive and lasting impacts in our communities through our business activities and our volunteer and charitable efforts. We are a vital part of the communities in which we live and work, and we encourage our employees to engage with our local communities by leading or participating in events to foster community 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 our communities. We also partnered with local community health centers to offer COVID-19 and flu vaccines for employees.
Information about our Executive Officers
The following table presents the Company’s executive officers’ names, ages, positions and offices, and business experience during the last five years as of February 28, 2022. There is no family relationship between any of the Company’s executive officers or directors. Each executive officer is appointed by the Board of Directors of the Company.
|Name||Age||Positions and Offices, and Business Experience|
|Dominic Ng||63||Chairman and Chief Executive Officer of the Company and the Bank since 1992.|
|Douglas P. Krause||65|
Vice Chairman and Chief Corporate Officer of the Company and the Bank since 2020; 2018 - 2020: Executive Vice President, General Counsel and Corporate Secretary; 2010 - 2018: Executive Vice President, Chief Risk Officer and General Counsel.
|Irene H. Oh||44||Executive Vice President and Chief Financial Officer of the Company and the Bank since 2010.|
|Parker Shi||52||Executive Vice President and Chief Operating Officer of the Company and the Bank since December 2021; June 2021 - November 2021: Executive Vice President & Chief Strategy, Growth and Technology Officer; March 2021 - June 2021: Consultant of the Bank; 2020: Senior Advisor at PharmScript; 2018 - 2019: Senior Managing Director at Accenture; 2013 - 2018: Senior Partner at McKinsey & Company.|
|Nick Huang||57||Executive Vice President and Head of Commercial Banking of the Company and the Bank since November 2021; 2018 - 2020: Chief Executive Officer of Institutional and International Banking at CTBC Bank; 2017 - 2018: Deputy Chief Executive Officer of Institutional and International Banking at CTBC Bank.|
|Gary Teo||49||Senior Vice President and Head of Human Resources of the Company and the Bank since 2015.|
|Lisa L. Kim||57||Executive Vice President, General Counsel and Corporate Secretary since 2020; 2014 - 2020: Executive Vice President, General Counsel and Secretary at Cathay General Bancorp and Cathay Bank|
Supervision and Regulation
East West and the Bank are subject to extensive and comprehensive regulations 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 conduct business, including China and Hong Kong. East West also has a wholly-owned nonbank subsidiary, East West Markets, LLC ("East West Markets"), which is an SEC-registered broker-dealer and a member of the Financial Industry Regulatory Authority, Inc. ("FINRA"). East West Markets is subject to regulatory requirements from a number of regulatory bodies, including the SEC, FINRA, and state securities regulators.
The Company is also subject to the disclosure and regulatory requirements under 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.
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.
As a bank holding company and pursuant to its election of financial holding company status, East West is subject to regulation, supervision, and examination 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 the section captioned “Regulatory Capital Requirements” included elsewhere under this item);
•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 the 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 state-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”) ratings of at least “Satisfactory.” A depository institution subsidiary is considered “well capitalized” if it satisfies the requirements for this status discussed in the sections captioned “Regulatory 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, 2021, East West is a financial holding company and has financial subsidiaries, as discussed in Item 1. Business — Organization.
The Bank and its Subsidiaries
East West Bank is a California state-chartered bank and a member of the Federal Reserve System, 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, monitor 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 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 Foreign 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 risk-based capital (i.e. Tier 1 plus Tier 2 capital) 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, 2021, 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 16 — 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.
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 April 2020, in recognition of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) requirements and to facilitate the use of the Paycheck Protection Program Liquidity Facility (“PPPLF”), the federal 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 the Paycheck Protection Program (“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 federal banking agencies’ “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers 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 on 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 this regulatory guidance provided banking organizations such as the Bank a capital benefit by increasing their 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 federal banking 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 provided 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 were delayed through the year 2021, after which the effects are being phased-in over a three-year period from January 1, 2022 through December 31, 2024.
Prompt Corrective Action
The FDIA, as amended, requires federal banking agencies to take PCA with respect to insured 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 regulations. The capital tiers in the PCA framework do not apply directly to bank holding companies (such as the Company). Under the federal banking agencies’ regulations implementing the PCA provisions of the FDIA, an insured depository institution (such as the Bank) 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, although an “adequately capitalized” institution may apply to the FDIC for a waiver of this restriction.
Economic Growth, Regulatory Relief, and Consumer Protection 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 and other federal banking agencies. Among other things, the EGRRCPA provided regulatory relief, including from risk committee requirements, for bank holding companies with total consolidated assets between $10 billion and $50 billion. We were among the bank holding companies in this range until we exceeded $50 billion in total consolidated assets as of September 30, 2020.
The EGRRCPA lifted the asset size threshold and provided relief for banks and bank holding companies with total consolidated 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. We are among the bank holding companies in this range. Although the Company and the Bank are not required to conduct company-run or supervisory stress tests, we continue to conduct annual capital and quarterly liquidity stress tests.
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 with total consolidated assets exceeding $10 billion (such as the Bank) and their affiliates. 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. Effective 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. The Bank is 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 may 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 strong.
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. Regulation W limits the types, terms and amounts of these transactions and generally requires the transactions to be on an arm’s-length basis. In general, Regulation W requires that “covered transactions,” which include a bank’s extension 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 principal stockholders, as well as to entities controlled by such persons (collectively, “insiders”). 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. Based on the most recent CRA examination as of March 8, 2021, the Bank was rated “outstanding”. On September 21, 2020, the Federal Reserve issued an Advance Notice of Proposed Rulemaking that invited the public to comment on ways to modernize CRA regulations to strengthen, clarify, and tailor the regulations to reflect the current banking landscape and better meet the core purposes of the CRA. On July 20, 2021, the federal banking agencies issued an interagency statement indicating a joint agency commitment to work together to strengthen and modernize regulations implementing 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.
Following the outbreak of the COVID-19 pandemic, extraordinary growth in insured deposits caused the DIF reserve ratio to fall below the statutory minimum of 1.35 percent. This growth was primarily due to U.S. monetary policy action, direct government assistance to consumers and businesses, and an overall reduction in spending. The FDIC adopted a restoration plan on September 15, 2020 to restore the DIF reserve ratio to at least 1.35 percent by September 30, 2028. Under the restoration plan, the FDIC will continue to closely monitor the factors that affect the DIF reserve ratio and will provide progress reports and, as necessary, modifications to the plan at least semiannually. According to the Restoration Plan Semiannual Update issued on December 14, 2021, the DIF reserve ratio was at 1.27 percent as of September 30, 2021. The FDIC expects the surge of insured deposits resulting from the pandemic to eventually recede and insured deposit growth rates to normalize in the medium to long-term.
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. The application date of the final rule was 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 that the institution 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”), and other 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 recordkeeping and reporting requirements. Regulatory agencies require that the Bank have an effective governance structure for the program that 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 Bank regularly evaluates and continues to enhance its systems and procedures to ensure compliance with BSA/AML laws and regulations.
The Anti-Money Laundering Act of 2020 (“AML Act”) was enacted in January 2021 as part of the National Defense Authorization Act for Fiscal Year 2020 and includes the most substantial changes to U.S. AML law since the PATRIOT Act. Among other changes, the AML Act imposes new beneficial ownership reporting requirements for certain entities doing business in the U.S.; requires the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) to establish government-wide priorities for AML and countering the financing of terrorism (“CFT”); increases AML whistleblower awards and expands whistleblower protections; modernizes the statutory definition of “financial institution” to include “value that substitutes for currency”; enhances penalties for BSA and AML violations; streamlines and modernizes BSA and AML requirements; and improves coordination and cooperation among international, federal, state, and tribal AML law enforcement agencies. The federal banking agencies are expected to revise the BSA regulations to incorporate the AML/CFT priorities.
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. Federal 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
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 federal banking 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 risk posed by cybersecurity threats. The 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. The federal banking agencies issued a final rule in November 2021 that requires banking organizations to notify their primary federal regulator of significant computer security incidents within 36 hours of determining that such an incident has occurred. The compliance date of this rule is May 1, 2022. We are implementing policies and procedures to ensure compliance with this rule should such an incident occur in the future.
Consumer data privacy and data protection are also the subject of state laws. For example, the Bank is 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.
The Standing Committee of China’s National People’s Congress passed the Personal Information Protection Law (“PIPL”), effective November 1, 2021. The PIPL establishes guiding principles on protection of a Chinese citizen’s personal information and applies to entities operating in China, foreign organizations, and individuals processing personal information outside China. Failure to comply with the PIPL requirements can result in monetary penalties, entities or individuals placed on government’s banned list, or potential termination of future business activities in China, and potentially impact our Hong Kong and China operations.
Future Legislation, Regulation and Supervision Activities
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 statutes, 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 internal business processes, subject the Company to increased supervision activities and disclosure and reporting requirements, 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, regulation or policy.
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 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 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.
Stockholders may also request a copy of any of the above-referenced reports and corporate governance documents 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 [email protected]
ITEM 1A. RISK FACTORS
We are exposed to a variety of risks, some of which are inherent to the financial services industry and others of which are more specific to our businesses. Our 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: capital risk; market risk; liquidity risk; credit risk; operational risk; compliance risk; legal risk; strategic risk; and reputational risk. ERM is comprised of our senior management and chaired by our 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. 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 that we might face. 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 an 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 eight states where we have branches or office locations. As part of our continued response to the recent developments of the COVID-19 pandemic, the Company has implemented office reopening and return to office plans. With various safety protocols implemented throughout our facilities, we have continued to provide financial services to our customers and support to our communities throughout the pandemic. The worldwide distribution of vaccines has made significant progress in containing the virus. However, the emergence of new variants, as well as insufficient adoption and long-term effectiveness of vaccines, may negatively affect our ability to resume full normal operations and provide services to our customers.
The prolongation of the COVID-19 pandemic and emergence of new variants could continue to cause disruption in global supply chains, labor market shortages, and increase in employment costs, which in turn adversely affect the ability of the Company’s borrowers to satisfy their obligations. If our customers experience credit deterioration, including an 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 increase. Further, failures to contain the COVID-19 pandemic and the emergence of variants 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.
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. Any defaults by such financial services institutions, or 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. Additionally, changes in the government’s monetary policy addressing the COVID-19 pandemic could potentially have an adverse effect on our results of operations and financial condition.
The extent to which the COVID-19 pandemic continues 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, or the impact of those actions on global economic activities and economic conditions when the COVID-19 pandemic subsides.
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 actions to address the economic and financial effects of the COVID-19 pandemic. The Federal Reserve sharply reduced interest rates and instituted quantitative easing measures, as well as domestic and global capital market support programs; however, to help curtail rising inflation, the Federal Reserve is expected to increase interest rates and reduce quantitative easing measures. 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 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, the Main Street Lending Program (“MSLP”), relief with respect to TDRs, mortgage forbearance, and extended unemployment benefits.
During 2021 and 2020, the Company supported its customers by offering Small Business Administration (“SBA”) loans under the 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.
In response to the COVID-19 pandemic, U.S. federal banking regulatory agencies have encouraged lenders to extend additional loans, and the federal government has enacted legislation supporting various sectors, including small businesses. However, 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.
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 globally, particularly in the U.S. and China, including factors such as the level and volatility of short-term and long-term interest rates, inflation, deflation, home prices, collateral asset 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 China. The deterioration of any of these conditions could adversely affect our consumer and commercial businesses, securities and derivatives portfolios, the level of charge-offs and provision for credit losses, the carrying value of deferred tax assets, capital levels, liquidity, and results of operations. In addition, because the Company’s operations and the collateral securing its real estate lending portfolio are primarily concentrated in Northern and Southern California, the Company may be particularly susceptible to adverse economic conditions in the state of California. Any unfavorable changes in economic and market conditions in California and other regions where we operate could lead to the following outcomes:
•greater than expected losses in the Company’s credit exposure due to unforeseen economic conditions, which may, in turn, adversely impact the Company’s results of operations and financial condition;
•failure of the Company’s commercial and residential borrowers to make timely repayments of their loans, or a decrease in the value of real estate collateral securing the payment of such loans, which could result in credit losses, delinquencies, foreclosures and customer bankruptcies, and in turn have a material adverse effect on the Company’s results of operations and financial condition;
•a decrease in deposit balances, and the demand for loans and other products and services;
•future disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, which may result in an inability to borrow on favorable terms or at all from other financial institutions;
•an adverse effect on the value of the AFS debt securities portfolio as a result of 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 economic and political relations between the U.S. and China, including trade policies and the imposition of tariffs and retaliatory tariffs, may adversely impact the Company’s businesses, results of operations and financial condition.
Economic trade and political tensions, including tariffs and other punitive trade policies and disputes, between the U.S. and China pose a risk to the businesses of the Company and its customers. The imposition of 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 customers’ 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 customer in industry sectors that are most sensitive to the tariffs.
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 China. Our presence in 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. 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, as well as the impacts of climate change, could adversely affect the Company.
Natural disasters such as wildfires, earthquakes, extreme weather conditions, hurricanes, floods, widespread health emergencies or 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. Natural disasters may be more frequent or severe due to the effects of climate change, which may include altered distribution and intensity of rainfall, prolonged droughts or flooding, increased frequency of wildfires, rising sea levels, and a rising heat index. Additionally, our business and operations have been affected by the ongoing COVID-19 pandemic and could be adversely affected by the effects of epidemics or pandemics or other adverse public health developments. Temporary closures of our branches and offices or a reduction of consumer spending could adversely impact our operating results and the performance of loans to impacted borrowers in the U.S or China. 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.
Risks arising from climate change, including physical risks and transition risks, could have a material adverse impact on our business and results of operations.
Climate change could present financial risks to us through changes in the physical climate that affect our operations directly or that impact our customers or collateral. Climate change also could present financial risks to us as a result of transition risks, such as societal and/or technological responses to climate change, which could include changes in climate policy or in the regulation of financial institutions with respect to risks posed by climate change. These climate-related physical risks and transition risks could have a financial impact on us both directly on our business and operations and as a result of material adverse impacts to our customers, including declines in asset values, reduced availability of insurance, significant interruptions to business operations, and negative consequences to business models and the need to make changes in response to those consequences. The risks of regulatory changes and compliance requirements related to climate change may impose operational burdens and increased compliance costs, capital requirements, or the risk of litigation, which could adversely affect the Company’s businesses, results of operations and financial condition.
Risks Related to Financial Matters
A significant 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 particularly prevalent in 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 residential 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.
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 in response to inflation, competition, regulatory requirements and a change in our product mix. Changes in key variable market interest rates such as the Federal Funds, National Prime 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. Rising interest rates may cause our funding costs to increase at a faster pace than the yield we earn from our assets, ultimately causing our net interest margin to decrease. Higher interest rates may also result in lower mortgage production 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.
The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that after specified dates, LIBOR settings will cease to be provided by any administrator. As of December 31, 2021, the one-week and two-month tenors of USD LIBOR ceased to be published. The overnight, one-, three-, six- and 12-month USD LIBOR tenors will continue to be calculated using panel bank submissions for the purpose of legacy contracts and will permanently cease on June 30, 2023. Banking regulators have increased regulatory scrutiny and intensified supervisory focus of financial institutions’ LIBOR transition plans, preparations and readiness, including the use of credit-sensitive rates.
The U.S. federal banking agencies issued guidance to strongly encourage banking organizations to cease using USD LIBOR as a reference rate in new contracts by December 31, 2021. In connection with this, the Company ceased extending new LIBOR loans during the fourth quarter of 2021 and began offering new variable rate loans based on alternative reference rates.
The LIBOR transition is anticipated to continue through June 30, 2023. The Company created a cross-functional team to manage the communication of the Company’s transition plans with both internal and external stakeholders. The cross-functional team also helps ensures that the Company appropriately updates its business processes, analytical tools, information systems and contract language to minimize disruption during and after the LIBOR transition. 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 impact the financial performance of previously recorded transactions, requiring different hedging strategies, result in our hedges being ineffective or impact the availability of cost of floating rate funding, affect our liquidity and capital planning and management or other adverse financial consequences. Although the implementation of the Secured Overnight Financing Rate (“SOFR”) index 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, operational and legal costs, increased scrutiny from regulators, reputational harm or other adverse consequences. 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. This may include exposure to increased basis risk, increased possibility of disagreements with counterparties and the resulting costs in connection with remediating these problems. This transition may also result in our customers challenging the determination of their interest payments, entering into fewer transactions or postponing their financing needs, or disputing the interpretation of implementation of contract “fallback” provisions and other transition related changes, which could reduce the Company’s revenue and adversely impact our business. In addition, the transition from LIBOR to another benchmark rate or rates could have adverse impacts on floating-rate obligations such as 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. For additional information on the discontinuation of LIBOR, refer to Item 7. MD&A — Other Matters.
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 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. Consequently, the impact of these changes on our businesses 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 businesses, 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, 2021, 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 — Regulatory 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 the Company 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 stockholders of each class of stock. 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.
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 evaluate us regularly, 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, on a regular basis. If we experience a decline in our credit ratings, 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 not be changed 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 the U.S. Generally Accepted Accounting Principles (“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 borrower characteristics, 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