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I've always been wary of relying too much on screens to find stocks. Screens identify stocks based on metrics that the user (that's you) inputs. While this can be a good starting place for research, there's often more to the numbers than meets the eye.
So wouldn't it figure that a screen of U.S. banks led me astray?
Specifically, a low loan-loss provision-to-non-performing-loan ratio threw me off the scent of East West Bancorp (Nasdaq: EWBC ) . Thankfully, an insightful reader and the bank's chief financial officer helped set me straight.
Earlier this week, I had a chance to speak with Irene Oh, East West's CFO, and she gave me the skinny on East West's balance sheet as well as a view of the opportunities that the bank sees in its future.
Greedy when others are fearful
Fearful eyes have been focused on the Federal Deposit Insurance Corp.'s takeovers of failing banks around the country. But on the other end of the spectrum, banks such as Bank of Nova Scotia (NYSE: BNS ) , IberiaBank (Nasdaq: IBKC ) , Wintrust Financial (Nasdaq: WTFC ) , and, yes, East West have been buying up failed banks from the FDIC. And in many of these types of transactions, the FDIC shoulders much of the risk of the balance sheet that it's unloading.
It's that last point that's key, and reveals why East West's loss-provision ratio isn't what meets the eye. In late 2009, the bank acquired the banking operations of United Commercial Bank. That transaction added an impressive $7.7 billion in loans to East West's balance sheet. While that loan book wasn't in the best condition -- thus, UCB's failure in the first place -- East West put those loans on its balance sheet at a discount and its downside is protected by the FDIC in the form of a loss-sharing agreement that puts 80% the losses from UCB loans back on the FDIC.
Better than the big guys?
Much of the focus in the finance and banking industry tends to swirl around massive players such as Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , and Citigroup (NYSE: C ) . But while these can technically be labeled "banks," the dynamics of the businesses are much different than that of the smaller banks that are primarily focused on, well, banking. And those massive banks may be starting to face headwinds that small and midsized banks without big investment banking divisions will avoid.
Combine the relative disinterest in the smaller end of the market and big uncertainties that huge investment banking exposure can provide, and I think there's good reason to believe that there are still some gems to be found in the banking sector. And East West may well be one of them.
Banking itself is largely a commodity business. One bank's money is just as good to a borrower as another and there are limited ways for a bank to significantly differentiate itself so that it's not simply competing on price.
East West, however, has a particular edge that will resonate with anyone intrigued by the opportunity to our East. East West focuses on the Asian-American community -- a focus that in itself benefits the bank in its core West Coast markets through tight-knit communities and word-of-mouth promotion.
But the bank also has branches in Hong Kong and China -- areas where many midsized Western businesses would love to either enter or tap for efficient, low-cost manufacturing. As I learned from the company's CFO, East West is able to make cross-border introductions for businesses interested in making that leap -- provided, of course, that they bring their banking business to East West.
This not only gives East West an edge against competing banks in initially winning customers, but it also likely creates a stronger, stickier relationship with the customer from day one.
The bottom line is still the bottom line
While 2009 may have looked like a profitable year for East West from a GAAP perspective, gains from the UCB acquisition saved the bank's bottom line from another year of big losses as it continued to aggressively handle its problem loans. The past two quarters have looked better, though, with loan loss provisions declining and the bank reporting higher quality profits.
As with the rest of the banking industry, the future for East West will largely depend on the savvy of management. Further balance sheet deterioration rests on the quality of the work management has already done, while the company's ability to grow and increase profits will depend on the efforts being made to align the bank's business to today's realities.
There's no doubt in my mind that the banking environment will be anything but a cakewalk in the years ahead. However, I think investors should be able to look to the highest quality banks to provide solid -- if not eye-catching -- returns. East West is now one of the names that I think could deliver big things.
Banks like East West are no doubt hoping for an improving economy, but Warren Buffett doesn't think we're out of the recession yet.