Dan Hess, in his response to my posting yesterday, highlighted what (in my opinion) are the two fundamental issues behind an assessment of EWBC’s future prospects:

1. What was the “secret sauce” that provided EWBC with double-digit EPS growth for ten years?  Will these factors (or new factors) enable EWBC to resume its high growth rate after the current recession is over?

2. What is the risk in the current loan portfolio?  As Dan points out, the southern California real estate market is soft.  He points out Robert Shiller’s prediction that prices are down only half as far as they are likely to go.  Let’s do some slicing and dicing of the loan portfolio and stress-test it.  For example, how is the loan portfolio distributed among 1-4 family residential, 4+ family residential, land (residential and commercial), commercial real estate, other commercial, construction-related loans, etc. and what are the relative risks of these different loan types?  How are the loans geographically distributed and what regions or micro-markets are subject to greater or lesser risk?  What are the average and the distribution of loan-to-value ratios?  What do we think of the loan loss provision policy (conservative or aggressive)?  Let’s make some assessments of this.

While I gather information in the background to help with #2, let’s dwell on item #1 today.

Let me warn you that I am likely to pose more questions than answers today.  However, as the week wears on, let’s see if we can answer many of these questions.  I may also try to involve EWBC’s investor relations department to provide information that could help.

EWBC is only 30 years old, and seems to have experienced a period of rapid growth in its first few decades as it figured out how to serve what it claims was an underserved market of Asian American immigrants to southern California.  After 20%+ EPS growth throughout most of its history, EPS growth slowed to 18.2% in 2006 and 9.6% in 2007. EWBC also made two acquisitions, one in 2005 and another in 2007.  I am checking whether  acquisitions took place previous to 2005.  Sometimes acceleration in acquisitions is a sign that management sees slowing organic growth. 

Has EWBC’s market matured?

What is EWBC’s market share among the Asian American community in southern California?

Do other banks threaten EWBC by replicating its niche strategy?

What is the behavior of its core customer base?  Do they tend to move to mainstream banks the longer they are in the country?

Is EWBC affected by immigration trends (i.e. are they reliant on new immigrant flows) and, if so, could this be a negative?

Are EWBC’s newer investments in growth likely to be less lucrative than its previous investments?

What is EWBC’s performance (i.e. past few years) if one were to strip out acquisitions?

Are there likely to be other acquisitions available of banks that follow are similar strategy?

On another note, Danny Matthews has suggested a downward revision to predicted PE ratios, reflective of an assumption that EWBC’s growth rate is at a permanently lower band.  Even lowering the PE range to 5.5 to 13.3, as Danny suggests, yields a suggested return of 26% annually.

On another note, Danny Matthews has suggested a downward revision to predicted PE ratios, reflective of an assumption that EWBC’s growth rate is at a permanently lower band.  Even lowering the PE range to 5.5 to 13.3, as Danny suggests, yields a suggested return of 26% annually.

Hopefully that won't be permanent, but I don't see significantly higher PE's in the near term. Even if bad loans aren't affecting EWBC as much as other banks the availability to monies may be less than optimum until others start feeling more comfortable with the reward to risk ratios. I guess I am pointing to banks lending to other banks. Since the 13 and 5 PE range, at which they are currently operating, this may show greater potential for the future upside.