Earnings Call: Q2 2017

Jul 20, 2017

Good morning, and welcome to the East West Bancorp second quarter 2017 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Julianna Balicka. Please go ahead. Thank you, Carrie. Good morning, and thank you everyone for joining us to review the financial results of East West Bancorp for the second quarter of 2017. With me on this conference call today are Dominic Ng, our Chairman and Chief Executive Officer, Greg Guyett, our President and Chief Operating Officer, and Irene Oh, our Chief Financial Officer. We would like to caution you that during the course of the call, management may make projections or other forward-looking statements regarding events or future financial performance of the company within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties. For a more detailed description of risk factors that could affect the company's operating results, please refer to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2016. In addition, some of the numbers referenced on this call pertain to adjusted numbers. Please refer to our second quarter earnings release for the reconciliation of GAAP to non-GAAP measures. During the course of this call, we will be referencing a slide deck that is available as part of the webcast and on the investor relations site. As a reminder, today's call is being recorded and will be available in replay format on our investor relations website. I will now turn the call over to Dominic. Thank you, Julianna. Good morning. Thank you everyone for joining us for our second quarter 2017 earnings call. I will begin our discussion with a summary of results on slide 3. East West earned $118 million in the second quarter, up by 15% year-over-year, and posted earnings per share of $0.81, up by 14%. Our second quarter results continue our positive momentum from the first quarter. Loan growth of 11% annualized and a favorable impact of rising short-term interest rate drove a 7% linked quarter increase in net interest income to $290 million. A net interest margin expansion of 16 basis points to 3.49%. During the quarter, our loan yield, excluding accretion income, expanded by 13 basis points compared to a modest increase in deposit cost of only four basis points. Largely as a result of revenue expansion, the second quarter adjusted efficiency ratio was 41.3%. Adjusted non-interest expense grew a modest 2% linked quarter. This resulted in adjusted pre-tax, pre-provision income sequential quarter growth of 10%. In addition, our strong performance was supported by stable asset quality. Quarter-over-quarter, non-performing assets declined by 8% to 37 basis points of total assets. We posted net recoveries in each of our loan categories, resulting in total net loan recovery for the quarter of $2.6 million, or four basis points annualized. Moving on to slide four, you will see that East West operating results consistently generate attractive profitability. Our second quarter return on assets was 1.36%, up from 1.27% a year ago, and our second quarter return on equity was 13.05%, up from 12.7% a year ago. These strong returns and profitability have been achieved while making investments in people, process, and systems to improve risk management and enhance our product, meeting the expanding needs of our customers. At East West, our goal is to provide long-term value to our shareholders, and we believe that the investments that we have made and continue to make help us in realizing this objective. I will now turn the call over to Greg and Irene for a more detailed discussion of our business trends and second quarter results. Thank you, Dominic. I will begin by discussing our customer-related growth drivers in terms of loans, deposits, and fee income. Turning to slide five, as of June 30, East West's loan portfolio reached a record $27.2 billion. Second quarter loan growth of $732 million, or 11%, linked quarter annualized, was driven primarily by a $301 million increase in single-family mortgages, which grew 33% linked quarter annualized, and a $269 million increase in C&I loans, which grew 11% linked quarter annualized. Our C&I loan portfolio totaled $10.2 billion as of June 30, with growth spread across our industry verticals and sectors. The utilization rate was roughly in line with first quarter levels. The commercial real estate portfolio, including construction and land, totaled $9.1 billion at quarter end, up 6% linked quarter annualized. As we highlighted in our Q1 call, the higher net growth in the first quarter reflected a slower than typical pace of runoff, which was at more normal levels during the second quarter. Overall, Q2 loan growth was in line with our full-year outlook of low double-digit loan growth. As noted on slide six, our deposits reached a record $31.2 billion as of June 30, up by $611 million, or 8%, linked quarter annualized. The sequential quarter growth in deposits was primarily due to increases in interest-bearing checking deposits, time deposits, money market accounts, and savings deposits. Non-interest-bearing demand deposits were down modestly quarter-over-quarter by 2% to $10.5 billion. Average deposits grew 2% quarter-over-quarter, or 7% annualized, with positive growth in all categories, including DDAs. Over the past five quarters, our deposit mix has remained stable. As of June 30th, demand deposits comprised 34% of our total deposits, and time deposits comprised 19%. The steady share of DDA in our funding mix provides a strong foundation for a rising interest rate environment. Our deposits continue to comfortably exceed loans, and our loan-to-deposit ratio was 87% as of June 30th. We believe we can support our projected loan growth while staying disciplined in deposit pricing. Flipping to slide 7, you'll see a breakdown of our fee income. Excluding net gains on the sale of loans, securities, and fixed assets in the quarter, total fees and other operating income for Q2 totaled $42 million, up $3 million or 9% linked quarter. The linked quarter increase in fee income was broad-based across most of our customer-related fee income activities, including foreign exchange, swaps, letters of credit, loan fees, and branch fees. Excluding mark-to-market adjustments related to CVA and currency hedges, our customer-related fee income increased by 6% sequentially and 25% year-over-year, reflecting our associates' focus on engaging with clients in these areas. I'll now turn it over to Irene to cover the quarter's financial results in more detail. Thank you, Greg. I will begin with the summary income statement on slide 8. I will highlight a few items and move on to slides 9, 10, and 11 for a closer look at net interest income, margins, efficiency, and asset quality. Excluding the gain on sale of the commercial property last quarter, non-interest income grew by 7% quarter-over-quarter, which includes the customer-related fee income Greg discussed, as well as gains on sale of securities and loans. The provision for credit losses in the second quarter was $11 million, compared to $7 million in the first quarter and within range of our full-year provision expense expectations of $40 million-$50 million. During the second quarter, the company closed an additional renewable energy tax credit investment, which added $8.7 million to the tax credit amortization expense and contributed to the reduced effective tax rate of 25% for the quarter. For the second half of the year, the tax credit amortization expense is projected to be $50 million, and the full-year 2017 effective tax rate is projected to be 26%. Moving on to slide 9 to review net interest income and margins. Our net interest income increased by $18 million, or 7%, linked quarter to $290 million. Accretion income increased $3 million to $6 million, largely from the result of net recoveries in the second quarter. The remaining ASC 310-30 discount accretion on our loan portfolio is $43 million, of which we expect approximately $29 million will accrete as income over the life of the loan as of June 30th, 2017. Excluding accretion, our adjusted net interest income of $284 million grew by 6% linked quarter. Our second quarter of 2017 results continued to show the benefits of our asset-sensitive balance sheet. Excluding the impact from accretion, our adjusted net interest margin of 3.41% was up 12 basis points linked quarter benefiting from rising short-term interest rates. Adjusted for accretion, our loan yield expanded by 13 basis points quarter-over-quarter compared to a moderate increase in the cost of deposits of only four basis points. Following the June Fed funds increase, we have $800 million in loans subject to floors or about 3% of our loan book. Additionally, fixed-rate loans comprise $2.3 billion or 9% of our total loans. Turning to slide 10, our total non-interest expense for the second quarter of 2017 was $169 million. Excluding amortization of tax credit and other investments of $28 million and amortization of Core deposit intangibles of $2 million. Second quarter adjusted operating expense of $140 million increased by a modest 2% linked quarter, on track with our outlook for low single-digit growth. Our adjusted efficiency ratio was 41.3% in the second quarter, an improvement of 192 basis points from 43.3% last quarter, largely reflecting the revenue growth. The combination of our strong net interest income growth and the moderate increase in expenses drove attractive growth in our second quarter adjusted pre-tax, pre-provision income of $198 million, which increased by 10% linked quarter and 20% year-over-year. Over the past five quarters, our pre-tax, pre-provision profitability ratio has ranged from 204 to 227. As you can see in the detail on slide 11, our strong operating performance this quarter was supported by steady asset quality. The allowance for loan losses grew to $276 million as of June 30th, or 1.02% of loans held for investment, compared to $263 million, or 0.99% of loans held for investment as of March 31st, 2017. During the second quarter, we recorded annualized net recoveries of $3 million or four basis points of average loans, compared to annualized net charge-offs of $5 million or eight basis points in the first quarter. We posted net recoveries in the second quarter in all loan categories, with the greatest impact from net recoveries in C&I of $2 million. The total net recoveries in the quarter reflected $8 million of gross recoveries, partially offset by $5 million of gross charge-offs. Non-performing assets decreased by $12 million, or 8%, to $133 million, or 0.37% of assets as of June 30th, 2017, compared to 0.41 as of the end of the first quarter. East West continues to be vigilant in monitoring the credit quality of our loans and maintaining our prudent underwriting standards. At this point in the credit cycle, credit costs are at historic low levels, and it would be unrealistic for this to continue in perpetuity. Although we do not see any systemic issues in our portfolio and real estate market fundamentals continue to support strong asset quality, we are proactively working out non-accrual loans before the cycle turns. Moving on to capital ratios on Slide 12. East West capital ratios are strong. Tangible equity per share of 21.93 as of June 30th, 2017, grew 3% linked quarter and 8% since the beginning of the year. Our capital ratios increased by 21 to 27 basis points in the quarter and 39 to 58 basis points year-to-date. Current capital ratios are sufficient to support continued organic growth. East West Board of Directors has declared third quarter 2017 dividends for the company's common stock. The common stock cash dividend of $0.20 per share is payable on August 15th to stockholders of record on August 1st, 2017. I will now review our current outlook for 2017 on Slide 13, outlining our earnings drivers relative to full year 2016 results. We expect end-of-period loans to grow at a percentage rate in the low double digits, unchanged from our last quarter's outlook. We expect the loan growth to come from all of our loan portfolios. We have had a strong first half of the year in terms of loan growth, but in our outlook, we are conservatively reflecting the potential for a slower pace of growth in the second half of the year. We expect our adjusted net interest margin, including the impact of accretion income, to range from 3.35% and 3.45%, unchanged from our last quarter's outlook. Our outlook incorporates the current forward rate curve. As such, it includes one more Fed funds rate increase in December 2017. Now that we are halfway through the year, we project that our full year net interest margin should be towards the higher end of our range. We expect our adjusted non-interest expense, excluding tax credit amortization and core deposit intangible amortization, to increase at a percentage rate in the low single digits. This expectation remains unchanged from the previous outlook. We expect the provision for credit losses to range between $40 million and $50 million in 2017, again, unchanged from our previous outlook. Based on the current pipeline, we anticipate recognizing $115 million of tax credit investments in 2017 with an associated full-year tax credit expense of $95 million or $50 million in the second half of the year. These tax credits, along with other tax items, imply an effective tax rate of 26% for the full year of 2017. With that, I will now turn the call back to Dominic for closing remarks. Thank you, Irene. In summary, we had a solid second quarter and are optimistic in our outlook for the second half of 2017. Our organic growth and asset sensitivity support operating earnings growth and profitability expansion. We look forward to recognizing continued benefits from our asset sensitive balance sheet, which is supported by our strong deposit mix. Most importantly, we are committed to investing in the East West franchise to continue to enhance our enterprise risk management to support sustainable relationship driven growth over the long term. In our view, our differentiated bridge banking business model offers a unique value proposition for our banking clients, which helps deliver strong returns for our shareholders. I would now open the call to questions. We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. We do ask that you limit yourself to two questions only. At this time, we will pause momentarily to assemble our roster. The first question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead. Good morning. Good morning. I was wondering if you can be just sort of touching on your loan growth outlook. Obviously, it's been very strong this year to date, and it seems pretty broad based when we look at sort of the trends in Q2. Dominic, you've talked about being cautious on the CRE multifamily space. One, I guess as far as CRE is concerned, would love to get your updated thoughts on how you view the market and your appetite to lend into CRE and multifamily. On C&I, would love to get an update on sort of the specialty lending verticals you've been focused on. Is the growth that we are seeing on C&I market share driven or is it more in terms of your niche businesses seeing growth and those customers are driving the growth in C&I? Sure. Well, let me start. This is Greg. If I don't get to answer the several questions in the question, let us know. Starting with CRE. As I think we've said the last few quarters, of course, we are disciplined in our focus to the market, but I would highlight Irene's comments that we don't see at this point any areas or issues of concern. We continue to be open for business with our good long time customers across our footprint, and particularly look to find growth in some of the geographic areas that we have been present in for a shorter period of time, like New York and Texas. Obviously, you'll note that our construction and land exposure was roughly flat quarter-over-quarter. Again, we continue to be pretty focused around managing risk in the riskiest parts of the commercial real estate portfolio. But we continue to see opportunities to support good customers, and we will take advantage of those. On C&I think as we said in our prepared remarks, there was growth across the portfolio in the past quarter. I wouldn't say that any one of our particular verticals stood out. I know we've called out some in previous quarters where they have grown sort of above the trend in the rest of the portfolio. But I think that's healthy that we are sort of at a good reasonable growth rate across those verticals. They'll be episodic quarter by quarter. We saw lots of opportunities in energy, for example, in Q2, but we were quite disciplined given some of the volatility in commodity prices. What we want to make sure is that we can be consistent in these verticals and not hopping in and out of the market depending on how things are sort of going in some of the underlying trends. We continue to hire talented associates to grow our additional specialized industry verticals. That will remain an area of focus for us. At the same time, as we've highlighted, we are reinvesting in some of our traditional business areas. That again, has flown through in some of our broad based growth across the C&I portfolio. Did I get everything? Yeah, you did good. Well done. Thank you. Just a second one, switching to deposit costs. I'll make this simple. Your outlook on deposit betas. We saw a slight drop in non-interest bearing deposits at period end basis. Just wondering, are you seeing any push from customers to move into interest bearing deposits, or are you seeing any pressure to raise deposit costs generally? We have seen a few so far. There is nothing of material. There are a few commercial clients that have a meaningful amount of DDA. Now finally, when they see that rate have gone up to over 1%, in terms of Fed funds rate, they decided to move it to the money market account. But it is very few. It is not something that I would consider to be too much of a material situation that we have to be concerned about. But in the meantime, obviously, this is a given trend. When rates rise, except when rates rise above 1%, there is going to be a lot more customers maybe start paying a little bit more attention to the interest rate environment. We are fortunate, as of today, we have customers who have a very large deposit talking to our branches, and then they are looking for a little bit higher rate. But the pressure is not as such that we consider to be of any kind of imminent concern at this stage. But we continue to watch it very carefully. As quarter by quarter, and then month by month, day by day, we continue talking to our branch managers in the retail branches and also talking to our relationship manager in the commercial banking sector and making sure that we stay alert and then watching the movement and then watching what is happening in the market. But as of today, we feel somewhat fortunate because I do notice that a lot of the smaller community banks are having some major challenges to dealing with these rate movement, which affect the deposit volatility. But for us right now, so far so good. The next question comes from Michael Young of SunTrust. Please go ahead. Hey, good morning. Good morning. Good morning. I apologize, I hopped on late. If I missed this, I am sorry. The bump in the consulting expenses this quarter, was that the result of the independent review taking place? Maybe if you could just give us an update on the BSA/AML process and timeline there. Yes, you are right on. We actually are finalizing that. We actually, we did finalize it. That is why you saw the expenses there from a consulting expense, as our consultants who finished their validation of the remediation work of the BSA, which is really the most significant size of labor hours and so forth. A substantial amount of that billing came in, and the work were done in the second quarter, and that work is finished. In addition to that, we also had consulting expenses to validate the Actimize system. That also is an additional consulting expenses, both came in around the same time. So we, as of today, I would say that have complete most all the work that need to be done in terms of meeting the regulatory expectation. Right at this moment, I think we have examiners in our office reviewing our BSA results so far. Everything working according to schedule. We start a business as usual, I think that pretty much right around the middle of Q2, and we will continue. The fact is, we obviously, as of now, with a new computer system, with additional hires in the BSA expense, all of that versus what we had back in 2014 and 2015, the expenses were higher. However, these are all business as usual going forward. I would expect that maybe in the third quarter, the consulting expenses probably will trend down a little bit simply because we do not have this one-time bigger item that hit us in the second quarter. Okay, great. Thanks. Just switching gears to the loan growth side, single-family residential has been very strong through the first half. You are kind of maintaining your loan growth guidance for the second half, assuming that that may slow at some point or become more seasonal, maybe even into the fourth quarter, or is it just conservatism? When it comes to the single-family mortgages, I think that we are not going to expect these 30-plus percent growth quarter by quarter going forward. I think that what we are looking at today is that the pipeline is still relatively strong, and I think that the expectation of us originating similar kind of volumes in the third quarter, I think that is high. On the other hand, I think that single-family mortgages, a lot has to do with interest rate environment. If you look at today, the real estate market is still relatively stable in terms of the residential side. The interest rate environment, particularly the long rate, still relatively stable. Therefore, as long as the environment is such, we expect that we will continue to have a pretty good growth. Now, let me just explain again on these high growth rate of single-family mortgages this quarter versus prior year. I want to remind everyone that in 2015 and 2016, actually, we spent tremendous efforts in putting a new system and process in our residential mortgage division. With those type of enhancement, obviously in 2016, there was a lot of distraction from focusing in origination. All of that has been completed, I think sometime in the middle of Q1 2017. I would say that our mortgage division is more or less starting on the business as usual officially in the second quarter. That is why we had picked up also more volume. It is not only because the market in general is pretty good, but also we internally also have a better processing, a faster turnaround time, and just overall, the mortgage division has become more effective and more efficient, which allow us to originate a pretty healthy loan growth. I would just add, if you look at the commercial real estate and C&I portions of the portfolio, the low double-digit number I think is consistent with what we have actually seen, which is a healthy pace of originations. But the payoff and runoff level has fluctuated to some degree with interest rate expectations and how aggressive fixed rate lenders are on the CRE side, for example. The payoff runoff portion is hard to predict, and it has been somewhat volatile through the first half. The next question comes from Jared Shaw of Wells Fargo Securities. Please go ahead. Hi, good morning. Good morning. Good morning. My first question on the margin, what portion of the variable rate loan book moved above floors with the recent June hike? Would it be realistic to expect to see a similar level of loan yield increases following that June hike? Jared, we're pulling up the answers for your first question as far as what moved. I think realistically, though, on the second half of the question, we do have less loans where the fully index rate is below the floor. Every quarter, naturally, as rates have risen, that has changed. Although certainly, for each loan, C&I or CRE, if it's possible to get a little bit more price, we want to make sure we do so. Even with the rising rate environment, there are situations where we are putting in floors of a loan to get a little bit more yield. But as I mentioned in the prepared remarks, as of the end of June, we had about $800 million or so, and as of the end of March, that was higher than that. Actually, we're still looking for the number. Not much, though, but I'll get that to you maybe after the call, Jared. Okay. That's fine. Then, maybe just more of a general commentary on the sentiment with cross-border trade and the exposure in China now that we're another quarter, I guess, into the new administration. Any change in the views on the part of either yourselves or the customer base with the opportunities ahead of them? Well, in terms of the comprehensive economic dialogue that actually is taking place right now in Washington, D.C. Since Secretary of Treasury and also Secretary of Commerce are in dialogue together with their associates in dialogue with the counterpart in China, there's not a whole lot that we can comment, because until they actually finalize with some decision. I think my observation at this point is that the key really is that as long as both sides are focusing on constructive win-win solutions, there will be plenty of opportunities between U.S. and China to either invest or trade to both shore. But if for whatever reason, if it turn into a political rhetoric, then it's not going to be productive. We don't know which direction it goes at this point, but I hope that it will be a constructive dialogue that will result in some very tangible, concrete plan about what's going to be done next. Now, in terms of reflecting back on the East West, East West Bank have been benefiting for the last several years from investment coming in from China. I wanted to remind everyone that many of these investment, when they first started, let's say four years ago, five years ago, or two years ago, at the beginning, most of these investments who got into U.S. may be struggling a little bit at the beginning, but then after two to three years of being in U.S., working like a U.S. company, pretty much now some of these business start growing just like a U.S. entity. We are actually providing banking services to many of these entities that while they originally are from China, they are really working just like any other U.S. companies in the United States in many different industry sectors. Secondly, with our balance sheet, with our size, we really are not in position to finance any of these high-profile acquisitions that you will read on Wall Street Journal or New York Times. Most of our investors, they are coming from China, that when it comes down to East West providing any kind of banking services or financing support in a much smaller size, and that fit into our appetite. As of today, in fact, these activities are still going in a relatively healthy pace. Unlike those very, very large, high-profile deals that obviously, for the right reason, the Chinese government had decided to rein in and making sure that things do not get too much out of control so that they can effectively manage not just the GDP growth and also the currency, but in the meantime, continue to fulfill their promises of reform and building up their domestic market. All of those things they are juggling at the same time, it is going to require the government to constantly make adjustment here and there. From our standpoint, we continue to stick with working with the smaller deals, and in addition to that, companies that are coming here for strategic reason versus for pure financial reason. Because those companies coming in for strategic reasons, they are continually getting the approval from the central government to allow them to go abroad and invest in U.S. and other overseas countries. That is where we are at this stage, and we do not see, at this point, anything of material that may affect our ability to grow in the next two quarters. Thank you. The next question comes from Ken Zerbe of Morgan Stanley. Please go ahead. Great. Thank you. I guess first question, just in terms of capital, obviously, your capital ratios have been trending higher over time. It doesn't necessarily look like asset growth or dividends is really using up a lot of that capital generation. How do you think about capital and your plans for capital over time from here? Thanks. Well, we like the continued growth in our capital at this point because we wanted to be conservative, and we wanted to make sure that when there are opportunities in the future that allow us to have even more stronger organic growth, that we have the capital that's available that allow us to go forward in that direction. So far, we feel that we have pretty good organic growth, and we do not want to put ourselves in a position that when it comes to a certain level of growth, that we have to either sell down the loans or maybe asking our customers to say that, "Well, we reached a certain size limit, and you have to go somewhere else," and that's not going to be healthy. We wanted to have enough cushion to allow us to have the ability to fulfill the potential organic growth that may be coming. The reason is that we have made substantial investment, not only to our back office infrastructure, but investments that help us to enhance our capabilities so that some of the customers may be a little bit too complex for us to handle from a cash management point of view in the past. Now we can take them on. But the more of these customers that we can take on, the more customer we can expand into a deeper relationship, the more likely that we have a stronger organic growth in the future. So, we need the capital to support that. The other thing is that we also are in a position that we're well aware that we have pretty much 6 to 7 years of growth cycle, the strong growth environment. Economic cycle is cyclical. So every now and then, there's always going to be something that may cause a blip. We do not want to put East West in a position that in case there's a recession that come along, that somehow we are tight on capital. So our position is that since we're able to generate a very, very high return of equity and asset comparing with our peers, may not be as high compared with other industry, but compared with our banking industry overall peers, I think that we look pretty good. Therefore, we really don't think that it's necessary for us to really tighten up the capital too much. So at this stage right now, I would say that there's not going to be any plan for any kind of buyback or any other kind of capital plan to make our capital ratio lower or make it more efficient and so forth. Great. Okay. Helpful. Then just one other question. What drives the appetite you guys have for tax credit investments, right? Essentially, is it just the rate environment? Is there something more? I'm just kind of curious on why now, why increase it, say, this quarter versus last quarter. Thanks. Can you repeat the question again? Oh, yeah. Just in terms of the tax credit, your appetite for tax credit investments, right? Obviously, it affects the amortization, it affects the tax rate. It looks like you're going to have higher tax credit amortization, so I'm assuming you're putting on more tax credit investments. What drives that decision to add even more of those investments going forward than you did, say, at the beginning of the year? Sure. So at the beginning of the year, what we're providing and sharing with our forecast is really the pipeline, which investments we think that we're interested in that will close during the year. In the quarter, we shared that we did increase by one tax credit investment. That will be placed in service in 2017. That is some of the difference as far as the amortization and also the impact to the tax rate. At the end of the day, with the tax credit investments, what we're looking at is the quality of the project, also the IRR for that. Our view of this is really similar to other assets on the books as far as what makes sense from a risk relative to a return perspective. Certainly, our view right now is in a rate environment where short-term rates have risen. The long-term rates, 10-year swap rates are still relatively low. We feel that this is attractive, although it may not be the right kind of volume on a go-forward basis. Right now, it makes sense for us. Does that help answer your question? It does. Yeah. Okay, great. Perfect. Thank you very much. The next question comes from Lana Chan of BMO Capital Markets. Please go ahead. Hi. I think last quarter you gave us your exposure on retail industry within your CRE C&I portfolio is about $3 billion. Have you looked at, within that bucket, how much exposure there is to grocers, I guess, given what's happened with the Whole Foods Amazon deal and some other new entrants into the grocery market? Sure. Part of our review. I'm not sure I'll be able to answer all the questions specifically. We can follow up if needed. I would say in a general sense, just to remind folks on the call that we have in that portfolio, the average loan size is about $2 million with very low loan to values across the portfolio. I wouldn't say any of the loan to values stand out. The average is kind of also pretty consistent with where all the individual loans are. If you took that and you said sort of grocers to get to your question specifically, I think you'd kind of put that into three buckets or three categories. The first category would be sort of mainline chains, the kinds that are the target of a lot of the speculation in the wake of the Amazon Whole Foods announced transaction. I would say there, we have very little exposure to comparable grocery chains at that kind of size. The second area would be strip centers, I guess I would call them, that may be anchored by a grocery store that's, I don't know, anywhere between 10% and 30% of the center. These would be very small stores in the most part, ethnic grocers serving the communities in which they're located. Again, low loan to values. Often the grocery store that's anchoring the strip center, the same borrower owns the strip center which again, would largely be filled with service businesses, nail salons, hairdressers, and the like. The third area is we do have some customers in our C&I business. Again, the same types of grocery businesses that may have multiple locations in these strip centers serving the ethnic communities. These would tend to be small chains and small stores. I do not think any of those three categories I just talked about, well, certainly not the first one, but neither the second nor the third comprise a significant portion of the overall portfolio. Okay. Thank you. That is very good color. Appreciate it. Just one follow-up question on the loans and deposit growth. Year to date, it looks like total loan growth is outstripping total deposit growth by a few percentage points. How do you think about that in terms of funding for the year? Do you think that you will have to start stepping up some of the deposit rates to get the funding for the loan growth that you are targeting? Let me start with the general answer, and then maybe we can dig in a little bit. I think with a loan to deposit ratio of 87%, we continue to be very comfortable with the funding on our balance sheet, our liquidity, and our ability to fund the kind of organic growth that we have talked about for the balance of the year. I think, Rona, Dominic talked earlier about our approach to deposit pricing where we have seen a little bit of pressure, not very much, a little bit of pressure in some of our larger deposit customers, particularly in the commercial business, but certainly not enough to say it is trend. I think as we said in the prepared remarks, we feel comfortable that given our outlook on loan growth, we can maintain discipline in pricing and fund that loan growth through the balance of the year. Obviously, as Dominic highlighted, we continue to be vigilant because we do not want to be late to the party if all of a sudden we start to see deposit rates going up. We want to make sure we are competitive, but so far we have not seen any undue pressure there. The next question comes from Aaron Deer of Sandler O'Neill & Partners. Please go ahead. Hi. Good morning, everyone. Maybe if I could just follow up on that deposit discussion. I am curious, to the extent that you saw the decline in non-interest bearing deposits during the quarter, were you able to track where those flows went? Were those internal flows into other deposit accounts, or did they move externally? What kind of trends did you see there? Are you talking about the non-interest bearing deposit? Yes. Yeah, we actually have a slight growth from an average. I think we have a slight growth on average balance point of view. That is something that we When you look at the quarter end date, June 30, it is very difficult to make a specific comment simply because anything can happen in that particular day. But when it comes to the average balances, we actually continue to see some growth. Yeah. Okay. I will just add to that, Aaron, I think across the board, there were some customers that migrated into other deposit categories. We had obviously new customers as well, or new balances, and some that exited as well. Nothing unusual really in the nature of that. I think it is just the mix and the timing. Okay. It sounded like the C&I growth was fairly well diversified across the categories within there. I am just curious, because Dominic, you commented last quarter that sounded like there was an uptick in your line usage that helped drive last quarter's increase. Where did the line usage stand this quarter relative to last? I think I cannot remember if I had this in my prepared remarks or not, but roughly flat to the first quarter. We said on the first quarter call that we had seen a couple hundred basis point increase, and we did not expect that to continue growing at the same rate, and it was roughly flat in the second quarter. The next question comes from Matthew Clark of Piper Jaffray. Please go ahead. Hey, good morning. Morning. Just a follow-up question on the loan pipeline. Just curious how that looks today, year-over-year and linked quarter. Yeah. The loan pipeline certainly is consistent with the outlook that we're providing in terms of low double digit growth. So we're comfortable at this point with that. As I said a few minutes ago, probably the bigger point of volatility is what's happening in the competitive environment, particularly on the commercial real estate side and how aggressive the fixed rate term lenders are. As I said, we saw less aggressive approaches to our customers in the first quarter. I think that had something to do with expectations for interest rate increases. Some of that abated in the second quarter. So we saw a little bit of more aggressive behavior from some of those competitors. So it was hard to predict where that's going to go, but the underlying pipeline is consistent with our outlook. Okay. Just on expenses, with the low single digit core expense growth guidance still, it seems like there's going to be some relief in the second half. You talked to the consulting expenses coming down. Just curious if there's anything else that we should be thinking about. Yeah. Matthew, as Dominic mentioned, we do expect some of the consulting expenses to tick downward. I would say, though, we are continuing to build the business, make investments in people. So comp is something that we expect to continue to increase. But all in all, with other kind of moving items as well, we're comfortable with the low single digit guidance and forecast that we have. I think philosophically, again, I feel that because for the last few years, we have consistently generated pretty decent earnings and return of equity and return of assets, relatively speaking, compared with the industry average and now also compared with our peers. We always been consistently ranked above. So it really is kind of like appropriate and perfect timing for us to investing in the organization on risk management and infrastructure just to ensure that while we're growing, that we do not get ourselves in a position that we have not taken care of solidifying our overall risk management. For that reason, we have these net interest margin that are supporting, very favorable. We have the loan growth and the deposit rate has only ticked up a few basis points despite these several Fed fund hikes. It's really a great environment for us to invest a little bit heavier in terms of our system, the platform to make sure it's scalable, and then bring in more talented associates who can help us to sustain our growth in the long run. So we will continue to do that. I think that we've done that in 2016, and we're doing it in 2017, and I would expect in the third and the fourth quarter, we'll continue to find opportunity to hire the talent people and then find opportunity to upgrade with a system or certain infrastructure, et cetera. So from that standpoint, I think we should expect the expenses continue to grow steadily. We just need to make sure that we continue to have the ability to have the earnings that can support it. That's what we're doing right now. I would say that the guidance right now is exactly what we expected. The next questioning comes from Chris McGratty of KBW. Please go ahead. Good morning. Thanks for taking the question. Dominic, if I can follow up on Matt's question about the expenses. Obviously, the revenue picture is improving for you guys, probably a little bit better than peers, given the margin performance. As you look out longer term, maybe beyond this year, are there certain investments that you may have put off that make it a little bit easier, given that you can still maintain pretty good operating leverage, given the top line growth is growing a little bit quicker? Or should we be thinking about this lowish single digit is sustainable in the out years? Thanks. Not sure I understand the question. Chris McGratty. More on the expenses, right? Can you maintain a 3%, or will you maintain a low single-digit expense run rate going forward if you're making a little bit more on the revenue side? Are there certain investments you may have delayed that you might make next year? Well, I think at this stage right now, we have projects that we basically focus on one at a time. The key thing is it's not like while we are enjoying the current expansion of revenues and profitability, that we actually should just put a lot of time into just ignoring taking care of customers. So I think even on building or expanding and building on the back office, risk management, system infrastructure, and all of that, it's still sort of like a little bit more organized way of one step at a time going forward. We have put these things in place and continue to work on it. I think that the guidance is pretty much based on that kind of schedule. What I emphasize about we are continuing to invest. That doesn't mean that we have actually changed our direction and then load up more now than we should have. The other thing is that if you look back in a different way, we could have been in a position that not do some of these investments. Just to make sure that we maintain strong earnings. But I feel that we are a little bit fortunate right now that maybe some other banks out there that really are not in the same position and cannot afford to do what we're doing because of our ability to continue to have revenue expansion and profitability, that we are able to continue to invest. But East West has always been very frugal in a certain degree. We're always going to be watching every dime. But while we're watching every dime, we're not wasteful. I think the money that we spend, that we feel that worthwhile projects that will help us in the long run. And we're doing that in a sort of systematic and organized manner. I would just add that, to Dominic Ng's point, we are making a lot of investments which we are funding with the expense growth that we have discussed in our outlook around enterprise risk management and infrastructure, and quality of systems and MIS and so forth. I think we feel we can continue to make those investments with that type of expense outlook. Then I would say in the second piece of that is, if we were to see some interesting opportunities to put a team in place to expand into an industry vertical that we are not currently in or a geographic opportunity that is organic, that obviously we would do only if it came with significant revenue. Again, in those kinds of cases, you might see some volatility in that expense number. Again, that is only going to be where we see really attractive revenue opportunities. That is great color. Thank you. Just a follow-up. We have heard from a few banks about earnings credit rates being selectively addressed. Have you anything notable to report on earnings credit rates at the bank? No. Not really. The next question comes from David Chiaverini of Wedbush Securities. Please go ahead. Hi. Thanks. A question on residential mortgage lending. I am hearing anecdotally that the appetite for real estate properties in Southern C.A. from Chinese nationals could be waning, but based on your strong growth, it does not seem to be impacting your business. Are you seeing any slowdown in real estate buying activity by Chinese nationals? If so, are your mainstream borrowers picking up this slack? Again, I think you highlight the keyword, anecdotally. I also heard it anecdotally. In fact, if you look at the national report just came out, it was a stunning recognition of, actually, nationally, there is almost 40%, 50% increase of Chinese nationals investing in U.S. real estates. The numbers are kind of not somewhat in sync with what we have been hearing anecdotally. I think that has a lot to do with, I think, one, is that maybe, there are a lot more Chinese nationals for the last few years shopping, looking, and maybe also some of the transaction were complete in a much more intense competition kind of arena. For example, you would hear that there are multiple biddings. There are home were sold above the asking price. Those are the kind of things that happened in the last 2-3 years. Frankly, it is not just because of the Chinese investors. What we find is that in multiple areas that we have branches, U.S. citizens are bidding these homes in the same sort of aggressive manner. If I look at today, I would say that in general, when a property got listed on the market, it takes a little bit longer to get it sold. We have not seen price coming down. It just takes a little bit longer to get it sold. Every now and then, when we try to go in and look into, so who is buying it, then we will find that there is a so far as equal number of, in terms of percentage of Chinese national also still buying. I do feel that there is more likely of buying in the little bit lower end market versus the upper end market. If you hear that, like in N.Y. or maybe San Francisco and L.A., these multimillion-dollar homes, oftentimes in the last 2 or 3 years, you will hear that these are foreign investors who are acquiring these homes, including some from China. I would say that we would not expect too many of that in the next several months to the next couple of years. Again, keep in mind at East West scenario is that the home that we are financing, most of them are not in that kind of multimillion-dollar price range. We hardly have any of those multimillion-dollar price range kind of mortgages. In fact, most of the homes that we are financing have a mortgage in a much lower amount. Therefore, it is a little bit of different market. There is still pipeline there, and many of them are just refinancing. So, from our perspective, it's a little bit different than what the overall trend in the market as of today. I do expect that in the next year or two, my expectation that that volume of overseas investor buying homes in the United States has to come down a little. So far, these statistics haven't reflect that. We'll find out. I think that next year, about June, they will show the new report again, and we'll figure out whether that we will get it right because you're absolutely correct anecdotally. It appears that it is slowing down a little bit. But factual information that just came out reflect differently. So maybe next year it will come down a little bit. Thanks for that. And follow-up on cross-border lending. When you say East West does smaller deals rather than larger deals, how do you define the smaller deal size range? What size loans are we talking with these borrowers? Well, we're very much focused on the sort of broad middle market, and it can range. But I think generally if you look at where we've financed subsidiaries or affiliates of Chinese companies, the $10 million to $50 million range would be in our sweet spot. And again, it can be across a little bit of cash flow lending, a lot of collateral-supported lending, sometimes equipment finance. And I think Dominic made the point, which is, generally, we're looking at the credits of the subsidiaries or affiliates as they operate on a sort of standalone basis. Of course, we often have relationships at the parent company, which gives us additional comfort and confidence and a little bit of an edge in terms of winning business on this side of the ocean. The next question is a follow-up from Aaron Deer of Sandler O'Neill & Partners. Please go ahead. Aaron, you're- My question's been answered. Thank you. This concludes our question and answer session. I would now like to turn the conference back over to Dominic Ng for any closing remarks. Thank you. Again, I want to thank everyone for joining our call today, and we're looking forward to speaking with you again in October. Goodbye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a good day.