Earnings Call: Q4 2012

Jan 24, 2013

Good morning, and welcome to the East West Bancorp fourth quarter 2012 earnings conference call. All participants will be in listen only mode. If 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 touchtone phone. To withdraw your question, please press star then two. Please note that this event is being recorded. Now I'd like to turn the conference over to Kelly Adams. Ms. Adams, please go ahead. Good morning, and thank you for joining us to review the financial results of East West Bancorp for the fourth quarter and full year of 2012. Here to review the results are Dominic Ng, Chairman and Chief Executive Officer, Julia Gouw, President and Chief Operating Officer, and Irene Oh, Executive Vice President and Chief Financial Officer. We will then open the call to questions. Second, 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 factors that 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, 2011. Today's call is also being recorded and will be available in replay format at eastwestbank.com and streetevents.com. I will now turn the call over to Dominic. Thank you, Kelly. Good morning, and thank you all for joining us this morning for our earnings call. Yesterday afternoon, we were pleased to report financial results for the fourth quarter and full year of 2012. East West reported record earnings of $281.7 million for the full year 2012 and $71.9 million for the fourth quarter of the year. East West increased full year earnings by 15% or $36.5 million from $245.2 million in 2011 and increased earning per diluted share 18% to $1.89 from $1.60 in 2011. 2012 was a record year for East West, and we achieved many financial successes during the year. We finished the year with record assets of $22.5 billion and the highest annual net income in the history of the bank. We also achieved record loans of $15.1 billion and record deposits of $18.3 billion. It was the third consecutive year of record net income. Year to date, return on common equity and return on assets were both above our peers at 12.3% and 1.3%, respectively. Our strong financial performance for 2012 was accomplished through quality execution on all significant fronts, including loan growth, commercial deposit growth, operating expense control, and maintaining strong credit quality. During the full year of 2012, East West grew non-covered commercial and trade finance loans by $1.1 billion or 35% to a record $4.2 billion, fueling growth in our non-covered loans, excluding loans held for sale, to a record $12 billion, an increase of 16% or $1.7 billion. Core deposits also increased throughout the year as we continue to focus on attracting low cost deposits. As of December 31, 2012, we reached record levels of both total deposits and core deposits of $18.3 billion and $12.2 billion, respectively. Our ongoing efforts to increase profitable, lower cost commercial deposit relationships have continued to be successful, and the strong growth in core deposits was fueled by an increase in non-interest bearing deposits. As of December 31, 2012, non-interest bearing demand deposits total $4.5 billion, the highest ever in the history of the bank. The strong balance sheet growth was achieved during a difficult operating environment for the entire industry. Further, I am pleased to note that the growth did not come at the sacrifice of operating efficiency. We continue to maintain strong expense control and improved efficiency ratio for 2012 to 42.3%, amongst the lowest in the industry. Additionally, credit related costs continued to decrease in 2012. The provision for loan losses on non-covered loans was down 35%, and net charge off on non-covered loans was down 62% from a year ago. Credit cycle costs included in non-interest expense, net of reimbursement from the FDIC were down 11% or $4.9 million from 2011. Looking ahead, we expect reduction in credit cycle costs will continue to play a positive impact on our earnings in 2013 and also 2014. Although the low interest rate environment and stagnant economy continue to pose challenges for our industry, East West continues to perform well and outperform many of our peers with higher growth, higher profitability, and higher return to shareholders. As a financial institution focused on the U.S. and Greater China markets, we have an inherent competitive advantage over our peers in winning new customers and retaining existing customers who need our expertise, services, and operating platforms between the United States and the Greater China region. Our strong growth in non-covered commercial and trade finance loans in the fourth quarter and throughout 2012 is indicative of this advantage. In summary, we delivered a successful 2012 with solid financial results. Not only have our net income and earnings per share increased, the year-to-date tangible book value is also up 11% to $13.55 per share. Additionally, we returned $264 million back to shareholders in the form of dividends and the repurchase of common stock during the year. With our ability to grow our market share, deliver strong earnings, and maintain strong capital levels, we are confident we can continue to provide strong returns to shareholders in 2013. Yesterday, in our earnings release, we were pleased to announce that we will increase the common stock dividend by 50% to $0.60 per year, and that the board has also authorized a new stock repurchase program of $200 million. 2013 is the 40th anniversary of the founding of East West Bank, and we are pleased with our accomplishments thus far. We look forward to the next 40 years of delivering strong growth, profitability, and shareholder value. I will now turn the call over to Julia to speak in more detail about our key successes for last year. Thank you very much, Dominic, and good morning to everyone. I would like to spend a few minutes discussing the solid loan growth we experienced during the fourth quarter and full year, and then discuss the net interest margin and our expectations for the future. Finally, I will review the guidance we provided in the earnings release yesterday for the first quarter and the full year of 2013. In total, our loan portfolio increased to $15.1 billion at December 31, 2012, an increase of $577.1 million or 4% from September 30, 2012, and an increase of $578.6 million or 4% for the full year. Non-covered loan balances, excluding loans held for sale, increased 7% or $803.7 million from September 30, 2012, and increased 16% or $1.7 billion for the full year. Covered loan net decreased $243 million or 8% from September 30, 2012, and decreased $987.5 million or 25% for the full year. During the first half of 2012, the steady growth in the non-covered loan portfolio was offset by decreases in the covered portfolio. We were pleased to see that the overall increase in total loans for the fourth quarter and second half of 2012. The growth in our non-covered portfolio for the fourth quarter and full year of 2012 was driven by strong growth in commercial and trade finance loans, commercial real estate loans, and single-family loans, which I will discuss in more detail. Non-covered commercial and trade finance loans increased to $4.2 billion at December 31, 2012, an increase of $498.5 million or 13% from September 30, 2012, and an increase of $1.1 billion or 35% for the full year. Combined, total non-covered and covered commercial and trade finance loans increased to $4.8 billion or 32% of our total gross loan portfolio as of December 31, 2012, up from 30% and 27% of our total gross loan portfolio as of September 30, 2012, and December 31, 2011, respectively. The growth in non-covered commercial and trade finance loans during the full year and the fourth quarter stemmed from the strong growth across many sectors, including trade finance, manufacturing, entertainment, and technology. I would also like to note that part of the strong growth in the non-covered commercial and trade finance loans in the fourth quarter was seasonal and tax driven, and we experienced higher drawdowns and utilization than normal. Additionally, during the quarter, we continued to experience strong demand in our markets for commercial real estate loans and single-family loans. Our commercial real estate loan portfolio and single-family loan portfolios grew $124.4 million or 4%, and $121.7 million or 6% quarter to date, respectively. As previously discussed, we are well under the FFIEC guidelines for high CRE concentration at 170% of total risk-based capital as of December 31, 2012. As such, we are comfortable continuing to grow commercial real estate loans in 2013 proportionately as our total loan portfolio grows. Single-family loan originations continue to be strong. We originated 594 loans totaling $231 million during the fourth quarter, with an average loan size of $389,000 and an average loan-to-value of 53%. Our single-family loan originations are all from our retail branch network. As previously mentioned, our underwriting criteria for single-family loans are very high, and we require very high down payments and low loan-to-value ratios. Historically, the credit quality for our single-family loans has been outstanding regardless of real estate cycles, and we attribute this largely to the high down payment requirements. Many of the single-family loans we are currently originating are under our proprietary low loan-to-value and loan documentation program. This is a loan program that East West Bank has had since the 1970s, and the credit quality of the loans under this program has always been outstanding. The program is catered to our customer base, new immigrants who may be high savers and have very high down payments for homes but limited credit history in the U.S., and also small business owners who may not qualify for a conforming Fannie Mae loan. As you may know, earlier in the month, the Consumer Financial Protection Bureau issued a proposal on what constitutes a qualified mortgage. As the proposal is currently written, we can continue to originate our loan documentation loans until January 2014. After that point, we are comfortable that we'll be able to develop a loan program that will satisfy the requirements under the Consumer Financial Protection Bureau and meet the unique needs of our new immigrant and small business owner customers. Next, I would like to spend a few moments discussing the net interest margin for the fourth quarter and our expectations for the first quarter of 2013. Net interest income, adjusted for the net impact of covered loan dispositions, totaled $198.4 million for the fourth quarter of 2012, an increase of $2.1 million from $196.3 million in the prior quarter. The core net interest margin, excluding the net impact to interest income of $46.5 million, resulting from covered loan activity and amortization of the FDIC indemnification asset, totaled 3.84% for the fourth quarter of 2012. This compares to a core net interest margin, excluding the net impact on interest income of $25.6 million, resulting from the covered loan activity and amortization of the FDIC indemnification asset of 3.95% for the third quarter of 2012. Although the core net interest margin decreased 11 basis points from the third quarter of 2012, interest earnings assets increased $776.8 million or 4% to $20.6 billion, resulting in the increase in adjusted net interest income of $2.1 million quarter-over-quarter. Looking ahead to 2013, we expect the net interest margin will continue to drift downwards as long as interest rate environment remains low. However, we are confident that we will be able to maintain strong profitability and returns as we continue to grow the loan portfolio. Similar to the results of the fourth quarter, in 2013, we expect that the loan growth will offset the impact of low interest rate environment on our revenue. We continue to actively take opportunities to reduce our overall funding costs and higher cost time deposits. In the fourth quarter of 2012, we prepaid $43 million of Federal Home Loan Bank advances at an average effective cost of 1.6% and incurred a prepayment penalty of $3.2 million. Further, during the quarter, we restructured $75 million of the Federal Home Loan Bank advances, reducing the average effective cost by 86 basis points, and we restructured $150 million of securities sold under repurchase agreements, reducing the average effective cost by 195 basis points. For the full year of 2012, we have prepaid a total of $93 million of Federal Home Loan Bank advances. The cost of funds decreased three basis points from 67 basis points in the third quarter to 64 basis points in the fourth quarter of 2012, and decreased from 94 basis points for the full year of 2011 to 69 basis points for the full year of 2012. Looking forward to 2013, we will continue to look for opportunities to reduce overall funding costs. Although at this point, the opportunities to substantially lower the cost of deposits are reduced, given that many of the time deposits have already repriced downward. Lastly, I would like to provide a brief summary of our guidance for the first quarter of 2013. As in the past, in our earnings release yesterday, we provided guidance for the first quarter and full year of 2013. We currently estimate that fully diluted earnings per share for the full year of 2013 will be in the range of $2-$2.04, or an increase of 6%-8% from $1.89 for the full year of 2012. For the first quarter of 2013, we estimate that fully diluted earnings per share will range from $0.48-$0.50. With that, I would now like to turn the call over to Irene to discuss our fourth quarter 2012 and the full year financial results in more depth. Thank you very much, Julia, and good morning to everyone. I would like to discuss our financial results for the fourth quarter and full year of 2012 in more detail, specifically as it relates to credit quality, non-interest income, and non-interest expense. Starting with credit quality, we are pleased to see that asset quality metrics continued to improve in the fourth quarter of 2012. Non-performing assets declined to $141 million as of December 31, 2012, a decrease of $3.1 million or 2% from the prior quarter, and a decrease of $34 million or 19% from the prior year end. Total net charge-offs on non-covered loans decreased to $9.6 million for the fourth quarter of 2012 from $10.6 million in the third quarter of 2012 and $21.8 million in the fourth quarter of 2011. Total net charge-offs on non-covered loans decreased to $42.2 million for the year ended 2012, down from $112.1 million for the year ended 2011. Additionally, total non-performing assets, excluding cover assets, were down to 63 basis points of total assets as of December 31, 2012, down from 66 basis points and 80 basis points of total assets as of September 30, 2012, and December 31, 2011, respectively. For the fourth quarter of 2012, the provision for loan losses for non-covered loans was $13.3 million, an increase of $452,000 or 3% from the prior quarter, and a decrease of $6 million or 30% as compared to the fourth quarter of 2011. For the full year of 2012, the provision for loan losses for non-covered loans was $60.2 million, a decrease of $32.4 million or 35% as compared to the year ended 2011. East West continues to maintain a strong allowance for non-covered loans of $229.4 million or 1.92% of non-covered loans receivable as of December 31, 2012. Overall, we expect credit quality to continue to improve and estimate that the provision for loan losses on non-covered loans will approximate $10 million for the first quarter of 2013 and $35 million-$40 million for the full year of 2013. During the fourth quarter of 2012, the company recorded a reversal of provision for loan losses of $689,000 on covered loans outside of the scope of ASC 310-30. For the full year 2012, the company recorded $5 million of provision for loan losses on covered loans outside of the scope of ASC 310-30. Charge-off on these loans were $35,000 during the fourth quarter and $6.5 million during the full year of 2012. There were no charge-offs recorded on this specific loan portfolio in 2011. As these loans are covered under loss-share agreements with the FDIC, for any charge-offs, the company records income of 80% of the charge-off amount in non-interest income as a net increase in the FDIC receivable, resulting in a net impact to earnings of 20% of the charge-off amount. Moving on to non-interest income and expense. East West reported a non-interest loss for the fourth quarter of 2012 of $18.5 million, a decrease from non-interest income of $2.8 million and $937,000 in the third quarter of 2012 and the fourth quarter of 2011, respectively. For the full year 2012, the company reported a non-interest loss of $5.6 million, a decrease from non-interest income of $10.9 million in 2011. This decrease in non-interest loss for both the quarter and the year is primarily attributable to a decrease in the net reduction of the FDIC indemnification asset and FDIC receivable. In total, fee income, including branch fees, letter of credit, and foreign exchange income, loan fees, and other operating income increased during the year and during the quarter and totaled $26.9 million in the fourth quarter of 2012, an increase from both the prior quarter and the prior year end. The increase in fee income during the fourth quarter of 2012 was largely due to increases in ancillary loan fees and fees earned on interest rate swaps entered into by our customers. In addition, included in non-interest loss for the fourth quarter of 2012 were net gains on sales of fixed assets of $4.2 million, which were primarily due to the sale of a branch facility in New York acquired through the UCB acquisition. Moving on to non-interest expense. Total non-interest expense for the fourth quarter, excluding amounts to be reimbursed by the FDIC and prepayment penalties on FHLB advances and other borrowings, increased slightly to $98.1 million by less than 1% from both the third quarter 2012 and fourth quarter 2011. Credit cycle costs, which include other real estate-owned expense, loan-related expense, and legal expense, decreased $2.4 million or 16% from the third quarter of 2012, totaling $12.5 million for the fourth quarter as compared to $14.9 million for the third quarter of 2012 and $21.9 million for the fourth quarter 2011, which are included in non-interest expense. For the full year, credit cycle costs totaled $62.8 million, a decrease of 23%, or $18.4 million from the prior year. Of the total credit cycle costs incurred in the fourth quarter and full year, $4.9 million and $27.2 million are related to covered loans and other real estate owned, for which we expect that 80%, or $3.9 million and $21.7 million, are reimbursable by the FDIC, respectively. Finally, as stated in the earnings announcement released yesterday, East West's board of directors has declared a first quarter dividend on the common stock and Series A preferred stock. The common stock cash dividend of $0.15 per quarter is payable on or about February 22, 2013, to shareholders of record on February 8, 2013. This represents an increase of $0.05 per share, or a 50% increase from the prior quarterly dividend of $0.10 per share. The dividend on the Series A preferred stock of $20 per share is payable on February 1, 2013, to shareholders of record on January 15, 2013. I will now turn the call back to Dolly. Thank you, Irene. I will now open the call to questions. Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Jennifer Demba from SunTrust Robinson. Please go ahead, Ms. Demba. Thank you. Good morning. Just curious as to, you had very strong C&I and trade finance growth this year, in 2012, rather. Just wondering if you foresee quite that strong growth in 2013, and what particular industries you see driving what growth you will have? Well, in terms of the C&I growth, I think that because right around near the end of the year, we have a big surge. So some of the loans that we expect to close in 2013 first quarter have actually been booked in December of 2012. In that regard, I think that particularly in the first two quarters, I would not expect as high of a growth of C&I loans comparing with the last six months of 2012. Also, in terms of the areas of where we see growth from C&I would expect a continuation in import and export business, in the international trade finance. In terms of industry, I think we continue to see opportunities in entertainment, we continue to see opportunities in aviation, and also opportunities in high tech, et cetera. These are all areas, by the way, it's strategically important to China in terms of wanting to make sure they have more investment in these type of industries. So we expect that because there are a lot more flow of business between these two countries, the likelihood of East West getting involved is much higher. Thank you very much. Thank you. The next question comes from Dave Rochester from Deutsche Bank. Hey, good morning, guys. Good morning. Could you just quantify that portion of the loan growth that you mentioned was pulled forward into Q4 from January? When we look at the pipeline, because a lot of these loans were booked in December, when we looked at the pipeline in October, we think that most of the loans that got booked in December probably we expected to be more in early 2013. I would say that it's quite a bit of those loans in the pipeline that borrowers anticipating the tax increase, and they wanted to book it in 2012. That's why we think that going forward, the loan growth will not be as strong as what we experienced in Q4. Got you. Thanks. You had talked about higher utilization rates than normal in the C&I area this quarter. Can you talk about where those are today versus maybe where they were in Q3? I think Q4 is about 68%, 69%, which normally probably 65%, 66%. There's some seasonality in that. Yeah. Okay, great. And one last one on the margin. I noticed that the loan yield, excluding the covered portfolio, was actually up 5 bps this quarter. Can you talk about what drove that increase? Sure, Dave. This is Irene. So we have some loans that are accounted for under ASC 310-30, the SOP accounting, that are not covered. These are the loans that we acquired with the UCB transaction that are in China, which was not covered under loss share. And we had a small recovery in the fourth quarter, and that recovery is a yield enhancement. Got you. That's why it went up a little bit. Aside from that, obviously, with the current kind of rate environment, you wouldn't see a small increase. It was maybe just a couple of basis point impact to the margin or a few- That's right. Okay. Got you. Just in terms of spreads, have C&I spreads generally held steady for you guys versus last quarter? Yeah, it's pretty steady. Then the ARM rates on the resi side, you're still getting 4%-5% on that? For the single family? Yep. Yeah, in about 4.5%-5% range. Okay, great. Thank you very much. Thank you. The next question comes from Ken Zerbe from Morgan Stanley. Just in terms of your NIM guidance for 2013 at 365-375 bps, it is substantially lower than your prior guidance in the 380s. Is the main difference just that you have more securities, like a mix shift, or is there anything where you saw deterioration on more of a fundamental basis? Ken, basically when we looked at third quarter to fourth quarter, if you look at our financials, the increase that we have in liquidity, the increase in earning assets was quite frankly larger than we expected. The reduction in the NIM guidance is really a reflection of that higher liquidity, and then, as you say, redeploying those in lower-yielding securities. I think, the good news and the positive for us is with the growth that we have been having, and slowly over the course of 2013, as we will be able to move some of that lower-yielding asset into loans, we will be able to maintain the NII, as we did in the fourth quarter when it inched up a little bit. Okay, that helps. Then just the other question on expenses. Obviously, your guidance implies sort of flat to lower expenses versus where we are right now. What is it that you're taking out of expenses? Because obviously you're growing the balance sheet, growing the loan portfolio. Seems everything's going in the right direction, and I guess I wouldn't have expected a lot more expense improvements, but yet here we have them. What's driving that? Most of it is credit cycle costs that should continue to go down. Got it. The last couple of years, we really had a pretty high credit cycle cost, legal fees associated with some of the problem loans, and also the 20% of the covered loans expenses that we have to pay. I would say that the next few years, the leverage on the expenses is mostly in the credit cycle cost. Great. Thank you very much. Thank you. The next question comes from Joe Morford with RBC Capital Markets. Thanks. Good morning, everyone. Good morning. First was just a quick follow-up on the commercial loan growth. I was just curious, in the fourth quarter, how much of that specifically came from the trade finance type of activity? About 30%, yeah, of that growth is from trade finance, which is somewhat consistent. In general, we see about 30% of the growth of portfolio, 20%, 30% from trade finance. Okay. But we have been, Joe, maybe I will mention, what we have been very successful in the last couple of years is, in addition to, we used to be very heavy in the importers. We have been very successful in growing our exporter business on the trade finance. Okay. That's helpful. The other question was, you talked about limited room to further lower deposit costs, but are there additional opportunities to pay off or restructure advances of repos that you might be considering as well? Well, we'll continue to look at whether that's a good opportunity, but I would say that reducing the cost of funds or cost of deposits would be very limited for 2013. Okay. Thanks so much. Thank you. The next question comes from Aaron Deer from Sandler O'Neill & Partners. Hi, good morning, everyone. Good morning. Erika, I was wondering if you could give us an estimate of where the net accretable yield stood at year-end. Sure, Aaron. As of the end of the year, we were right about at $94 million of a net accretion remaining. Okay. What was behind the decision to shut down the loan sales and what is kind of the outlook for that going forward? Are you talking about the sale of the student loans? Yeah. Well, I do not know if we shut it down. We did not have any transactions in the fourth quarter, and if you look over kind of our financials, sometimes we have sold, sometimes we have not. I think, quite frankly, in the fourth quarter, we had the gain on the sale of the real estate. So really we just did not need to sell the student loans. Okay. We will look at that periodically and see if there is opportunity or if it makes sense for us. Okay. There hasn't been a change in the market pricing on that or anything that would No have driven the change in strategy? Okay. Also, I guess in the fee lines, I think you mentioned the increase in your FX fees. Can you say again what was behind that? Is that a sustainable level going forward? I don't know if the FX fees increased that much. One of the things that we did talk about was that the derivative income for selling swaps to interest rate swaps to our customers has increased a little bit. More specifically, the interest rate swap is for our customers who have commercial real estate mortgages, and many of them, in this low rate environment, prefer to have fixed rate loan. Obviously, we at East West do not want to take the interest rate exposure. Many banks out there are offering 10-year fixed at a very low rate, and I think that someday down the road, maybe three years, four years from now, I think they're going to be hurting in a big way. What we decided to do since two years ago is that we'll continue to make sure that we stay as neutral as possible in our asset liability management in terms of interest rate. So we offer this interest rate swap for all these customers who prefer to have a fixed rate, and many of our customers want to have fixed rate. We do adjustable, and they have fixed, and then just by doing a swap. Through that, we also picked up some fee income. That actually have grown quite a bit in 2012. Sure. No, it seems like a good strategy. What percentage, then, of the real estate loans that you are putting on that are longer term, so longer than seven years, are fixed rate but do not have associated swaps? We are not putting on any, yeah. We do not have much at all, longer term. Fixed rate. 3, 5, yeah. We usually do mostly floating, and then we have the customer to do the swap to fixed rate. Okay, that's great. Thanks for taking my question. Thank you. The next question comes from Anna Chan from BMO Capital Markets. Thanks. Good morning. Couple questions. One on the structured repos that you structured and the borrowings that you prepaid this quarter. Is that fully reflected in the cost of funds, or is that expected to benefit again in the first quarter? It will have some benefits because it was done during the quarter. Towards the end of the quarter. Towards the end of the quarter. Yes. Okay. Then, just following up on the commercial real estate, you've had two quarters of pretty good growth on the commercial real estate. Where are you seeing the opportunities there, and could you be a little bit more specific in terms of what the new yields are on that portfolio, on the loans that you're booking? In terms of the yield, what we try to get is, in general, about prime plus half. That is why we have been doing this interest rate swap for the customers to lock into the fixed rate. We generally take about prime plus half into our portfolio. Okay, and where are the opportunities now? Mostly in California and New York, that we see activities in terms of the commercial real estate. Okay, and then last question is on the, what are your assumptions for the purchase accounting accretion in 2013 per quarter? We expect probably about $50 million in total for the year. We have $94 million accretion left, about $50 million-$60 million for 2013, and the remaining in 2014. Okay, great, Julia. Thank you. The next question comes from Herman Chan from Wells Fargo Securities. Hi. As a follow-up to the comments made on the qualified mortgage rule, can you provide some color on any changes you would be implementing on future residential mortgage origination in 2014? Thanks. Well, for 2013, obviously, there is no change, so we are just business as usual. I think that among our managers in the mortgage division, we will be able to figure out a way to come up with programs that in full compliance with CFPB and also cater to the kind of clientele that we have. I feel pretty confident that year in, year out, we always have regulatory changes, from back in the old days, FIRREA to FDICIA, and now Dodd-Frank. We work in a regulatory environment. East West Bank specialize in follow the rules, and we do not try to create rules or lobby for rules. Whatever comes, we just do it. Usually, all worked out. Understood. A question on the bank's dividend philosophy. The $0.60 annual dividend is higher than pre-crisis levels. Absent an abundance of organic loan growth opportunities or maybe M&A opportunities, should we continue to see dividend growth even above the 30% or so payout ratio? Possibly. What we would like to see is, as we continue to grow the earnings per share each year, we would like to grow the dividend. In terms of payout, I think that we are comfortable between 30%-40% payout as a good payout. Then we will take a look, what is the loan growth? If we have very high loan growth, then maybe we are more on the 30%, 35% payout. Thank you very much. Thank you. The next question comes from Julianna Balicka from KBW. Good morning. Good morning. I have a couple questions to follow up on the pricing conversation. In terms of the opportunities for the loan products that you see right now, what do you perceive to be the best risk-adjusted opportunities to make new loans? Oh, for the new loans? I don't want to Can you repeat that, Juliana? You were coming in and out a little bit. Yeah, you cut out. Oh, I'm sorry. We can't hear you. I'm sorry. Can you hear? Okay. In terms of the new loans that you are able to make right now, which products do you perceive to be the best risk-adjusted pricing right now in the market? At this time, we would like to grow our loan portfolio across the board. We feel that as long as they are good loans and the pricing is good, in general because of our niche, our U.S. Greater China bridge strategy, we find that a lot of these loans, from the risk-adjusted basis, are priced pretty good for our expected return. We see opportunities across the board, the different types of loans. If some loans are priced very thinly, that we just don't think that it's really a good return, then we would not do that. One key advantage we have is that, at this stage right now, based on our current balance sheet, we actually are pretty free to do just about any kind of loans. Clearly, in 2010 and 2011, we did not have the luxury. We had a substantially higher real estate concentration then, because together with United Commercial Bank acquisitions, we piled up a lot of real estates. Even though a lot of those real estates from UCB were cover loans, the fact is we had to, at that time, anticipate by 2014, after 2014, all the cover loans will become non-cover loans. Altogether, if we have too much real estate concentration, that's not going to be good from a regulatory point of view. In that standpoint, that's why in 2010 and 2011, we pretty much more or less shut down the real estate loan origination engine, which we were pretty good at doing. We weren't able to do that, and we mainly focused on C&I. The good news of doing that is that by just pushing our folks to only focus on C&I, we actually have developed a very strong C&I origination platform, which so far, even today, we still, as indicated in financial performance from many different industries, whether it's entertainment, high tech, clean tech, even to agriculture and then different type of industries and trade finance, we continue to have very nice growth. In addition to that, now we are kicking up our real estate origination for CRE, and multifamily and so forth, and even construction loans. With that all added together, I looked at it as that our approach is that as long as it's good loans that are always going to pay back and then give us the reasonable return, we're going to do more of that. There's going to be some loans that we're going to originate that have a lower yield than our current NIM. We look at it in a totality standpoint, is that if our net interest income continues to grow faster than our peers, and our return of equity and return of asset continue to outperform our peers, it is okay to have net interest margin to be slightly below our normal expectation. As long as we can get the volume up and get our efficiency ratio in the low 40s and so forth, we will continue to originate those loans that we think that make sense for us. Very good. Thank you very much for the color. Thank you. The next question comes from Matthew Clark from Credit Suisse. Hey, good morning. I may have missed your QM related comments in your prepared remarks in the beginning, but just curious when the CFPB was last in to see you all and maybe what their initial feedback was around the no-doc product, because it does appear in the market to be in very high demand, and you guys aren't selling the product, you're portfolioing it, and it's got good credit history and all that. Just curious what maybe their initial stance is on the product. Well, they came out with the rules, which, in general, the rules just do not have any emphasis on the low loan-to-value, and that's what we really find our customer base, that they put a lot of down payment. That's why we are very comfortable in portfolioing these loans that have excellent asset quality. So we'll just continue to look at the regulations and, as Dominic said, what we are very good at is to follow the regulations and then to take a look how we can continue to serve our customer base based upon their unique needs. But, we'll do it in accordance to the regulations. Okay. I guess, can you just touch on what kind of yields you're seeing, whether or not you're seeing any meaningful change from the 5%, I think, in the last quarter or so? I assume you're also seeing increased housing prices in Southern California as well, so that only just helps with the LTV that you're putting on. But just curious how pricing's changed. We have not changed our pricing, so we pretty much price, if it's three-year fixed, 4.25%, five-year fixed, 5.25%. So some people take three years, some people take five years. On the average, I would say we got 4.5% to 4.75%. We have not changed the rates the last few quarters. How much- We have the same underwriting criteria as well. That is why the LTVs are also very low. Okay. Then I guess how large of a contribution would you let that portfolio get to in terms of your total mix? That is the thing, that given we do not have a heavy concentration in any particular loan, we are comfortable to also continue to grow the single family. We now have about $2 billion out of $15 billion, so it is not really a huge amount as a percentage. We will continue to grow that portfolio. One of the nice things on our portfolio is that, in the single family mortgages, is that the prepayment tends to be much lower because obviously these are not the type of customers who like to run around and shop for rate and do refinancing often, simply because they are not going to be the kind that likes to gather three years tax return and then have employer to verify the employment for whatever years and then provide financial statements and so forth. You have either new immigrants who do not have three years of history in the U.S., or you have small business owner, and their time would be better spent on running the business than to go in and gather financials for a mortgage lender. In that regard, I think that we would expect that these loans will stay on our book much more likely than a lot of these full doc deals that are out there that get refi-ed out very quickly. Okay. Thank you. The next question comes from John Pancari from Evercore Partners. Morning. Morning. Can you give a little bit more detail on the CFPB QM rules? How would you restructure that product? A little bit just more color on, would it be in the form of an equity line then instead, or I think you mentioned that in the past. How would you restructure it, and would that restructuring in itself potentially bring about a lower volume than what you've traditionally been used to with that low doc product in its traditional fashion? Well, the home equity loan is obviously one alternative, because a home equity loan is not included into this regulation. That clearly is a good alternative. Then we'll explore to see whether there are any other alternatives that make sense for us. The way I look at it is this, is that with a change, if we make it a little bit more cumbersome to these borrowers, would that make the volume much lower? Possibly. But on the other hand, the regulation have make it very difficult, in current stage, for many others. I looked at it as that, yeah, on one hand it may be a little bit more of a hassle. We may not be as efficient, and our service level may not be deemed as high as where we are right now in the future. But then, what's the alternative? Because frankly, I love to see how an individual who just got a new job and then to run around trying to have their employer to write a letter to B of A or Wells Fargo to say that, "Well, I'll guarantee this guy is going to stay with us for the next 2 years." How are we going to solve this? There's going to be a lot of practical issues that will be coming out from this regulation. Frankly, that's why we at East West try not to spend a lot of time to be involved with these sort of macro level issue. When they're all sorted out, we'll figure out a way to make it work. But as you said, we already know home equity is one good alternative sitting out there that we can explore. Okay, that's helpful. Now, in terms of the product that you already have on your books, the no-doc product, as well as what you're going to originate in 2013, do you perceive any added legal risk for any of those loans if you do go into foreclosure? Are you going to have a more difficult time in that the borrowers could point to them not having safe harbor protection under QM or anything to that extent? We've been in this business at East West, I just mentioned earlier about we are coming into January, our 40-year anniversary. We've been in this business for 40 years. There is not a bank in this country that have the kind of performance record in single family mortgage origination, in terms of delinquency or foreclosure or for losses than East West Bank. There is none. Actually, we engaged a public accounting firms, one of these big, well, back then it's Big Eight, now Big Four, that did a study on these type of loans. There wasn't anybody that have better record than this. It is shameful that we have regulation that unfortunately Not look into this as the guidance for all banks to actually copy from. But in the meantime, our view is that in terms of risk, there's hardly any, simply because the fact that these loans always perform. When you have people putting 40%, 50%, or sometimes more of down payment to acquire home, the likelihood of them defaulting is very low. One of the reason why we hardly ever have an opportunity to even foreclose on any of these type of mortgages, that at the end of the day, even in a very highly unlikely situation, which, let's say once every few years it happened, that we need to go through a foreclosure process. Long before we even get close to it, the house already been sold. Simply because, again, with that much equity in there, the borrower would always be better off to sell the house at a discount to take the losses, than having the bank to take over the house, because they can sell the house at discount with 20%, 30% off. It's still better than having the bank to foreclose with a 50% discount. That's why usually all worked out for us. It's one of the reason, frankly, if you look at why do East West have 42.3% efficiency ratio, because we don't spend a lot of time doing mortgage foreclosure. We don't spend a lot of time calling our mortgage customers, in terms of delinquency. We also don't spend a lot of time even underwriting, because there's not a whole lot of information to underwrite on, just that we like that 50% cash coming in. Interestingly enough, there are enough of these type of customers that wanted to have a bank to underwrite a loan like this and to deal with the hassle of actually providing all these documentation and so forth, to the banks that willing to pay them a 90% loan-to-value loan. Okay. All right. Thanks for taking my questions. Thank you. Once again, if you would like to ask a question, please press star then one on your touchtone phone. Next question comes from Mike Turner from Compass Point. Hi, good morning. On your risk-weighted assets, it looks like seasonally looking back a couple years, it seems to bump up in the fourth quarter, but this quarter was up $880 million. Maybe you could talk more about that increase. Mostly the production, the loan increase. Yeah. Total assets with the loans volume increasing. That's probably the larger driver for that. On balance sheet, and of course, off balance sheet as well, element of that. Will that come back down a little bit in the first quarter? Typically, when I look at the change in loans versus the change in risk-weighted assets, I know there's a lot of unsecured lines which have a higher weighting because of the full amount of the undrawn line. How do we think about that relationship going forward as far as changes in risk-weighted assets versus change in loans? I've always kind of assumed it was sort of 130% of total loans. Yeah. I wouldn't say, Mike, there's anything unusual about our activity right now. It really has to do with the growth in the loans and the mix change. We can talk offline if you like, as far as any other kind of changes that we've had. It's really the mix change of the assets. Sometimes we have more security, sometimes the loan security is obviously lower yield, lower risk weighting. Okay, thanks. On credit related costs, out of your, say, $98 million or so a quarter in operating expenses, how much of that is, call it credit related, that it's embedded in a bunch of different line items, but how much additional savings is there that could be garnered from credit related costs over the next several years? The areas that we really look at as credit related are legal expense, REO expense, which is of course, write down, then also ongoing expenses for real estate that we own, that we foreclosed on, and then loan related expenses. If you look at those line items, certainly they're at an elevated level right now for the fourth quarter before the reimbursement of the FDIC, you're looking at $12 million-$13 million. The reimbursement of the FDIC lowers that amount by a couple million. $4 million, actually. That is the area where I'd see the most opportunity to kind of reduce during the course of 2013, and then also obviously 2014 as the years progress as well. Okay. Nothing else in like consulting or personnel? That's what you- Not that much. mentioned is 90%. Right. All right. Thank you very much. Okay. Thank you. Now we have a follow-up question from Matthew Clark with Credit Suisse. Hey, can you just clarify why you would even consider restructuring the low or no-doc product to begin with? You are assuming the risk in this product, and you are not selling it, so why even consider it? Maybe if it We are not restructuring, what do you mean by restructuring our no-doc? Well, why would you even consider having to tweak the product? Oh, because CFPB would no longer allow no-doc loans in 2014. But for us, when we look at the risk relative to the return, this is a very profitable product for our customers, and it is also something that they very much need and demand. So we are trying to find some sort of solution for that. Yeah. So, this is a product that our customers, if you think about it, is that new immigrants that coming to this country that want to purchase a home and like to get a mortgage and establish credit history and so forth, they got to start somewhere. And we always been the great start for these new immigrants and so forth. And so it is something that we have done and we will continue to do. And with the change of law that will be coming from CFPB starting in January 2014, we just need to find an alternative to still cater to these customers and take good care of them, and also help East West to continue to generate some decent profits. Okay, fair enough. Thank you. This concludes our question and answer session. I'd like to turn the conference back over to Dominic Ng for any closing remarks. Well, thank you all for joining us for today's call, and I am looking forward to speaking with all of you in April. Thank you.