Earnings Call: Q2 2012

Jul 19, 2012

Good morning, and welcome to the East West Bancorp second quarter 2012 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 touch tone phone. 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 Kelly Adams, Senior Vice President. Please go ahead. Thank you. Good morning, and thank you for joining us to review the financial results of East West Bancorp for the second quarter 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 for joining our earnings call. Yesterday afternoon, we were pleased to report financial results for the second quarter of 2012. East West reported strong earnings of $70.6 million or $0.47 per diluted share for the second quarter of 2012. We increased second quarter net income by $10 million or 17%, and increased earnings per diluted share by $0.08 or 21% from the prior year period. As compared to the prior quarter, East West grew earnings by $2.5 million or 4% and increased earning per share by $0.02 and also 4%. Once again, East West demonstrate strong operating performance. Our second quarter net income of $70.6 million was the highest in the last 10 quarters, resulting in a solid return of assets of 1.3% and return of average common equity of 12.5% for the quarter. We grew our non-covered loans, excluding loans held for sale, by $296.8 million or 3% quarter to date. This increase in our non-covered loan portfolio was primarily attributable to growth in our commercial and trade finance loans, which grew $180 million or 6% to $3.4 billion as of June 30, 2012. This growth in commercial and trade finance loans is the continuation of strong momentum from the first quarter of 2012. Year to date, we have grown our non-covered commercial and trade finance loans by $276.2 million or 9%. During the second quarter and first half of 2012, East West continues to experience strong momentum in winning new customers and retaining existing customers who need our expertise, services, and operating platform between the U.S. and Greater China. As a financial institution solely focused on the U.S. and Greater China market, we believe we have an inherent competitive advantage over our peers in this arena. Our strong growth in non-covered commercial and trade finance loans in the second quarter and over the last several quarters is reflective of this advantage over our peers. Also, at East West, we understand that strong operating performance for financial institutions does not solely depend on growing the balance sheet and winning new customers, but also balancing growth with prudent credit underwriting, interest rate risk management, and expense control. We strive to be a top-performing bank quarter after quarter, year after year, and know that to do so, an ongoing focus on risk management and the health of the entire balance sheet is absolutely necessary. We believe that during the second quarter and first half of 2012, we made strong progress on all of these fronts, and we continue to demonstrate our ability to perform well despite the challenging operating environment. In the second quarter, our efficiency ratio improved to 42%, while the cost of funds and deposits, credit costs, and non-interest expense were all down compared to the prior quarter and the prior year period. As in the past, in our earnings release, we provided guidance for the third quarter of 2012 and the full year of 2012. We currently estimated that fully diluted earnings per share for the full year of 2012 will range from $1.84 to $1.86 or an increase of 15% to 16% from the full year of 2011. This updated guidance for the full year 2012 is also an increase of approximately 3% from our previously released guidance earlier this year in April. We currently estimated that fully diluted earnings per share for the third quarter of 2012 will range from $0.45 to $0.47. In summary, we believe that our strong results during the second quarter and first half of the year will serve as a strong foundation for the remainder of the year. Year to date, tangible book value is up 4% to $12.67 per share. Additionally, we have returned $179 million back to shareholders in the form of common dividends and the repurchase of common stock in the first half of the year. We believe that we can continue to return strong value to shareholders, and that we are well on our way for another year of record earnings for 2012. With that, I will now turn the call over to Julia to speak in more detail about our key successes in the second quarter of 2012. Thank you very much, Dominic, and good morning to everyone. I will start by discussing the growth we have experienced in our non-covered loan portfolio. As of June 30, 2012, non-covered loan balances, excluding loans held for sale, increased 3% or $296.8 million during the second quarter to $10.8 billion at June 30, 2012, while covered loans decreased to $167.1 million or 7% from March 31, 2012, to $3.4 billion as of June 30, 2012. The growth in our non-covered portfolio for the second quarter of 2012 was driven by strong growth in commercial and trade finance loans and single-family mortgage loans, which I will discuss in more detail. Non-covered commercial and trade finance loans increased $180 million or 6% to $3.4 billion. Combined, total non-covered and covered commercial and trade finance loans increased to $4 billion or 28% of our total gross loan portfolio as of June 30, 2012, up $130 million or 3% of our total gross loan portfolio as of March 31, 2012. As we have mentioned on previous earnings calls, our long-term strategy is to have the commercial loan portfolio equal a third of the total loans. In addition to the solid growth in our commercial and trade finance loan portfolios, we continue to experience strong demand in our markets for single family loans. Our single family loan portfolio grew $64.8 million or 3% quarter to date to $2 billion at June 30, 2012. These single family loan originations are primarily 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. In the second quarter, we originated 440 single family loans totaling $135 million with an average loan size of $300,000 and a loan to value of 49%. 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. Moving on to credit quality. We are pleased to see that asset quality metrics continue to improve in the second quarter of 2012. Non-performing assets declined to $155.7 million as of June 30, 2012, a decrease of $11.5 million or 7% from the prior quarter. Gross charge-offs also decreased, totaling $14.8 million, and recoveries totaled $3.1 million for the second quarter of 2012. Total net charge-offs increased slightly to $11.7 million for the second quarter of 2012 from $10.3 million in the first quarter, resulting from two larger construction and land loan recoveries in the first quarter. Additionally, non-accrual loans excluding covered loans decreased to $112.4 million as of June 30, 2012. The total non-performing assets, excluding covered assets to total assets ratio, was under 1% for the 11th consecutive quarter, with non-performing assets down to $155.7 million or 72 basis points of total assets as of June 30, 2012. The provision for loan losses was $15.5 million for the second quarter, a decrease of 14% or $2.6 million from the prior quarter, and a decrease of 42% or $11 million as compared to the second quarter of 2011. East West continues to maintain a strong allowance for non-covered loan losses of $219.5 million or 2.03% of non-covered loan receivable at June 30, 2012. Overall, we expect credit quality to continue to improve and estimate that provision for loan losses will be $12 million-$15 million for the third quarter of 2012. In addition to prudently growing our loan portfolio, we also focus on growing low-cost core deposits and thereby reducing our reliance on time deposits and improving the cost of deposits. Core deposits increased to a record $11 billion at June 30, 2012, or an increase of 5%, or $476.9 million from March 31, 2012. Within core deposits, we experienced the largest increases in money markets and non-interest-bearing demand deposits, which increased 6%, or $245.4 million to $4.9 billion, and $138 million, or 4%, to $3.8 billion, respectively. Core deposits now equal 64% of total deposits, and non-interest-bearing deposits now equal 22% of total deposits as of June 30, 2012. As we continue to build our commercial banking platform, we remain focused on building core deposit accounts related to these new commercial and trade finance loans. Lastly, I would like to provide a brief update on our recent capital management actions and our initial view on the recently proposed joint agency notices for the proposed rulemaking related to Basel III. As we first announced in January 2012, as a direct result of the strength of our core earnings, balance sheet, and capital levels, the board of directors authorized a stock repurchase of $200 million of our common stock. During the second quarter, we repurchased 2.2 million shares at a weighted average of $21.95 price. During the first half of 2012, we have repurchased a total of 6.8 million shares for a total cost of $149.9 million, or approximately 75% of the amount authorized under our repurchase program. We expect to buy back the remaining balance of the authorized amount of $50 million during the third quarter of 2012. Regarding the proposed Basel III changes to the regulatory capital definition and the calculation of risk-weighted assets, we are very comfortable that we will continue to exceed all well-capitalized requirements even after the new proposals are fully phased in. As of June 30, 2012, we calculate that under the fully phased-in proposed ruling, our common equity Tier 1 capital to risk-weighted asset ratio would be 13.2%. Also, if the proposed capital rules were fully phased in and in effect as of June 30, 2012, we would exceed all well-capitalized guidelines by over $700 million, and the total risk-based capital would be 15.6%, down from 17.3%. Currently, we believe that the largest impact the proposals have to East West Bank and East West Bancorp capital levels result from the exclusion of trust preferred securities as Tier 1 capital and the proposed changes in the risk weightings of some real estate loans, foreign exposures, and unfunded commitments. Overall, given the high-quality nature of our capital and balance sheet, the proposed changes to the capital framework do not impact the regulatory capital ratios of East West in a material way. With that, I would now like to turn the call over to Irene to discuss our second quarter 2012 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 second quarter of 2012 in more detail, specifically actions and fluctuations that impacted our net interest margin, non-interest income, and non-interest expense. Second quarter earnings totaled $70.6 million, an increase of 4% from the prior quarter, an increase of 17% from the prior year quarter. For the second quarter, we reported an adjusted net interest margin of 4.01%, compared to 4.21% and 4.03% as of March 31, 2012, and March 30, 2011, respectively. The decline in the core margin in the second quarter of 2012 compared to the first quarter is due to the larger impact of covered loan disposition and amortization activity in the second quarter and the continued downward repricing of the investment securities and loan portfolios. In past earning calls, we have discussed that the income from the covered loans accounted for under ASC 310-30 does fluctuate quarter over quarter, depending on the cash flow activity that occurs in each period. However, as of June 30, 2012, the net accretable income remaining that will flow through net income over the life of the loan is $125 million. As most of the covered loans are commercial loans with shorter remaining terms to maturity, we expect that the majority of this net accretable income of $125 million will be recognized over the next 36 months. During the quarter, total interest expense declined $1.9 million, or 5%, and the cost of funds decreased four basis points from the prior quarter, primarily due to the strong growth in core deposits and the reduction of high-cost time deposits. For the past few quarters, a significant portion of time deposits have matured, and as a result, the company was able to reduce both the balance and the average cost of time deposits over that period and also during the second quarter of 2012. At this point, as most of the higher-cost time deposits have repriced downwards, we do not expect that there are significant opportunities to further reduce the cost of time deposits. The extended low-interest rate environment continues to be a challenge for East West and the rest of the banking industry. During the quarter, our net interest margin was pressured due to lowered loan and investment securities repricing downwards and the volatility in the accretable income on covered loans. We expect that until the rate environment rises, this downward interest rate margin pressure will continue. However, given the strong loan growth we are experiencing, additional accretable income, and the ability to further reduce funding costs, we expect that in total, we will be able to maintain an adjusted net interest margin at or near 4% for the third quarter of 2012. Moving on to non-interest income and expense. East West reported a non-interest loss for the second quarter of 2012 of $11.7 million, a decrease from non-interest income of $21.7 million in the first quarter of 2012, and $12.5 million in the second quarter of 2011. The decrease in non-interest income from the prior quarter and prior year is primarily attributable to an increase in the net reduction of the FDIC indemnification asset and FDIC receivable. Branch fees, letter of credit, and foreign exchange income, loan fees, and other operating income increased and totaled $22.2 million in the second quarter of 2012, an increase from both the prior quarter and the prior year period. The increase in fee income during the second quarter of 2012 was largely due to increases in fees derived from assisting our commercial customers in entering into back-to-back interest rate swaps. In addition, included in non-interest loss for the second quarter of 2012 were net gains on sales of loans of $6.4 million and net gains on sales of investment securities of $71,000. The gain on sale of loans in the second quarter of 2012 was primarily due to the sale of $150 million in government-guaranteed student loans with a resulting gain of $5.1 million. During the second quarter, we also sold higher duration securities, reducing the effective duration of available-for-sale investment securities portfolio from 2.5 years at March 31, 2012, to 1.6 years as of June 30, 2012. Also, as of June 30, cash and cash equivalents were higher than usual as we have not yet redeployed all the proceeds back into investment securities. Moving on to non-interest expense. Total non-interest expense for the second quarter, excluding amounts to be reimbursed by the FDIC and prepayment penalties for FHLB advances, decreased $4.7 million or 5% from the first quarter of 2012 to $96.6 million. The decrease in non-interest expense, net of amounts reimbursed by the FDIC and the prepayment penalty FHLB advances, was primarily due to a reduction in compensation and employee benefits. Compensation and employee benefits decreased $3.5 million or 8% from the first quarter of 2012, primarily due to a decrease in payroll taxes and an increase in the offset to compensation expense from deferred loan costs due to an increase in loan origination volume in the second quarter. Credit cycle costs, which include other real estate-owned expense, loan-related expense, and legal expense, decreased $9.7 million or 43% from the first quarter of 2012, totaling $12.8 million for the second quarter as compared to $22.5 million for the first quarter of 2012 and $25.7 million for the second quarter of 2011. Of the total credit cycle costs incurred in the second quarter, $3.4 million related to covered loans and other real estate owned, for which we expect that 80% or $2.7 million is reimbursable by the FDIC. The decrease in credit cycle costs was largely due to a reduction in other real estate owned and legal expenditures. Lastly, during the second quarter of 2012, the company prepaid $30 million of FHLB advances carrying an effective rate of 2.43%, incurring a prepayment penalty of $2.3 million, which is included in non-interest expense. Given the continued reduction in credit cycle costs and the expectation that this will continue to trend downward, we expect that non-interest expense will continue to remain low and forecast that it will be approximately $100 million for the third quarter of 2012, net of amounts that are reimbursable by the FDIC. Finally, as stated in the earnings announcement released yesterday, East West has declared third-quarter dividends on the common stock and Series A preferred stock. The common stock cash dividend of $0.10 per share is payable on or about August 24, 2012, to shareholders of record on August 10, 2012. The dividend on the Series A preferred stock of $20 per share is payable on August 1, 2012, to shareholders of record on July 15, 2012. I will now turn the call over to Dominic. Thank you, Irene. I will 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. At this time, we will pause momentarily to assemble our roster. Our first question is from Dave Rochester of Deutsche Bank. Hey, good morning, guys. Good morning, Dave. I had a question on your margin guidance. I'm just trying to figure out what the main driver of the stable NIM is for next quarter. You've got core deposit costs that look like they've stabilized, and given your commentary it sounds like you can't really bring CD costs down much more. Loan yields continue to reprice lower. Is it that you think you can just reduce excess liquidity? Dave, this is Julia. A combination. The loan yields has been holding up okay, so the combination of some of the payoffs of the Federal Home Loan Bank advances, plus reinvestment of some of the cash that we will have as of June 30 to some short duration safe investment security. Plus, we'll have some accretions on the yields on the covered loans. So we think that around 4% is doable in the near future. However, we do think that, in the long term, the trend would be there'll be some pressure on the net interest margin, just like every other banks. This extremely low interest rate environment is hurting us because our cost of deposits have really come down dramatically, that it's not easy to reduce it any further. Got it. Thanks. On reinvestment rates for what you're looking at, the shorter duration securities, what would those be, roughly? Probably about like low 1%, somewhere over there. Okay. Just drilling down into loan yields for the quarter, if you could talk about maybe where you're putting on C&I and maybe the resi ARMs and CRE as well. For the C&I loans, so far for the, I would say for the last 12 months or so, we continue to have a pretty diversified type of growth that hit various different sectors. Predominantly, I would say that close to one-third of the C&I loans are in the trade finance sector. More so, I think we are growing more in the export area. In the past, like most of the banks in trade finance business, 80%, 90% of the portfolio in import. We have picked up a pretty good momentum for the last several months from doing more export trade finance. That has been very positive because it kind of balanced things out for us. In addition to that, from manufacturing, logistic and transportation, technology, health care, entertainment, clean tech, et cetera, we pretty much cover them all. I expect that going forward, in the next six months, we will continue to have pretty healthy growth in all of these sectors because of our pipeline. One other thing is actually the agriculture and food area is also another area that we expect that we will see some more momentum going forward in the next six months. In terms of production yields, what are you looking at for trade finance versus maybe your traditional C&I? It has been holding up in the yields. If you look at the yields on the C&I loans, have been pretty stable. Dave, I think you also asked about the pricing on the single-family loans. Yep. That is holding up as well. It is about 5%. Okay, maybe C&I is still in that $325 million-$350 million range. Is that? Yeah. Including the loan fees, I would say closer to 4%. Closer to 4%? Commercial real estate, is that around 4%? Commercial real estate, yeah, 4%-4.5%, depending on the deals. All right, great. Thanks. Our next question is from Joe Morford of RBC Capital Markets. Hi, good morning, everyone. Good morning, Joe. I guess, wondering if you could talk a little bit more about the outlook for loan growth. I think in the past you've said maybe you're targeting upwards of 10% growth rate for the year. Is that still the target? And what does the pipeline look like at period end? It looked like C&I demand was a little stronger this quarter. Yeah, for the non-covered loans, we're estimating about a 10% loan growth. On the C&I, we always give a forecast about $100 million a quarter. This second quarter, we had a pretty good $180 million. We think that we may do better than $100 million, but we're projecting about $100 million C&I loan growth a quarter. Yeah, I think at this point, based on what's happening in the pipeline, I think it looks like that we may exceed that $100 million target that we have. But at this stage, we just going to stick with our original plan of $100 million growth on C&I. Okay. The other question is just, curious, what other opportunities do you have to restructure or prepaid borrowings to help to support the margin? And is that something you're looking to do? So certainly, I think, we have been pretty active in prepaying those FHLB advances. If there are opportunities to do so in the future, certainly we will do that. I think on the repo side, the prepayment penalties are pretty steep. So our strategy really would be, at this point, if there are opportunities to prepay the FHLB advances, and then also, whatever kind of higher cost CDs that we have, work those out as well. Okay, thanks so much. The next question is from Aaron Deer of Sandler O'Neill. Hey, good morning, everyone. Good morning, Aaron. I just have a question on the pay downs that you had on the covered loan book. It seems like that was fairly sizable this quarter. Anything behind that rapid level for high level pay downs? That was our strategy to reduce the duration on the investment securities. No. Aaron, it's really hard to hear you. If you wouldn't mind just repeating the question. His question is on the Covered loans. Covered loans pay down seemed very rapid. Oh, yeah. Covered. Okay. Is that what you are asking, Aaron, just to make sure? Yes, that is correct. Oh, okay. Sorry. Aaron, on the covered loans, we have talked about this before as far as the payoff. It is something, there is only so much we can do. There is activity that happens. And obviously, with the accounting for the covered loans, the ASC 310 tended to create a certain amount of volatility in the P&L. I would say, though, another thing that we have made a little bit of initiative in 2012 is we have a little over 2 years left with loss share on the UCB assisted deal. And one of the things that we have made as an initiative in 2012 is working through and looking at which ones are potentially problematic. If there is any issue, we would rather work that out through with the borrower while we still have loss share. That has also been an emphasis for us to work out the substandard or problematic loans. But you are seeing that as well as far as the elevated reduction in the balances. Okay. And then- Let me just add to this. It is actually working out pretty good for us because, obviously back in November 2009, when we first took over the portfolio of close to $8 billion, and with East West loan portfolio wasn't that much bigger, and the concern is that what do we do come 2014 if we have all the loss shares lifted? That with a portfolio that may potentially be maybe somewhat dicey. I think as is happening right now for the last 2 and a half years, I think we are progressing very well because this portfolio is now down to less than $4 billion. And most of those problematic loans have been resolved, charged off, et cetera. We are getting, I think, definitely a much smaller portfolio for us to be worried about, and actually much stronger portfolio compared to what it was 2 and a half years ago. So with a better portfolio, smaller portfolio, we are going to continue to shrink down because we need to reduce as many of the substandard problematic loans as much as possible. And we feel pretty confident that come to 2014, all of these problematic type of issues will be resolved. And to do that, we need to have pretty nice growth momentum from our non-covered C&I loans. And so far, again, we have been pretty fortunate. And our business strategy and our direction that we are taking right now allow us to continue to grow a pretty diversified C&I and trade finance loans. As long as we get pretty nice growth on the non-covered side, we are able to more or less offset against the outflow of the covered. So net-net, I think going into 2014, we will be in a great shape that basically the cover loans actually allow us the opportunity to nicely diversify our entire loan portfolio. And it is going to make East West Bank's balance sheet much more diversified and stronger and more core in the commercial side going forward. So I think that so far it has been working out pretty good. Yeah, it seems like it's been a good strategy for you. Then just a quick follow-up. Irene, I think you touched on the loan sales in the quarter. It sounded like it was student loans. Can you repeat what the composition was in terms of the type sold, what the premium was, and maybe what your outlook is for continued gains? Sure. During the quarter, the gain on sale of loans was primarily due to student loans. We sold $150 million, a gain of about $5.1 million or so. The remainder was largely because we also have SBA 7 loans that we originate and sell the guaranteed portion of that. About $15 million is what we sold last quarter. Okay, and the outlook going forward, kind of similar level of sales or is that going to come back some? We do it opportunistically, depending on the pricing and availability for the sale. So, it's not going to be necessarily every quarter that we'll have that. Okay, great. Thanks for taking my question. Next we have a question from Lana Chan of BMO Capital Markets. Hi, good morning. Good morning, Lana. One question on credit. As you continue to see gradual improvement on the credit quality trends, if I look at your reserve ratio as a percent of loans, it hasn't really come down all that much. Still pretty strong at over 2%. What is your thinking with that ratio going forward in terms of how much flexibility you have to bring that down further. I think in the future, as the economy really improves, there might be a possibility that ratio may go down. But at this time, to be on the conservative side, we feel that about 2% allowance is appropriate and conservative. Lana, another thing I'd add is we've had pretty good growth on the non-covered side, the portfolio where we are adding an allowance to, because as you recall, on the covered side, we have the discount. So, with that growth engine still being there, that's another reason why we have continued to maintain that allowance. Although obviously you're correct, the overall credit performance has improved. Okay. Just one follow-up for Dominic on his comments on the trade finance and seeing more coming from financing exporters. Are you seeing any slowdown with your customer base in California with potential slowdown over in China and what the risks are there, both on the import and export side? Well, I think, in terms of the slowdown in China at this point, we do not expect much slowdown from our customer side because what's happening right now is that while maybe specific individual customers may have a slower sales revenue due to whatever the economic circumstances that's happening, whether it's from U.S. or greater China region or even to a much smaller extent for us, like the European zone and so forth. Overall, we are picking up more clients and basically, we are gaining more market share specifically from the export side. When we are gaining more market share, I think in terms of the total number of customers keep increasing. So from the East West loan growth opportunity, I think we see the next 6 months will be pretty certain that we will be growing. But individual to individual customer basis, there's always some minor slowdown here and there. Frankly, I looked at this point, in China, despite the fact that there are a lot of discussion about China slowing down, the fact is everything is pretty much by design from the government. All along, I think over a year ago, the government wanted to take this double-digit growth on GDP down to 8%. So now it's about 7.6. If you round it up, it's right around 8%. So it's still within the boundary of what the government intention. In addition to that, I think that when you have a one-party political system and then change leadership every 10 years, they are much more conducive to make adjustment more quickly without any sort of bickering between a partisanship on two-party system. Therefore, I think that if the markets slow down even further, without a doubt, the leadership in China will step in and do what's necessary to get it back up to close to 8% again. So what we see so far is that the government has been running a pretty tight ship as we expected. A year ago when they talked about real estate bubble and they wanted to tame this real estate bubbles. In addition, slow down the inflation. So within a year they did exactly just that. So I do feel that the government will adjust to the economic situation based on the numbers they see. And we at East West will be very cautiously to work being very much up to speed with what's exactly happening in terms of economic condition on a monthly basis, weekly basis, and even daily basis. On top of that, we are able to adjust to the environment much easier because we're so much smaller in terms as an organization in China, so we can move much more quickly. Keep in mind that our focus has not been extending domestically in China and trying to be a bank for all consumers, commercial customers, and also state enterprise and so forth. We are mainly there to be the financial bridge between the East and West. That is to say that when there are investors from China who would like to invest in U.S., we help them out for the banking services and also for U.S. customers who want to do business in China, we help them with the banking services. That very unique focus had not slowed down at all. In fact, the State Department just put out a news about 1 million visa has been granted to Chinese citizens for this fiscal year, which is substantially higher than ever before by the U.S. government in terms of granting visa for Chinese citizens from China. So there will be more people coming out as a tourist. There will be more people coming out as students. There will be a lot more foreign direct investment coming out from China, and that is a fact, and I think that will continue to grow. So we expect that our business opportunity in terms of capturing the market share in this very unique niche will be very strong. That is why even if economies slow down globally, what we do is so different and what we are is so small, and it is not hard for us to gain market share. It would be a lot harder if we were, let us say, B of A or JPMorgan with that kind of size. Then we really have to have a very large dollar amount of growth in order to gain a 10%. But for us, getting 100 some odd million dollars growth per quarter will get us over 10% growth. So we feel pretty good about where we are today. Okay. Thanks very much. Our next question is from Jen Demba of SunTrust Robinson Humphrey. Thank you. Good morning. It sounds like you are going to finish up your current buyback authorization in the third quarter. Do you have any plans to re-up that as we go into next year? Jennifer, we are not planning to do any more buyback for the remaining of the year. Every year in the beginning of the year, in January, we evaluate how much dividend are we going to pay and do more repurchase. Our plan right now is that most likely we will increase the dividends from $0.40 to $0.60 a year, and then do another $200 million buyback in 2013. Okay. Thank you. Our next question is from Julianna Balicka of KBW. Good morning. Good morning. I have a follow-up question on the potential prepayment of the repo financing. You had said that the penalties right now are too expensive. What are your views in terms of extending the duration of some of that funding in order to lower the interest rate? We have done some expansion, so we will evaluate, but most likely, we will stay with the current structure. The reason that it would not make sense to prepay the repo is because it has an optionality, unlike Federal Home Loan Bank advances, there is no optionality. So, the prepayment penalty is just a straight present value of the difference in the interest rate. So the likelihood for us to prepay the repo may not be very high because it is very expensive. Okay. That makes sense. In terms of just a housekeeping question, I am sorry if I missed this earlier in your remarks, what was the scheduled accretion in your interest income this quarter? What is the remaining accretion that you are expecting to run through earnings? Juliana, so normally what we forecast is about $15 million in a quarter. It was a little bit more than that, but around there. Last quarter, it was more than that as well, which is one of the reasons that the NIM was higher last quarter. As of June 30, the net accretable yield that we have, income, is about $125 million. Okay, very good. That makes sense. A final question, if I may. You had talked previously about the loans that you were making in China that were providing you good loan growth, that you had to get your quota reauthorized. So, if you have gotten that or what is the timing on that? Juliana, can you repeat? You are breaking up. Can you repeat your question? Yeah, because you're breaking up, yes. Can you repeat your question? Is it something about China? Yeah. There were some loans that you were making in China previously where you had reached your quota. Then the government was reissuing new quotas so you can continue making those same kind of loans again. I thought they were cash collateralized, kind of currency transfer. I am trying to remember. What is the question? Have you gotten the new quota or what? No, it is the same. We could not do more. The fact is, I think, Chinese government most likely is kind of experimenting the opening up the renminbi currency. This cross-border guarantee transaction that they are encouraging banks to do is something that they started in 2011. So far, we are not getting any more. Therefore, we are kind of stuck and not able to continue much more than what we did before. Okay. Very good. Thank you very much. Thank you. Next, we have a question from Herman Chan of Wells Fargo. Hi. Thanks. I wanted to revisit the covered loans a little bit. On the remaining outflow expected on the covered loan side, how much do you think could be renewed and become a future non-covered loan? Those good customers, we will continue to retain those customers. By the end of 2014, when the loss share expires, they become non-covered loans. Because right now, even if we renew beyond 2014, it will continue to be covered, then they become non-covered loans when the loss share expires in November 2014 for the UCB loans. Yeah, Herman, as of June 30, we had $3.4 billion in covered loans, net of a discount of about $650 million. I think an easy way to look at that as well, as you're projecting out is, in that covered portfolio, the construction, the land loans, realistically, those probably will not be with us at the end of loss share. Then we give a pretty good disclosure in our 10-Qs. I don't have it in front of me, but we can talk about it offline as well. If you look at the substandard loans within that category, the expectation will be some of those we'd work out before loss share ends. If there's any charge-offs or losses, we take that during the period where we have loss share, and we get reimbursed from the FDIC on those as well. But the other categories, single-family, multifamily, CRE, C&I, those are categories where we feel, for the good quality customers, we are trying to retain them all. Got it. Thanks. Just wanted to revisit your capital. You mentioned that under Basel III, a Tier 1 common ratio of 13%, that's almost double the minimum requirement, plus the capital conservation buffer. Given these excess capital levels, can you refresh us on the priorities of capital management in light of the low yield environment? Thanks. Yeah, our plan is, each year we will evaluate how much dividend that we should pay and do a buyback if we have excess capital. Our plan for January 2013 is to increase the dividend from $0.40 to $0.60 a year and do another $200 million buyback. This total is approximately 100% payout for the 2012, for the previous year earnings. Okay. Thanks for taking my questions. The next question is from Gary Tenner of D.A. Davidson. Thanks. Good morning. I just had a couple of questions. I just wanted to revisit the student loan sale. That came out of the held for sale portfolio, I imagine, and that would explain the decline in that line item. Are the student loan sales, is that typically an annual event, or is that sort of an ongoing action? It would be more opportunistic. When there is a good opportunity, we will do that. It is not necessarily an annual or a quarterly event. We will evaluate each time. Well, it is a combination. One is that we, on an ongoing basis, we have been having a pretty good opportunity to acquire student loans and at a pretty decent yield. What we do is that we also do not want to have student loans be as we continue to find opportunity to generate student loans, we would not want to have student loans to exceed a certain percentage of our overall loan portfolio. While we are building up the student loan portfolio to a certain size, we will always look for opportunity to downsize it back into a certain percentage so that we have proper asset allocation in terms of creating the loan diversification. One, we do not have any pressure or any reason that we have to sell the student loans. If we have to exceed a certain percentage of the allocation, it is no big deal. On the other hand, when we get good price, we said we might as well sell down some of the student loans, so that will allow us to get back to the asset allocation percentage that we originally intend. To a certain degree, it is opportunistic to see good price out there. On the other hand, it is also a discipline on asset allocation. Okay, the reduction, though, in the held for sale portfolio should not be viewed as any sort of slowdown in production or origination in any part of your loan book, particularly? That's right, because those are all the government-guaranteed student loans that we're purchasing, Gary. The current kind of run rate, we're buying probably about $40 million on a monthly basis. Okay. Would you consider, as you're trying to figure out sort of reinvestment of your securities cash flows, keeping some of the government-guaranteed portions of your SBA as opposed to selling those as an alternative to reinvesting in low-yielding mortgage backs or anything like that? We also will evaluate sometimes, if the pricing is very good, it makes sense for us to sell the guaranteed portion. Okay. Just one last question. Does your guidance for the remainder of this year include the remaining repurchase authorization of about $50 million? Gary, it does. It is a small amount. It does include that. It does include that. Okay. Yeah. Very good. Thank you. Just $50 million, the impact would be small. Okay, thank you. The next question is from Brett Rabatin of Sterne Agee. Hi, good morning. I wanted to make sure I understood the magnitude of what you are doing from a liquidity to the securities portfolio perspective, what you are buying. I also wanted to see if you could provide any color around any additional pressure that could occur in the liquidity yields from the Chinese rate cuts. I know you have some liquidity over there from that. Can you address those things? Yeah. Brett, so why don't I start with a question about the liquidity. In China, we do have a certain amount of liquidity in China. We have placements in other banks in China. It is about $400 million, and the yields on those are fairly attractive. That is why you can see for us, cash and cash- Equivalent to short-term investments. The yield for the quarter, 1.5%, it's pretty high, especially relative to rates are in the U.S. The rate environment is simply different in China. Rates are higher, and that's why the loan rates are higher and the CD costs are higher as well. Well, I guess as it relates to that, my question is, does the liquidity yield going forward have any additional pressure as a result of any additional or any change in the China rates? Also, just wanted to make sure I understood what you're doing in terms of the securities book, deploying liquidity into the securities book, and what the magnitude is, and whether you want to look at it from a total revenue perspective or just a margin perspective, how you're looking at that. Sure. I think, as it turned out for the second quarter, we had sale activity, certain securities were called. So it happened that as of June 30, we had excess liquidity. Certainly, we'll be reinvesting some of that in securities, primarily shorter duration. Probably we're thinking probably about 1% or so is the yield that we would achieve. At this time, given that even though most people expect that low interest rates will stay for some time, there's no reason for us to take interest rate risk because rates can go up very quickly. As a result, we are actually even reducing the duration from 2.5 years to 1.5 years. So we feel very comfortable if rates were to move up very quickly, that we will not get hurt from holding longer duration investment securities. Right. No, I understand the desire not to take additional interest rate risk. I guess I'm just trying to make sure. There wasn't any other reasons why you had excess liquidity during the quarter other than you did sell some securities, correct? Right. Yeah. It's just the timing. We have not invested the proceeds. Okay. Great. Thanks for the color. Again, if you have a question, please press star and then one at this time. Our next question is from Mike Turner of Compass Point. Hi, good morning. Just kind of a follow-up to earlier questions. When I look at results, expenses are down, credit's getting better, loan growth is better than peers, and deposit growth is great. It just seems like your business is running on all cylinders. Up until now, the low end rate environment, net interest income's really kind of defied the environment. As you look out over the next 2 years, what sort are your thoughts on the ability to continue to grow through that? Or is it really just sort of it's a factor of the environment and rates are too low to be able to do that, particularly given that a big portion of your liabilities, it's just not even economical to refinance them? I think in term of net interest margins, so next 2 years, if interest rates are staying this low, there's a likelihood that the NIM may be reduced to 3.8%, 3.9%. But as far as the income, the growth on our loan portfolio will offset the NIM reduction for us to continue to maintain the strong core profitability. But it will get harder as the time goes by because the interest rates are just so low. But in the meantime, we continue to build our core deposit, our non-interest bearing deposits now at 22% of the total deposits will someday give us that earnings leverage once the interest rates go up. Yeah, I think that there's still plenty of room for us to make improvement while we continue to execute our business strategy. For good example is that it's only a couple of years ago, our time deposit is 60 some odd percent of total deposits. It's now down to 40 some odd percent. Now, if we keep working on it, we will get it down to even maybe 30% or something. As much as interest rate may continue to remain low, if we just convert these time deposit to core deposit, and when it comes to the asset side, when we look at diversifying our loan portfolio and look at various industries that allow East West to be able to offer better service and with a decent yield instead of competing with every single bank in town for the same customer and drive our pricing down. I think that just making sure we focus in the right type of industry, that we will be able to add value, that we will be able to charge a decent amount of loan rate, and then converting more deposit from time to core, we will be able to continue to help strengthen the margin. Now, in addition to that, when it comes down, margin is just a mean to an end. What we really want is to get some really good core profitability that we can grow year in, year out. My view is that as much as we like to have strong margin because it's a good mean to a good end, that's not the end game, because we can always increase volume of production and maintain costs at the same level and using volume to generate very strong core profitability, even margin strength a little. I think that our focus really is looking at the overall core profitability. As we are right now, we are very fortunate. As much as the rate environment is somewhat challenging, we have quarter to quarter put in some really decent earnings, which allow us to be generous when it comes down to provision. We looked at it and said, "Hey, why not just make sure that we stay consistent on a 2% level on allowances?" On top of that, with the kind of loan growth that we have today, that generates some decent income. So we are able to say that, you know what? Why don't we even take the duration of investment securities from 2.5 years down to 1.5 years? A lot of these action trying to make us safer and safer is because we can afford it. The whole idea is that the more we can afford it, the more that we do more conservative type of actions, the easier time we get in the next two years. Our expectation is that, I'll be the first one to say that two years ago, I didn't expect interest rates to be that low. So we're preparing for the future two years ago and decided to stay short and as much adjustable loans as possible. Boy, were we wrong. But you know what? Looking back, we could afford it, and that's why we did what we did. The last thing we need to do is to go out there and sort of at the tail end of the cycle and then have to, because of earnings pressure and juice up yield and then start doing something a little bit more aggressive in terms of speculating interest rate environment and so forth, and then get caught. Now, if it turn into a Japanese environment in the next 10 years, we still can get by. Just based on what you've seen that we've done for the last two years, we're doing fine. But I expected that at some point in time, interest rates suddenly one day is going to pop up, like 1995. Suddenly, interest rate popped up. When that happened, I think that East West should be okay because we are putting our asset liability management in a position that allow us to enjoy some pickup in yield when that moment arrives. I think that's the game plan that we're taking right now. As I talked about earlier, we're going to be very much disciplined in focusing on making sure our overall risk management is sound and safe. So we are looking at not only just how to grow business, but what are we going to do in terms of taking care of the credit underwriting and what are we going to do in terms of managing our interest rate risk, and what are we going to do managing the regulatory and compliance risk, all of the above. As long as we don't have a lot of these sort of sudden hiccup or distraction, I think that overall our people from the frontline would always deliver the results for us. We feel pretty confident that things are going to be fine. Thank you. That's very helpful. Just one last kind of technical question. It looks like your risk-weighted assets were down about $400 million quarter-over-quarter. I know you sold some loans, primarily, though, I think government guaranteed. Was there some other little thing that I'm missing that made the risk-weighted assets decline? Yeah, I think that's part of it as well. That's part of it, and then also, obviously, the securities, there was a shift because a lot of it was in cash as well. Okay. All right. Thank you so much. This concludes our question and answer session. I would now like to turn the conference back over to Dominic Ng for our closing remarks. Well, thank you all for joining us for today's call, and I look forward to talking to you in October. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.