Earnings Call: Q2 2011

Jul 21, 2011

Good morning, and welcome to the East West Bancorp second quarter 2011 earnings conference call and webcast. All participants will be in a listen-only mode. Should you need assistance, you may signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity for you to ask questions. To ask a question, you may press star and then one using a touch-tone telephone. To withdraw your question, you may press star and then two. Please note that today's event is being recorded. At this time, I would like to turn the conference call over to Kelly Adams, First Vice President. Please go ahead. Good morning, and thank you for joining us to review the financial results of East West Bancorp for the second quarter of 2011. Here to review the results are Dominic Ng, Chairman and CEO; 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. First, 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, 2010. 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. Thank you all for joining us. Yesterday afternoon, we were pleased to report financial results for the second quarter of 2011. East West reported strong earnings of $60.5 million, or $0.39 per diluted share for the second quarter. This is the fifth consecutive quarter we have increased net income, and we are pleased with the progress we have made in growing a strong balance sheet and increasing revenue. I am going to quickly touch on just a few highlights for the quarter and ask Julia and Irene to discuss our results in more detail later on. Year-over-year, East West increased earnings by 67%, or $24.2 million, and increased earning per share by 86%, or $0.18. From the first quarter of 2011, East West increased earnings by 8%, or $4.5 million, and increased earnings per share by 5%, or $0.02. This earnings growth was fueled by an increase in average earning assets to $19.4 billion for the second quarter, which is an increase of $1.9 billion or 11% from the year-ago period. Although we are only at the midpoint for 2011, East West has already made significant progress in achieving our 2011 goals and making strides towards our long-term strategic goals, including growing our commercial loan portfolio and fee-based revenue sources. During the second quarter, total loans receivable increased $300.2 million, or 2% to $14 billion, and total fees and other operating income increased $3.1 million, or 17% to $22.1 million. In addition to our progress in these key areas, credit quality metrics continue to improve with each passing quarter. Charge-offs declined 8% during the second quarter, and non-performing assets declined to $181 million, or to only 0.83% of total assets at June 30, 2011. Overall, our ability to grow market share combined with reduced credit costs and strong expense control will result in strong earnings. This earnings trend and growth will position our franchise to provide superior value to shareholders in 2011 and beyond. I will now turn the call over to Julia to speak in more detail about our key successes during the second quarter of 2011. Thank you very much, Dominic, and good morning to everyone. As discussed in previous calls, East West has focused on making investments in our infrastructure to increase revenue, diversify our business, and improve efficiency. We have directly realized benefits from these investments, as seen most clearly in our commercial and trade finance loan growth during the first half of 2011. I would like to spend a little time discussing this in detail and providing some insight into where we are seeing the most growth and opportunities. During the second quarter, total non-covered loans increased $543 million to $9.7 billion at June 30, 2011. The primary driver of this increase was an increase in commercial and trade finance loans of $500 million or 23%. As we mentioned in our earnings release yesterday, approximately half of this commercial and trade finance loan growth stemmed from our commercial lending platform in the U.S., while the other half was from our Hong Kong and China lending platform. The loan growth from Hong Kong and China was a result of our cross-border renminbi trade settlement finance business. Over 80% of these cross-border RMB loans are 100% secured by a combination of cash and/or stand-by LCs issued by large financial institutions. This growth in the cross-border RMB business also led to an increase in deposits in Hong Kong and China of about CNY 370 million increase quarter-over-quarter. In addition, we also noticed growth of $84.9 million or 7% of our non-covered single-family loan portfolio and growth of $69 million or 2% in our non-covered commercial real estate portfolio. Customer demand remains high for single-family loans in our niche markets. The loans we originated in the second quarter were generally small with very low loan-to-value ratios. The average loan balance of these loans is $350,000, and average loan to value is about 55%. On the commercial real estate front, loan balances increased $69 million or 2% quarter to date. The growth in commercial real estate loans during the second quarter was largely due to expanding relationships with existing customers and new loans to new commercial customers. Our growth in non-covered commercial and trade finance and single-family loans was offset by decreases in the non-covered land, construction, and consumer loan portfolios. as of June 30, 2011, our construction and land loans equal only 3% of total loans. Further, during the quarter, we sold $212 million of government-guaranteed student loans at a gain of approximately $5.9 million. In addition, as expected, the covered loan portfolio continued to decline, decreasing $243 million or 5% from March 31, 2011. In general, with our strengthened lending platform in place, we are confident that the select portfolios we are focusing on will continue to grow in future quarters. With the growth in commercial and trade finance loans, we have also experienced improvements in core non-interest income from fee-based revenues. We reported total non-interest income of $12.5 million during the quarter as compared to non-interest income of $11.1 million during the first quarter of 2011. Non-interest income was impacted by a net decrease in the FDIC indemnification asset and receivable of $18.8 million. In addition, during the quarter, the company recorded a $5.9 million gain on the sale of student loans, a net gain of $1.1 million on investment securities sold, and gains on sales of two bank premises totaling $2.2 million. Aside from this activity, our core fees and other operating income increased in the second quarter to $22.1 million, up $3.1 million or 17% from the first quarter of 2011 and up $5.8 million or 35% from the second quarter of 2010. As we continue to look for opportunities to diversify our income sources and increase fee-based income, we expect to continue to see improvements in core fees and other operating income. Although we continue to make investments to support future growth opportunities, we also remain disciplined over expense control. Excluding prepayment penalties of $4.4 million on the Federal Home Loan Bank prepayments and netting out amounts that are reimbursable by the FDIC, second quarter non-interest expense totaled $99.6 million. The increase in the non-interest expense from the first quarter of 2011 was primarily related to an increase in credit cycle costs as well as compensation costs. As we have discussed before, under loss share agreements with the FDIC, 80% of eligible expenses on covered assets are reimbursable from the FDIC. In the second quarter, we incurred $17 million in expenses on covered loans and other real estate owned, for which we expect that 80% or $13.6 million will be reimbursed by the FDIC. Of the $13.6 million of the expense reimbursable by FDIC, $11.6 million is related to net write-downs and expenses on other real estate owned, and $2 million is related to legal and other loan-related expenses. Although we have experienced increased credit cycle costs and compensation expenses as compared to the first quarter, as compared to prior year, total operating costs have declined as evidenced by the $7.7 million or 6% decrease in total non-interest expense in the second quarter of 2011 as compared to the prior year period. We expect that non-interest expense will continue to remain low and forecast that it will be approximately $97 million-$100 million for the remaining quarters of 2011, net of amounts that are reimbursable by the FDIC. Before I turn the call over to Irene, I would like to talk briefly about the status of our operations in Greater China. As you may recall from our previous discussions, when we first acquired the UCB China banking operation from the FDIC on November 6, 2009, we quickly recognized the need to make operational changes. We immediately put into action plan in place to recapitalize and strengthen the balance sheet of the China subsidiary. We are pleased to report that our China operations are now stable. We increased capital levels, charged off problem loans, reduced non-performing assets, and improved the loan-to-deposit ratio. At this point, we do not have any regulatory constraints, exceed all regulatory requirements, and are able to look for opportunities to grow in a careful, prudent way. At the end of June 30, 2011, non-accrual loans total only $1.5 million, or less than 1%, of total loans outstanding. Total loans in China was approximately $165 million as of June 30, 2011, and total deposits were $380 million, for loan to deposit ratio of less than 50%. Now, with a stronger balance sheet and infrastructure in place, we are focused on utilizing our presence in Greater China to provide more services and products to our cross-border customers. With that, I would like to turn over the call to Irene to discuss our second quarter 2011 financial results in more depth. Thank you very much, Julia, and good morning to everyone. I am going to provide a little bit more insight into our financial results for the quarter, especially as it relates to our net interest margin and credit quality. We reported net income for the second quarter at $60.5 million, or $0.39 per diluted share. Compared to the prior quarter, earnings per share improved two cents or 5%, and compared to the prior year, earnings per share improved 18 cents or 86%. This increase in profitability from the prior quarter is a result of an increase in earning assets and an increase in non-interest income. Average earning assets increased to $19.4 billion for the quarter ending June 30, 2011, compared to $18.7 billion for the quarter ending March 31, 2011. The total increase in average earning assets was primarily due to an increase in average loans and investments. The core net interest margin, excluding the net impact to interest income of $32.4 million, resulting from covered loan activity, remained stable at 4.03% for the quarter as compared to adjusted net interest margin of 394 for the first quarter of 2011 and adjusted net interest margin of 395 for the second quarter of 2010. The improvement in our net interest margin from the prior quarter and prior year is primarily related to an increase in the yield on investment securities and covered loans, and a stable yield on non-covered loans. As the low interest rate environment continues to extend, we are faced with challenges in increasing the net interest margin. As competition for commercial loans, both commercial and trade finance loans and commercial real estate loans remain stiff, yield pressures continue. East West continues to look for opportunities to minimize our cost of funds and maximize our yield through redeployment of excess liquidity into higher interest earning assets, while also ensuring prudent interest rate risk management. In the second quarter of 2011, East West prepaid $260.7 million of Federal Home Loan Bank advances at an average effective cost of 1.6%. We also improved the yield on our investment securities portfolio by 22 basis points to 2.90% by repositioning the portfolio. Despite these challenges, and as a result of the actions that management has taken, we feel that we will be able to make a solid net interest margin of about 4% for the remainder of 2011. Moving on to credit quality. All asset quality metrics improved during the second quarter of 2011. For the seventh consecutive quarter, net charge-offs have declined. Further, non-performing assets, excluding covered assets, decreased by $7.1 million or 4% from the prior quarter to $181.2 million or only 83 basis points of total assets at quarter end. The decrease in the non-performing assets was primarily due to an $8 million or 5% decrease in non-accrual loans during the second quarter of 2011. I am pleased to report that movements into non-accrual loans has also decreased sizably for the past three quarters and totaled about $16 million in the second quarter of 2011. In future quarters, we expect the inflow to continue to decline while we are also actively managing our REO sales, resulting in a decline in non-performing asset levels. Additionally, other credit metrics have also improved. Compared to March 31, 2011, we saw improvements in both classified assets and delinquent loans. All data points indicate that credit is improving and should be a diminishing issue with each passing quarter. The provision for loan losses was $26.5 million for the second quarter of 2011, virtually unchanged from the prior quarter, and a decrease of 52% as compared to the second quarter of 2010. Although our allowance for loan losses remains very strong at 2.29% of non-covered loans, our allowance and provision has declined for several quarters as a result of credit quality improvement, which was partially offset by increases in the allowance on commercial and trade finance loans as these portfolios have continued to grow. As in the past, in our earnings release, we provide an updated guidance for the full year of 2011. We currently estimate that fully diluted earnings per share will range from $1.52 to $1.54 for the full year of 2011. This updated EPS guidance for the remainder of 2011 is based on the following assumptions: a stable balance sheet, a stable interest rate environment, and an adjusted net interest margin of approximately 4%, provision for loan losses of approximately $45 million for the remainder of the year. Total non-interest expense of about $97 million to $100 million each quarter, net of amounts to be reimbursed by the FDIC, and an effective tax rate of approximately 37%. Finally, as stated in the earnings announcement released yesterday, East West Board of Directors has declared third quarter dividends on the common stock and Series A preferred stock. The common stock cash dividend of $0.05 is payable on or about August 24, 2011, to shareholders of record on August 10, 2011. The dividend on the Series A preferred stock of $20 per share is payable on August 1, 2011, to shareholders of record on July 15, 2011. I will now turn the call back to Dominic. Thank you, Irene. Thank you, everyone, for joining the call this morning, and I will now open the call to questions. At this time, we will begin the question and answer session. To ask a question, you may press star and then one using a touch-tone telephone. If you are using a speakerphone, we do ask that you kindly please pick up your handset before pressing the keys to ensure good sound quality. If at any time your question has been answered or if you wish to be removed from the queue, you may press star and then two. Once again, in order to ask a question, please press star and one. Our first question comes from Ken Zerbe from Morgan Stanley. Thanks. I guess, first of all, regarding the commercial loan growth, how do we get comfort, given that the rapid pace that you have been able to grow C&I loans, that they are being put on with very good risk underwriting? That we are not going to see, and I am not implying this, but we are not going to see a blow-up in a year or two years or three years because of just the growth was too much for you to properly manage. Thanks. Well, first of all, I think that if we looked at the C&I loan growth, close to 50% of those loans are in the Greater China region, and as we pointed out earlier, more than 80% of them are actually secured by cash and stand by LCs from very large financial institutions. These are basically 100% all guaranteed loans. So on one hand, you look at the loan growth may be big, but then on the other hand, these are not loans that would have any risk at all. Then you have the rest of the loans that we looked at. Keep in mind also is that we have a situation here that, in general, a lot of our competitors that have done business or sort of compete with us in the past are under either MOU and cease and desist orders. Even as of today, they're still going through that kind of pain. We got out of that. We never, actually, thank goodness, I've been here 20 years. We never once been in any kind of regulatory orders. So in this situation, I think that we have a much better opportunity to capture or capitalize on these good C&I opportunities that frankly, if it's in a very strong economic environment, I think we will have a hard time to take these clients to come to us because we have a very interesting dynamic here. East West went from $10 billion to $20 billion after the United Commercial Bank and also the Washington First International Bank acquisition. So from a size point of view, we are much bigger. In addition to that, we have much broader reach in terms of our branch network. Not only just in the state of California, we have substantial more branches that the customers see are looking more and more like sometimes Starbucks in Chinatown when people walk around, say every corner they turn is East West Bank. So it's much easier for us to attract customers. These clients out there recognize our strength on the balance sheet. They recognize that we're doing well, and all of that sort of fuel the additional opportunity for us to get additional C&I loans. One other thing that I want to add. The reason you see that payroll costs are going up is because. Just keep in mind that we were able to create substantial amount of efficiency with these mergers because there are a lot of overlap, and we're able to really reduce the headcount dramatically through this people and system integration. But on the side, we out there are hiring quite a few of commercial lenders. All of that combined, every commercial lenders come in, produce additional C&I loans. So I think that's just a trend that is going right now that we have this sort of the right timing to grow the business. Frankly, I think that if the economy turn dramatically positive, and if other banks also come back sooner, we would expect that we would not have as easy of a time, and gradually or naturally, that we would not have as high of a C&I growth. It is a combination of this opportunity in the Greater China, that cross-border trade settlement that allow us to make cash, collateralize, or maybe stand by LC type of loans that normally, frankly, 2 years ago, even if we had the license, we would not be able to do it because the regulation in China would not allow us to do that. On top of that, with this sort of uncompetitive environment in the banking world in our regions, amount of competitors, I think those combination help us to be where we are today. All right. That is very helpful. Just one other question regarding net interest margin. Obviously, you have the 4% guidance for the full year, and I am assuming that the first half is roughly 4%, so the second half should be 4%. But what factors would actually lead to a disappointment in NIM? What would drive NIM below the 4% that you are looking for? Because I assume that you are taking into account the reinvestment of cash flows on securities, given where loan yields are. I guess, where does the surprise come from if there were to be one? Thanks. Ken, this is Julie. I think that the likelihood that we would have a net interest margin in the near future to go down significantly below the 4% is probably very low. So we believe that for the next 2 quarters, margin around 4% is very achievable. However, the very low interest rate environment, if it prolongs into full year in 2012, we will see some possibility of slight compression because the asset yield will continue to be very depressed, and there is no way to reduce the deposit rates below what it is right now. But in the near future, we feel very comfortable that margin around 4% is very doable. Competition. If competition gets even more intense going forward from banks who are chasing. We are one of the few that actually have a very, well, I would say that have an easier time to grow loan balance, but a lot of banks are struggling to grow loan balance. For those banks who are struggling to grow loan balances, they may decide to go with a different strategy of really cutting down the pricing. We obviously do not want to have our good existing clients to go to another bank simply because the other bank offer like a 50 to 100 basis point lower in pricing. So every now and then we need to match. If that actually intensified in the next 6 months, there is a likelihood that would go down slightly. But dramatically, highly unlikely. All right, great. Thank you so much. Our next question comes from Joe Morford from RBC Capital Markets. Thanks. Good morning, everyone. This is the first time we've really heard you talk about growing in Hong Kong and China since you bought UCB, and I guess, can you just expand on your comments about the current strategy for those markets? How are you going to go about growing the business over there, and is it just going to be in this cross-border RMB business, or are you willing to start doing more of the general middle market or SME lending over there as well? No, I think our strategies are very consistent. Day one, when we took over both. Well, we have our branch in Hong Kong, actually, before we acquired Sure United Commercial Bank. The day one that we took over Hong Kong, United Commercial Bank and also China, we never changed our direction. East West has always prided ourselves as the financial bridge between East and West, and that's been our sort of vision and mission for the last 20 years, and that really hasn't changed at all, and it will not change going forward in the future. That is that in Hong Kong and in China, we're going to focus on cross-border trade. We're going to focus on helping Chinese enterprises, Chinese entrepreneurs to invest in the U.S. We're going to help U.S. companies to explore opportunities in doing business in China. We will also help high net worth Chinese individual customers, and there are many more recently coming to U.S. and settle down in various neighborhoods where we have our branches. That's pretty much what we do, and that's going to be the focus of what we'll be doing also in the future. The idea about, let's say, expanding in China or in Hong Kong to focus on the retail or commercial banking business that have no strategic connection with United States will be something that we will continue to avoid. We just don't think that we can add value if we do not use our U.S. and California franchise as a leverage. Whenever you go in to do banking business that you have no strategic value, have no value add proposition, there is going to be a high likelihood that you end up taking worse quality credits that the other banks don't want. We do not want to get ourselves stuck in that position. That's the kind of direction that we're going to be going forward to. My sense is that China and Hong Kong are not going to be growing in the same kind of magnitude like U.S. A good example will be, we're now 22 billion, and the China loan balance is only about less than 170 million. In Hong Kong, it's only 400 some odd million. Altogether, it's a very small balance sheet. You see the growth for the last quarter simply because it is so ridiculously small. Any growth looks kind of big. I looked at it is that I just don't foresee that China suddenly will go from a 170 million to like a billion and a half in a year or two, that kind of stuff, and it's just most likely not possible because we are going to be very focused. We are not looking at China market as, well, it's 1.3 billion population there, and then we're just having a great time, chasing every one of them. That's just not the strategy. Okay, that's very helpful. Thanks. I guess the other question I had was, just curious how you were able to keep the yield on non-covered loans stable in the quarter, given the competitive environment you talked about and the fact that about a third of the growth this quarter came from the cash-secured trade finance loans, which I suspect is thinner spread business. Well, it's the inflow and also the increase, as much as it looks big, but then, as a percentage of the portfolio is not that high. I think that's why you don't see major changes, that the yield is pretty stable. Yeah. To put it into perspective, it's $300 million net growth in our loans out of $14 billion of loans. Then on top of that, we have a $22 billion asset balance sheet. Altogether, I think that relatively speaking, from a growth perspective, it looks high, but then from an overall balance sheet perspective, it's actually relatively small. By and large, the margin is primarily affected by the rest of the portfolio that's been with the book for a while. Okay. Makes sense. Thanks so much. Thank you. Our next question comes from Lana Chan from BMO Capital Markets. Hi. Good morning. Good morning. Couple questions. One on the increase in the securities yield. You talked about repositioning the portfolio this quarter. Could you be more specific about what you actually did in the portfolio? Hi, Lana. It's Irene. Yeah. Some of the things that we're doing in the securities portfolio, which we started in the first quarter as well, is we want to make sure that we're having prudent interest rate risk management. However, we note that our investment securities portfolio, generally speaking, compared to many peer banks, is lower, the yield is lower because a lot of our securities are very short-term in nature. So we have a little bit more of a barbell strategy where there are a small number of securities we're going out a little bit longer. For the vast majority, the impact of the portfolio is the shorter term, lower rate, but that has helped. Making this slight change has helped increase the yield a little bit in our portfolio. Okay. What's the average duration now? It's still pretty short. I would say about two years, two and a half years. Two and a half. Okay. If you look at the yield itself at 2.9, you would see it lower than a lot of other banks who probably take on more interest rate risk in their portfolio. Okay. Also, could you remind us what other opportunities there are for lowering your overall funding costs, other opportunities to prepay some of the borrowings? Yes. We always have the opportunity to prepay the Federal Home Loan Bank advances, but the impact would not be a lot, and we'll continue to look at our cost of funds, the deposit rates. I do not expect that any changes will be dramatic. However, we'll continue to find ways to maximize our funding opportunities and lower the cost of funds. It will be gradual. Yeah. I think that quarter by quarter, I think that we should expect some slight decreases in the cost of deposit. Lana, we have about half a billion of FHLB advances currently with effective rate of 225. The more of a higher cost was we have already prepaid. Okay. Just one last question. You actually showed some commercial real estate growth this quarter for the first time in quite a while. Could you talk about what opportunities you are seeing there and what is growing? Yeah. Most of them are either existing relationship. We are not going to just do a transactional commercial real estate, but some of our clients that they had opportunity to get good assets, commercial real estate, we will be willing to finance that. In addition, some of them are coming from new commercial loan customers who in addition to their business, they have an owner-occupied warehouse or sometimes, additional investments, then we will do that. What we are not going to do is somebody just coming in with one-off transactions. They are buying a real estate or just want to refinance one property. Are you seeing better yields on the commercial real estate now than before with a lot of competition? It depends because particularly for these commercial C&I clients, this real estate is a package deal. So whenever we take on a C&I client, we want the entire relationship. So we take the line of credit, then we have to take the warehouse, then the office building, where they are located, what not. Then obviously their demand deposit account and the money market account, et cetera. So when we do that, because of the package deal, most of these clients have pretty good rate for these real estate loans. So we have to offer just as good of a competitive rate to get them over. On the other hand, if it is an existing client buying additional piece of property because they got it for such a great deal, like one of these FDIC sort of great bargain, they obviously are not nickel and dime with us because just to be in the transaction, they already make so much money. So for us to charge a little bit more, they are very comfortable with it. Also, there is not a lot of banks out there doing these kind of deals anyway. So for these good existing clients, some of them are willing to pay a little bit higher rate. So it is a combination of these two, so to get where we are. Okay. Thank you very much. Our next question comes from Gary Tenner from D.A. Davidson. Please go ahead with your question. Thanks. Morning. Just a question on the commercial loan growth that you had this quarter beyond the trade finance. How much of that is new versus existing customers? Combination but I would say majority are new customers for the C&I. Yeah. Okay. How much would you estimate had been SNC or purchased loans? Can you repeat the question again? How much of the loan growth is growth in syndicated loans? Oh, very small. Out of that $500 million total increase, which is 250 in U.S., 250 in Hong Kong and China, only $30 million is an increase from the syndicated loans. It's a pretty small part of the increase. Okay, great. The comment on the cross-border reduction and the outlook for the Chinese portfolio, you kind of said, well, it is not going to go up to $1.5 billion overnight. Can you kind of give us your expectation of where that portfolio might get to, say, by the end of 2012? It all depends on the opportunities that come along, because obviously we have a lot more of these cross-border deals to do. If we actually do get, surprisingly, we do get some spread because that is obviously not 4% spread, but we do get usually a couple of percent spread. You know what? If there are more of these opportunities, we will take some more of these, and also if strategically important for us, we will do some more. But now, as of now, the Chinese government provide quota to each bank about how much you can do just to control the foreign exchange. We pretty much tapped out. This is an interesting thing, though. When we are done with our quota, we go ask to see whether we can get more. I have no idea what they are going to give us. They may just say that everybody stop, no more. Or they may come back and say that we want you to do more. This all come from the government policy, so it is hard for us to predict. So my sense right now is that conservatively, we may not be doing a whole lot more. Is that quota sort of a maximum portfolio level, or is that an annual quota of new loans you can make? How does that work? What they do is that they look at your balance sheet to see how big you are in terms of how much loans you have. Obviously, they look at your capital, how much you have done. Then they will make an allocation. Now, in terms of exactly the detail, this is so new. I am sure that the Chinese government who are in control of their foreign currency at this moment, they are sort of coming up with new policy as it goes. We get whatever we can get, and that is what this is all about. It is conceivable, though, that you may not be able to put any more of those loans on the books the rest of this year, let us say? Not necessarily. No. We may not be able to do any more cross-border guarantee loans that are specifically granted by the Chinese government from the foreign exchange agency. However, there are always going to be some loans that we can do. For example, we have quite a few U.S. customers who are currently doing business in China. These are customers we know very well. We know exactly what their financial conditions are. They have credit exposure with us in the United States. We are very comfortable if they are in China, they need to do some business, and they need us to provide some level of financing. We are very comfortable to finance these kind of customers. Vice versa, there may be a company from China that we are currently doing business in the United States with their subsidiary operations in the United States. Their parent company to provide more support to the subsidiary company in the United States may choose to develop some additional banking relationship to support our branch in Shanghai. For that reason, we may want to get into provide some sort of credit support, just as a token credit support to sort of open up the opportunity to have more commercial deposits from these type of Chinese companies that already been doing business United States. So those kind of combinations are the type of activities that may potentially open up to allow us to do more business there. There is a different dynamic here is that everything that we do in China is more strategic, not necessary that we ever going to be counting on them to say, well, without this loan growth, we would not make our earnings, or without the loan growth, we would not have the balance sheet that we want. That kind of responsibility is shouldered by our U.S. counterpart. So like the domestic U.S. branches and operation need to get the engine going. China is primary focused on strategic advantage, strategic leverage. The strategic leverage is that because we have these Chinese companies, that's why we have so many U.S. domestic C&I borrowers who are interested to do business with us because we are very unique brand that none of the other banks in U.S. can compete with us in this category. That's why the China and the Hong Kong operation are very critical for our strategic existence, but we do not need them to go out there and crank up loans and deposits. All right, Dominic, thank you very much. Our next question comes from Julianna Balicka from Keefe, Bruyette & Woods. Morning. Excellent quarter. Thank you. Thank you. I have a couple follow-up questions, if I may. Just to go back to this, on the growth topic that you were just addressing on that $250 million that came from the cross-border activity versus the $250 million that came from your U.S.-based operations. That $250 million that was from the U.S.-based operations, that's kind of a level from which we should be thinking about forward future growth for the rest of the year, correct? We think that probably $150 million a quarter is doable. We may not be able to sustain the $250 like a net increase. The first quarter, we did about $200 million, and second quarter, $250. I would say probably $150 million per quarter for the remaining of the year is a doable target. That makes sense. On the $250 million that you attributed to the cross-border loans that Dominic Ng was just discussing, since there's a cap there from the China side, when you were referencing the companies that were U.S.-based with China operations, and those are an additional source of growth, would that be part of that $250 million cross-border, or would that be part of the $250 million domestic? No, it will be the $250 million in Hong Kong and China. However, they may not be cross-border. It's just we are very comfortable with the parent company in U.S., so we give them the credit in China to their subsidiary or operation in China, but we are relying on the global company's financial strength. Right. But as loans over there, when we report that, it would be the loans in China. Conceivably, there's going to be growth from both sides of the $250 million that you have from this quarter, right? The $150 million in the U.S. and then some more over on the $250 million on the cross-border, yeah? Correct. Yeah. Okay, very good. The question that I had on the follow-up was in terms of loan yields, can you tell us what kind of loan yields you are seeing on C&I, just straight up regular small business C&I in the U.S., trade finance in the U.S. C&I, and maybe some of the yields you're seeing in the China or Hong Kong loans? Can you just give us a little bit more granularity there, please? Yeah. Right now for the C&I loans, we're seeing about 350 on the average. Some higher, some lower. But these are U.S.-based or China-based, or? US-based. In Hong Kong, it's lower. In China, it's higher. Then is there a difference in yields between just straight trade finance C&I versus regular C&I that you're seeing or anything like that? No, it's more case by case. So there's not really a clear cut that one is higher than others. Okay, very good. Thank you very much. Those are my follow-up. Thank you. Our next question comes from Brett Rabatin from Sterne Agee. Hi, good morning. Wanted to ask on credit quality, generally speaking, as the construction book continues to diminish, should it be reasonable to expect that charge-offs next year continue to decline, or can you give us some color on loss content as you see it as we go into the second half? Hi, Brett, it's Irene Oh. Yeah, definitely our expectation for 2012 would be that provision charge-offs continue to go down. As you mentioned, construction, land, it's less than 3% of our book right now. So as those balances, as we chip away at those, there'll be less provision in charge-offs in 2012. Okay. The other question I wanted to ask is, you're giving guidance to a flattish balance sheet. Assuming that would be the case next year as well, capital continues to accumulate. I know I've asked you about share buybacks and increased dividends in the future. Can you give us some color on how you plan on managing capital next year or even in the second half as well? First of all, I think that we at East West always do things one step at a time, and when it comes to this capital management, maybe sometimes a little bit slower than the others. Our plan is that we most likely will increase dividends, looking at most likely maybe right at the beginning of next year. That's what I would say that will be very highly likely, to get our dividends to double up to where we are today. Secondly, after we increase dividends to double to where we are today, then we look at the balance sheet. If we continue to have these $500 million of kind of like quarter growth and then getting very good loans and then the economy allow us to keep growing, well, then we may not do much with the sort of capital management. If for some good reasons, another great acquisition opportunity come along, we obviously will use the capital deploy for acquisition. However, assuming in this kind of trend today, we have nice organic growth, and there's really no reason for us to get distracted and go in and buy a distressed real estate shop. If that's the trend that we're going, we have nice organic C&I growth and everything's going as good as it is today, then I think there's high likelihood we have excess capital even after we double our dividends. At that point, I think it will be appropriate for us to look into stock buyback. All of that, I think that we're going to try to have it looked at in 2012. Okay. That's great color, Dominic. Just one last one on the loan portfolio team. Can you talk about the additions you've made to the staff the past year, and then perhaps if you feel that the loan lending team is fully productive at this point, or if you think that they still have capacity to continue to ramp up, meaning you won't have to make new hires as loan growth continues to show up on the balance sheet? Well, our hiring practice is really, I would say, more strategic and opportunistic. Strategic and opportunistic is that we try to identify specific industries that are relevant to East West, particularly industries that maybe companies from China are interested to participate in the U.S. or invest in the U.S. and vice versa. For that reason, anytime we find great commercial bankers that have these type of industry expertise or special technical skills, we'll bring them on. As of today, I would say that because of quite a few new hires that we've been bringing on since 2010, obviously the one that came in less than a year always have excess capacity to grow their portfolio. They will need to take their time to gradually build up the portfolio. But in the meantime, while these existing new hires are ramping up in terms of their capacity, we will continue to look for these strategic hires out there, and also opportunistic hires. Every now and then, there is one bank that for whatever reason, I think there is not that much we can find, quite frankly, from distressed bank. I would say most of the new hires that we brought in are from very strong banks. But every now and then, these very strong banks would like to do a restructure or organization movement and so forth, and that will cause distress to some of these commercial bankers. So it give us the opportunity to bring them back to East West instead of where they were. These type of opportunistic hires are something that we continue to explore, and I think that going forward in 2012, we will still be looking at these kind of opportunities. Okay, great. Thanks for the color. Thank you. The next question comes from Christopher Nolan from CRT Capital. Hi, thanks for taking the call. How should we look at the reserve ratio going forward? It should be a function of non-performing loan volumes or some other metric? Yeah. The allowance is always a combination of the portfolio mix, the non-performing assets. But we believe that if the non-performing assets continue to decline, like once they stabilize in the long term, some allowance around 2% seems like a reasonable ratio that we can expect. Okay. Turning to China for a second, the restriction on the lending cap that Dominic Ng was mentioning earlier that the Chinese government imposes, is that for include Hong Kong loans or just for Mainland China loans, or does that apply to all of it? Well, actually, yes and no. It applies to our subsidiary bank in China. However, Hong Kong, in the last quarter, benefit from this cross-border renminbi trade settlement financing because a loan made in Hong Kong, a deposit placed in China. That type of arrangement were taking place last quarter. So I would expect that if there is no more quota Hong Kong will be affected slightly because of that. Hong Kong will lose that one additional product they can sell. But if it opened up again, then I think that Hong Kong will continue to have the opportunity to explore this type of financing opportunities. So if the cap is not increased, you could see some incremental growth from Hong Kong, correct? Yeah. Great. I guess final question, how much did Hong Kong account for that $250 million increase of loans from China? China increased about $60 million, $50 million, so the rest actually is booked in Hong Kong. Okay. So Hong Kong is- Yeah. Okay. 50 million in China, 20 million- Hong Kong has a bigger growth in loans. China has the bigger growth in deposits. Got it. So we could see continued, potentially continued growth in China just from Hong Kong growing. Well, no, again, it depends on this cross-border allocation. Also, that's just one product. There's always other lending opportunities that we can look at like vendor financing. There are a lot of opportunities that we can look at. But Hong Kong does not have good pricing. The competition in Hong Kong when it comes to loan yield is really intense. So as much as I think that there are plenty opportunities for us to make loans in Hong Kong, I just don't like the yield there. For that, I think that I don't expect Hong Kong would have any kind of meaningful growth actually going forward in the next two quarters, simply because the loan yield has been coming down quite a bit. On the other hand, China, the loan yield has been phenomenally good. But we need to make sure we find the right type of lending vehicle for us to do the right thing in China. Great. Thanks for taking my questions. All right. Our next question comes from Aaron Deer from Sandler O'Neill & Partners. Hi. Good morning, everyone. Good morning. Just a quick question on one of the guidance components with respect to looking for a flattish balance sheet for the remainder of the year. Given the strong loan growth that you've been seeing, I'm wondering if that's just an offset from some of the runoff in the UCB portfolio, if you're looking to see a loan mix or rather an earning asset mix, putting more of the liquidity in the balance sheet to work, or why wouldn't we be looking to maybe see a little bit more overall total asset growth between now and the end of the year? That's correct, Aaron. We are expecting that there'll continue to be growth, as Julie mentioned, at least about approximately $150 million on the C&I front on the non-covered loans. But it would be offset by decreases in the covered portfolio. This quarter, a little over $200 million. Pretty much the same last quarter as well. So that portfolio will naturally continue to decline. So net-net, we feel that a flattish balance sheet is a more appropriate kind of estimate for us. Okay. Within the securities book, are you putting more of your excess funding to work there? If so, what are you buying and what kind of durations are you taking on those? No, we talked earlier that we want to keep the investment security short. Going back to, we have very good margins. The way it is right now, we are very profitable. It doesn't make sense for us at this point of time to take on more interest rate risk, and that's why our yield on the investment securities is lower than majority of our peer banks, because we want to keep it short. We just have to wait it out until the interest rates go up to take on some duration risk on the portfolio. Okay. Thanks for taking my questions. I appreciate it. Once again, if you would like to ask a question, please press star and then one using a touch-tone telephone. Our next question comes from Matthew Keating from Barclays. Yes, thanks for taking my question. Turning back to credit briefly. After ticking down for most of last year, non-accrual residential mortgage loans have increased for the past three straight quarters. I was just wondering if you could comment on trends here with this book growing about 7% in 2Q. It also represents now about 14% of your non-covered loans. Just wondering if you have any targets on how large of your overall book this could ultimately represent. Thanks. Even though it increased slightly, if you look at the portfolio that we have, it is still a very small percentage that is non-performing. I think the question is on how big of a residential mortgage. Let me just make sure, is that your question on how big a residential mortgage you are expecting us to grow? Yeah. I am just wondering what your targets might be for that portion of your book. Well, this is another relatively opportunistic. This is now more on the retail banking side. I tell you, for the last several months, the major banks who have been doing residential mortgage have really scaled back. Well, I do not know they scaled back or the paperwork have become so ridiculously tedious that most of our retail customers that normally would go to the large banks for the conventional mortgage loan have now turned over to East West and asked us to provide financing for their either refi or new purchase for their residential mortgage. As Julia Gouw talked about earlier, the new residential loan origination that we originated in the last three months is around 55% loan to value. So it is a very different kind of mix, like the typical loans that you heard about in these congressional hearings. Got you. Thank you. Just one last question. Perhaps, Irene, you could help with this. We're just wondering if you could comment on the level of regular purchase accounting accretion in the quarter outside of the impact from the covered loan dispositions and such. It's about $15 million a quarter, Matthew. Okay, great. Thanks very much. Thank you. Our next question comes from Jonathan Elmi from Macquarie Capital. Please go ahead with your question. Hey, good morning, everyone. Thanks for taking my question. Just quickly on the expense guidance, if I look at the second quarter expense level and then take out the FDIC reimbursement of $13.6 million, it still looks like you guys are above the high end of the quarterly guidance for the back half of 2011, if I'm thinking about that right. So what's going to drive those expense levels down in the next quarter? Just wanted some clarification there. Well, some of the expenses, we have to pay the 20% of the FDIC reimbursable expenses and some of the legal expenses. There's a likelihood that is slightly lower, but, we feel that $97 million to $100 million per quarter, the next two quarters is a good range for core expenses. The core expenses are very stable, Jonathan. It's really these unknown kind of credit costs, which can kind of creep up in a quarter. That's why we give that range. Okay. That is fair. Just one last question, if we could just go back to the margin for a second. When I look at the non-covered loan yields, obviously there was a bit of pressure there in the first quarter of 2011. I guess I just want to try to understand what the primary drivers of that first quarter compression were and why they did not recur in the second quarter. Any help there would definitely be appreciated. We had talked about this on the call last quarter as well, but what particularly happened in the decrease in the yield on the non-covered loans in the first quarter was because there just happened to be many loans where the floors came off at that period or they were repricing downwards. Right now we feel it will be a little bit more stable for the remainder of the year. Okay. Thanks very much, guys. Our next question comes from Ram Shankar from FBR. Please go ahead with your question. Good morning, everyone. Thanks for taking my question. Just on the RMB loans, what are the average terms of these? I mean, how long are these loans? Average? Yeah, the life of the loan, I guess. It will be a little bit over a year because most of them are one-year loans. The majority of them are one-year loans. There are a few of them that are three to five years terms and so forth. I would say that, if you average them all out, it will probably maybe less than a year and a half. Okay, thanks. Just on the trade finance side, is there a typical seasonality pattern involved in this? Do you expect more line withdrawals next quarter ahead of the holiday season? Is that typical in that type of business? I think it depends on the customers. If their business is going, they will borrow more. It's not necessarily the timing of it. Not that much because, again, a lot of our trade deals are not just. Years ago, everybody just sell toys and garments, so they're all going after the Christmas season. In today's world, the trade, is all over the map, and different type of products. There are imports, there are exports. So I really don't see that the seasonality should make any difference at all. Okay. A couple of numbers from Irene. What was the accretable yield balance at June 30, Irene? $170 million is the accretable discount that will come into income. The net accretable discount. Okay. What was the duration of the investment book last quarter, if you could remind us of that? I would say it's about the same, about between two, 2.5 years. Okay. It's pretty similar. Okay. Thanks for taking my question. Good quarter, guys. Thank you. Our next question comes from Jennifer Demba from SunTrust Robinson Humphrey. Thank you. Julia, I think you mentioned in your commentary that you expect nice growth in your core fee income line items over the foreseeable future. Can you just give us a little color on that? Are we talking about sort of a low double-digit growth, or can you just give us some more color on that? It will not be dramatic because fee income is quite difficult to get. But a combination because we have a lot more customers from the activities, from the deposits, from FX transactions that they do. But it will not be in the total revenue basis. It is not going to be very significant. But, compared to the core fees of about $22 million a quarter, maybe we will see a $1 million increase. So that is around what we are thinking. Okay. Thank you very much. Thank you. And we have a follow-up question from Julianna Balicka from Keefe, Bruyette & Woods. Good morning. Thank you for letting me come back into the queue. I have a question on your C&I loan growth. To what degree, or is there a visible presence of tech-oriented loans vertical, a lot of cross-border activity, for example, semiconductor fabs, et cetera? Could you comment a little bit on the impact of tech in Northern California in there? Not much in this quarter. We are expanding our tech group. I would expect that the growth will be hopefully coming in the third and the fourth quarter. In terms of in the first and second quarter, I think that we do have some very minor loans that are from the tech industry, but it's relatively minor at this stage. This is definitely a strategically important area that we expected to have more growth going forward in 2012. Could you give us some idea of how large you expect it? How many people you hired, or just give us a little bit more color there? Well, we currently have a group of tech lenders in Silicon Valley, but I think that we are in the process of hiring more. I would say that I would be able to give you a much better idea comes the end of the third quarter. Then I'll be able to give you a better idea about how many people we have. Then I'll be able to get you a better idea how much loans that we're going to be doing 2012 and so forth. Excellent. Thank you so much. I am sorry, I did not hear. I said excellent. Thank you very much. Okay, thank you. We have an additional follow-up question from Ram Shankar from FBR. Thanks again for taking my question. Just on the UCB loan marks, you narrowed it down from 20% to 14% in 4Q. Just based on the pace of prepayment activity that you've seen and just overall better credit, is there a chance that you can maybe lower that mark down? Are you guys monitoring that? Yeah. On a quarterly basis, we look at what the credit performance has been and will continue to be. We project out in the future. I say at this point, it's not outside the realm of possibility that we might lower that credit mark, but we'd have to do a full analysis. We would continue to do that on a quarterly basis periodically. Okay, great. Thanks for allowing me to ask the follow-up. This concludes our question and answer session. At this time, I would like to turn the conference call back over to Mr. Dominic Ng for any closing remarks. Well, thank you all for joining us on today's call, and I look forward to speaking to you in the next quarter. Thank you. The conference is now concluded. We thank you for attending today's presentation. You may now disconnect your telephone lines.