BancAnalysts Association of Boston Conference

Nov 7, 2019

Hello. We are going to get going here, the last presentation of the day. Up next, we have East West Bancorp. East West is international trade. It is headquartered in Pasadena, California. The bank has a particular focus on the Asian American community and operates through over 130 branches in major U.S. metro markets. It also has about 10 offices across China, Taiwan, and Hong Kong. At September 30th, they had assets of about $41 billion. Presenting today for East West is Julianna Balicka, and she joined East West in 2016, and prior to that, she had a career on the sell side covering regional banks for KBW. With that, please join me in welcoming Julianna. Thank you. It is a pleasure to be here. Thank you, everybody. I understand I am what is keeping you from cocktail hours. I will try to keep this brief, efficient, and to the point, and I very much appreciate you taking the time to listen to what we have to say. The theme of this conference, as far as I was led to understand, was how do we, as regional banks, compete against the big national banks nationwide, especially with the advent of technology making it easier for consumers to switch accounts and have less loyalty to the community bank. Well, the answer for East West from this perspective is slightly different. Our model is differentially focused on the Asian American sector, and at $43 billion in assets, we are the largest Asian American bank and the largest Chinese American bank focused in the U.S. Not only do we have a U.S. presence where our footprint follows the Chinese American bank population, we also have a license to operate commercially, to do commercial banking in mainland China, and we have locations in Greater China, in mainland China, and in Hong Kong. So what that means is that our niche of customers, who we call Chinese affinity, has moved beyond the Chinese American as the Chinese population and folks have become more global citizens. We have more and more commercial customers with business operations in both sides of the Pacific. Our customer base banks with East West for the affinity reasons and for the value add that we provide in understanding business flows between the two countries rather than particularly because we have a nifty technology. In some ways, that helps us compete against national banks just because we are in our own specialized niche lane. That also does mean that from the perspective of some of the answers some of the other banks have given, it is less incumbent on us to have the niftiest, latest technology, and it is more important for us to be able to serve all aspects of our customer base on the consumer and the commercial side, from small to larger banking side, and less all about the latest technology fixes. Just to kind of step back and take a look at East West's history over time to illustrate the point that I am making here. We went public 20 years ago in 1998. A little over 20 years ago. We celebrated our 20-year anniversary last year, and at that point in time, we were at $2 billion in assets, L.A.-based, and very much a Chinese American bank providing home mortgages and small business loans to our core customer base in Chinatown and adjacent communities in L.A. It took us a number of years to even cross $10 billion in assets, as you can see, in 2006. We did that through the traditional way of growing for a community bank, through acquisitions of peer banks in our space. At that point in time, other than the fact that our customer base was Chinese American and our products were tailored to helping immigrants do well in the U.S. and assimilate into the U.S., we were very much a community bank, walked and talked like any other community bank in many ways. We crossed $10 billion in 2006, then in 2009, we jumped to $20 billion with the acquisition of our peer bank, UCBH Holdings, through the FDIC. That bank did not make it through the credit crisis, but it did position us for the next stage of growth, where we are today, which is to pursue cross-border business between the U.S. and China. UCBH, as you know, was also a Chinese American bank, and importantly, it gave us a license to operate commercial banking, gave us a commercial banking license to operate in local currency in China. From then on out, you can see from that curve, it was a much faster growth trajectory. We got to $30 billion much more quickly than it took us to get through the first $20 billion. From $30 billion to $40 billion was just three short years, and today we're at $43 billion in assets. How does that allow us to And here you go. Here are some of the big banks you can see. There's a number of banks of our size and then the big boys. In California, our marketplace is very much for the consumer banks dominated by JPMorgan, Bank of America, Citigroup and Wells, and then with a handful of larger regional banks. With our particular portfolio, and let me just switch over to this side, we stand out from other regional banks for the fact that we have a good balance of commercial and consumer customers in our balance sheet. On the loan side, you can see that a quarter of our book is single-family mortgage and HELOCs, which we self-originate and which we keep for our portfolio and our core customer base of Chinese Americans. But then we also importantly have 36% of our book is in commercial C&I business. The C&I business has moved from just simply being small business Chinese American business into middle market, small to middle market business, corporate business, for customers that are all stripes and sizes, from small Chinese American local banks to wholesale trade importers, exporters, to manufacturers, to specialized industry customers in business areas that have a lot of cross-border capital flows between the U.S. and China. Furthermore, on the deposit side, one way that we do stand out from some other regional banks of our size in other regions is we do have a good mix of consumer deposits in our deposit mix, where 13 billion of our deposits are consumer branches with our core customer base. That customer base has been very sticky over time, has been with us for years. In some ways, while we do worry about the digitization of the consumer business in the U.S., these customers are less digitized than others, and they often come to the branch for a lot of socialization, for their favorite branch manager, good old-fashioned relationship banking, which works very well for us. That being said, we are not immune to the changing industry, and we have been investing in a digital banking platform on the consumer bank, about $20 million-$30 million a year for the last couple of years, that we will be rolling out in the coming year, that you'll hear more about it. But the point is, we do recognize that we have to keep up with the platform to be as good or close enough to Wells Fargo or B of A, but the customer does not choose us because our application is more nifty. The customer chooses us because we help them feel more at home in the U.S., and because we understand their particular business needs, language needs, cultural needs, because they have some amount of understanding between the U.S. and China that we can provide value-added services too. On the commercial side, it's a little bit more competitive, just straight up against other national or regional banks. There we have been, over the last several years, investing in the platforms and treasury management services to where at this point in time, we can go head-to-head against any other bank, and it really is about driving growth from a relationship basis. That is basically East West positioning in terms of how do we think about competing against the national banks in the coming environment. The rest of the slides focus on our more recent results and our expectations for the rest of the year and our more traditional financial slide deck that you might find yourself looking at during any other conference. Maybe with these remarks, given the conference theme, maybe we can jump into Q&A so that I just don't rehash the earnings conference call that we just had a couple weeks ago. Because I'm sure that is incredibly exciting for everybody to listen to. Okay. We'll open it up now to Q&A, if anyone has any questions out there. Just with regards to the kind of trade tensions between U.S. and China. How is that affecting you guys and how you're responding to that? Yeah. For our customers, the trade tensions, I think are manifesting themselves in a couple different ways. One, it does impact the growth appetite of our commercial borrowers, but I don't necessarily think that that's unique to East West in the sense that I think commercial customers across the U.S. are probably reacting. Commercial businesses, I mean, are reacting to the geopolitical and macroeconomic volatility more so than trade tensions directly. But for us, we do think that it is a question of growth foregone. You can see from our numbers that year to date, our C&I loan growth has been slower this year than it has been in other years. The fourth quarter will be an important quarter for us to kind of measure that as a yardstick because our wholesale trade portfolio tends to be strongest growth seasonally weighted towards the fourth quarter. Last year that grew at 6%-10% year over year. So come January, we'll see how that has grown. That's about 10% of our C&I portfolio, so that's one slice. However, broadly speaking, throughout C&I, there is a sense from customers that given the volatility, they're less inclined to invest in their business, which then translates back to us. Also, another way where we are seeing the impact of the trade tensions, or rather the political tensions, is entertainment lending. It's a cross-border vertical that we have developed over the last few years, and it's been a great growth area for us, especially as money from China has flown into investing in the U.S. entertainment industry and vice versa. Because of politics, that money has not been flowing in this year. So there is definitely a lack of growth in certain areas due to politics. Just going on that, Julianna, if you think about the loan growth guidance was 10%, then it was lowered down to 7%. You have a number of factors, one being what you call the political issues, be it the trade tariffs with China. You also have elevated prepays in your book, as well as just kind of what the overall underlying demand is from your domestic borrowers. How would you allocate that when you think about whatever that reduction, how would you prioritize that or allocate that into the buckets? Well, I would say that for the September reduction and the outlook for the year, some of those factors were obviously not new to the third quarter. They've been kind of Right percolating throughout the year. Geopolitical volatility, tensions, and all that. What really kind of moved us from 10% to that 7% number come September really was prioritized within all those factors that you mentioned. There was a higher level of pay-downs that we experienced in September that we were not necessarily expecting, say in July with second quarter earnings. Our growth trends from July to August had strengthened, and it looked like we were still kind of in the neighborhood of that approximately 10% for the full year. However, come September, a number of loans prepaid early part in commercial real estate as well because of rates having to drop. Also in September, we had some pay downs in entertainment that we knew there were the projects were ending, but then there was not a replacement of new loans that had been in the pipeline that didn't materialize. One could say that was related to the politics of the changing environment. Also I would say that there were some loans that should have closed in the third quarter, spilled over into fourth quarter. Net where we ended September, we weren't going to hit the 10% for the year. That being said, our guidance does imply strengthening in the fourth quarter, reflecting some of this typical annual seasonality we see in the fourth quarter. Also I would say as of October, we were up $200 million already in loans. Of course, there's pay downs and payoffs that will happen later in the quarter. The point is it's a strong start to the quarter. Right. Okay. I guess sticking with the China theme, let's say we get phase one signed, and let's say we get a different tariff reduction in tariff on both sides. When we see that, obviously I think, okay, East West is going to benefit the most from reduction in trade tension. But from your perspective, does that actually truly drive, I mean, would you actually see stronger loan growth? I mean, obviously improved sentiment then, but what does drive better loan growth with East West? What do we need to see? A full reduction, or is it just the tariffs or? I'm trying to think how correlated- Well, I think the improved sentiment will help a lot because that will help commercial customers feel more comfortable growing their business. So that will have an impact. But I think at the end of the day, the most important driver for our growth is still the U.S. consumer. So to the extent that the outlook for the U.S. economy is stable or good, we will be able to do well. And when it comes to growth for us, part of the reason why we're able to grow more strongly than other peer banks is because we have a well-diversified loan portfolio. So for example, with the share that we have in commercial real estate and the share that we have in single-family mortgage, and single-family mortgage for us has been growing in the mid-teens digits year to date. If you pulled back C&I loan growth to be low single digits, you are still, and you kept just mathematically given the kind of balance of our balance sheet. If you grew CRE and SFR between 5%-10% range, which is robust, and if you grew C&I in the low single digits, you're still net growing above 5% for the total loan portfolio. So net, that's still a pretty good loan growth rate compared to most banks. So for what would drive C&I loan growth higher from where it is today would be two things. One, or what would in any given point, not from today, but at any given point in time, what would drive more robust C&I loan growth would come probably from two areas. One, a feeling that the U.S. consumer will continue to feel good and be robust and buy products, which will then drive improved sentiment from our commercial customers, especially our smaller wholesale trade customers, manufacturing customers. Also improved geopolitical situation between the U.S. and China, where there is more capital flow coming in from China into the U.S., for example, like in entertainment. So sentiment will help a lot. Now, whether or not that will change pipelines within a quarter or two, or will that take more like over the course of a year? We shall see. I mean, next year we are going to be going through an election year. I am not sure whether that will contribute to sentiment volatility or not. Just on prepaid, just as you are talking about then, have they relented at all? I get it is usually back-end weighted, but I am just curious on- It is back-end weighted. I mean, as I said- At this time at the end of October, if we're up net $200 million. Right it's seeming to be okay. But ask me in a couple more weeks. Right when I've got November numbers. Is it mostly the shadow banking market that you're seeing? No. No. No. It's other banks Other banks being more competitive on rates, which is what I would say actually. We have mentioned that overall, given where the environment is today, especially with the uncertainty around C&I. Of course, that changes week to week. But with the uncertainty in the economy and the macroeconomy in general, we have said that we are more comfortable growing in commercial real estate where we have continued to underwrite at a 65% LTV or lower. I can actually flip to the slide that illustrates this point. Here we go. The average LTV on our CRE portfolio is 50%. We started at 60%-65% LTV to begin with. This is not a bad time from a credit risk perspective. This is a very strong portfolio. We were a little less inclined to grow in CRE when you had a lot of C&I loan growth because that was higher yielding. However, at this point in time, it's still an excellent loan with not a bad price, and with a low interest rate environment, we are more comfortable with maybe doing a little bit more growth in that area. Commercial real estate, okay. So to your question about pay downs and payoffs, maybe we will let fewer loans pay off. Right. Okay. Go ahead. Maybe on the credit side, over the past quarter, you've noted a few energy NPLs. In the previous presentation, you mentioned the energy market. What's the latest there, and how long does it take for you to get through these energy credits at a time? So as we said at the earnings conference call, in our energy portfolio, we reviewed it during the second quarter. As we noted, we had the charge-offs that you saw in our 3Q results. We have four loans that are on non-accrual, two of which we have taken the charge-offs on. So substandard doubtful loss is 3% of our loan portfolio. We have two more loans, $25 million on special mention, so that's 5% of our energy portfolio, which is $1.29 billion. That is on special mention, substandard doubtful loss. So criticized and classified. We feel that at this point in time, we have appropriately marked our energy loans in the whole book, including these particular loans that are the problem loans or troubled loans. The resolution of these loans is continuing. This coming quarter, there'll be some incremental charge-offs, obviously not at the same magnitude that you saw in the 3Q just because the full process of resolving them isn't completely finished. I will say that the loss content on those two particular loans was much greater than expected, and it was out of line with the underlying collateral. The previous presenters spoke very eloquently about the issues that the particular industry faced. I think those are similar issues that we faced as well in terms of the collateral evaluation versus the productivity of fracking and the new technologies. We're continuing to work through that portfolio, and we're continuing to reduce the risk, and we feel that given the review that we've done, we're comfortable with where the reserves are for that portfolio today. And all else equal, assuming that the industry doesn't worsen because of these several bad companies, then this is where we are. But if there happens to be a broader weakening in energy that spills over into good performers, then we'd be having another conversation. Lana? Okay. You folks are spending the strongest capital ratio of any bank I've followed. Given the slower loan growth expectations for this year, what are your sort of thoughts about capital allocation? Well, the loan growth expectations for this year were dialed back, but when we think about our capital allocation, we do think about it on a multi-year basis. When we think about do we feel that our multi-year loan growth profile, organic loan growth profile has substantially changed? No, we do not think so. Albeit there's some volatility and uncertainty around C&I, but A, we have the real estate portfolios that can pull forward, and B, while there's some uncertainty today, this does present an opportunity for us to provide more value added to our customers to help them interpret and understand the certainty. We are not in any way, shape, or form saying that our growth profile is changing in a material way. Therefore, from that perspective, we continue to believe that organic growth is the best use of capital. Given our returns in the mid-teens are strong and consistently strong ROA and ROEs, we feel that our returns profile is not sufficiently changing, and our growth profile is not sufficiently changing where buybacks become compelling, especially given the fact that in a couple of years from now, we think we'll have opportunity to use that capital more proactively, hopefully. Are you talking M&A when you say that, or are you just talking about? Generally speaking. Yeah, generally speaking. M&A is not instigated by the buyer. It's instigated by the seller. Right. I'm going to throw another one because I was speaking with Mike Selfridge earlier today and just talking about there's been a lot of movement at different teams, the most recent being JPMorgan hired away a team from Silicon Valley Bank. like venture capital. private equity team. It's an attractive business with an attractive risk profile that comes with high-quality deposits. It seems like more and more people are coming into the game. I'm just curious how you guys view the competitive dynamic, how it's changed, and if you've seen any difference, and if you're reacting at all. Well, from the perspective of whether or not JPMorgan and Wells Fargo are competitors or Chase at the branch-based level are competitors for us from the Chinese affinity bank space, very much so. When you go and look at our branch footprint across the street, there oftentimes is a Wells. There's oftentimes a Chase branch through Washington Mutual. So from a Chinese American banking perspective, they've always been present. And they've tried over time to have more direct initiatives to kind of penetrating the Asian American sector. But because they're national banks, sometimes they mess up a little. They sell the wrong festival with the wrong symbols in the local newspaper, which then works to our benefit. Right. But nevertheless, it's not that they're not present in our space. Yeah. But in order for them to At the cross-border level, JP Morgan Corporate Bank and Citibank have licenses in China. They're big gorillas over there. Right. But at the end of the day, the customer base that we serve, they're too small to be given the white glove treatment by the national banks. So we feel there's definitely a lot of space for us to run in. Right. And we continue to compete against HSBC in the U.S., Standard Chartered in China. So there's not a substantial change to the competition, whereas from what you mentioned about Silicon Valley Bank, it seems like JPMorgan is deciding to spend a little bit more attention to a great niche. Right. But we'll see whether or not they're successful or if they advertise the wrong symbols with the wrong festival as they did with- Right. Well, that was maybe JP Morgan. That might have been Wells. The point is. Yeah. All right, let me ask a different way. When you look at You guys are very specialized. Aside from the Asian American focus, you have a lot of different niches. Specialized verticals. Has there been any shift in the competitive dynamic that makes any of those niches less attractive, more attractive that you guys are seeing? Yeah. We select our niches based on our perception of where the cross-border business flows will be. Right? From time to time, they do become more competitive from other banks. Like for example, private equity lending. We've been doing that for a number of years, and of course, more recently, a lot of banks have started up teams, hired away teams from other banks, and are starting verticals in the space. It's a great space. For us, the differentiating factor there isn't to compete head to head against other regional banks. It is to try to find a cross-border niche there. So funds that are based in Hong Kong and want to invest in properties, companies in the U.S., we can definitely help facilitate that and win that business over say, name a bank that recently started a private equity-- Signature Bank. Private equity team. For a Hong Kong-based fund, do you pick East West or you pick Signature Bank? Right. We find the niche for ourselves in these industry verticals, and that's how we've selected them. Entertainment, that was a great example of the cross-border business that's flowed both ways and is a component of our China balance sheet. Right. Private equity has its niche area where we can focus on. Life sciences and technology, competing against Silicon Valley Bank head to head, they're the dominant player in this space. Right. Nevertheless, within technology and life sciences, there are a lot of companies that have an Asia or China strategy to their business, whether it's in the supply chain, whether it's in engineering, somewhere or another. By providing an understanding of that, we can compete without necessarily having to compete on price and covenants. Since you brought up this question, I should also mention that in the last couple of years, what we've done was not just rely on these specialized industry verticals to drive cross-border growth. We've set up a team at the bank that is a cross-border kind of product team, like a matrix structure, where we've pulled out bankers from all of our C&I industries, including kind of general C&I, where they're the specialists in cross-border banking. We've moved some of them over to China. They sit both in the U.S. and China. They work together, and their mandate is to go through our existing loan portfolio and expand the cross-border market share, wallet share of our commercial customers and consumer customers, and also to find new businesses or, say, subsidiaries of Chinese companies in the U.S. There's no reason why we shouldn't be banking a lot of those, and our market share on those is very small. A more targeted, systematized approach is where we are ready to do that now that we have, over the last decade or so, we've established the banking capabilities of being a regional bank. Now we need to more systematically apply that to winning cross-border business. Okay, thanks. Hey, Tom. A question about HSBC and the competitive dynamic within the U.S. with them. Because while obviously they're a huge bank, their U.S. operations aren't particularly profitable. There's been debate as to whether there's going to be a broad restructuring at HSBC, because they're still searching for a new CEO. Have the dynamics of the competition with HSBC changed in the last several years? I think the dynamics at the enterprise and corporate level of HSBC do not necessarily translate into changing dynamics at the branch level. Our RMs, when they're competing for business against a banker from HSBC, that continues to be very much part and parcel of the game. There's less impact than one would think from the corporate level on down at these levels. It can be very competitive priced deposits from them. If they were to exit the U.S., would there be an opportunity for you to- Win some business? Yeah. Certainly. Or for you to acquire some of their operations? There will be certainly opportunity for us to capitalize on their retrenchment. On the income side, the past two quarters, you had a step up of about $50 million in net bank card revenues. It's never been as big a part of the story as NII, but how much of that is due to changes in interest rates and more temporary, and how much is more structural to the initiative going forward? I think a good amount of that is related to interest rates. I think if you look at where the step up has come, it really has come from derivatives and swap income. In the current interest rate environment, the demand for swap products has really increased. So if you look at the customer base in that table on the bottom right-hand side of the slide, our customer base revenue derivatives has now been running at over $11 million a quarter. So that's a response to current interest rate environment compared to in the 3Q of 2018 at $4 million. So that is environmental. We have broadened kind of the product set that we do offer through our IR group, but nevertheless, that is a reflection of interest rates. The same thing, improved volume from FX does come from a little bit reflecting market volatility. There has not been a substantial change in our verticals that we've put in that would drive that kind of an increase outside of the market forces. Maybe we can talk, especially given your balance sheet, the importance of it is paramount in preserving the NIM, but you guys did do a very good job with deposit cost during the quarter on a spot rate basis. The loan book is what it is in terms of the percent that's based off LIBOR. Maybe you could talk about the competition and maybe the differences in the different markets that you're seeing and the strategies that you're employing to get the deposit cost down. Yeah. Thank you for that compliment. We did manage to reduce our deposit costs nicely this quarter. We started the deposit cost reduction efforts back in the second quarter ahead of Fed funds cutting the rates, and then, of course, the momentum continued through the third quarter. It's continuing through the fourth quarter. In terms of the dynamics driving that, it's less about regional-based pricing competition as much as it's about, for one, we are more proactively reducing some of our higher cost deposits in our mix. What the previous presenter called network deposits. Those are priced at 2% or higher, and so just reducing that in the mix will help a lot. Second, across the board by deposit type, we have been working on reducing pricing, particularly exception pricing. In the run-up during rising rate environment, you control deposit costs through exception pricing rather than moving posted rates. You can reduce that fairly quickly, but it just takes time and iterations of calling the customer and reducing the rate, calling the customer and reducing the rate. So maybe the first Fed fund cuts you reduce by 10 bps or the next Fed fund cuts you can do 15 or 25, kind of customer specific. And thirdly, given the kind of changing interest rate environment and the outlook for declining rates and also frankly the outlook for slower loan growth, we are more comfortable operating maybe closer to 95% loan-to-deposit ratio. We have said over time that we're comfortable operating 90%-95%, and we've typically been closer to the 90% because you want to have excess liquidity, especially when growth is going to surprise you on the upside. As it has over the years. But given this year's growth dynamics, being a little closer to 95%, we feel is appropriate. That gives us an opportunity to kind of control the overall deposit costs. And then, lastly, it's come from branch-based DDA campaigns focused on the small business demand accounts, and that's really kind of helped to contribute and control deposit costs allowing us to run off and exit higher cost relationships. But it really hasn't been regional pricing driven. Right. As far as the competitive pricing dynamics, while we're anecdotally getting less and less questions about exception pricing and approvals for exception pricing, that's improved a little bit. With each incremental rate cut, our customers are becoming more receptive to lower rates. The sentiment's also improving there. Nevertheless, the competition at the branch level remains acute. When other banks start to also price a little lower, I think we'll all benefit. Right. Okay. If the Fed stopped and say we're done now, when would you anticipate stabilization of your net interest margin given what you're seeing in the marketplace now, all else being equal? All else equal, it'll probably take the second quarter. Okay After rates stop because with a 70% variable rate loan portfolio. Right it takes about a quarter for most of the loans to renew and reprice. If the Fed stops raising in quarter one, quarter two we finish the loan repricing, and in quarter three margins should all equal stabilize. We will continue to have several quarters of benefits though from the maturity of CDs. In the fourth quarter of this year, first quarter of next year and second quarter of next year where we have $2 billion or more of CDs maturing each of those quarters at close to 2% rates. The CD rate in October was 1.36%, which is a blend of higher cost commercial CDs and our consumer CDs rate in October of new money originations and renewals was 1.11. So CDs maturing $2 billion plus for the next three quarters will help. Depending on when the Fed stops, if it stops now, then we'd still have a little bit of a lag on the deposit costs beyond when the loan portfolio repriced. But of course, then you get into the dynamics of where are the new loan yields coming in. Are they lower than your blended portfolio yields a little bit or a lot depending on what the growth is? I mean, in our SFR mortgage product, that's a high yielding product for us. Right. Right. If that's a growth grower, that might be net net a good thing. So, at least stabilization within the second quarter after rates cut. Okay. Yeah. All right. Yep. Thank you. Any other questions out there? We're actually almost out of time anyway. Oh my goodness. Yeah. Thank you. Well, we have actually, there is a cocktail, I don't know if it's a half hour or hour right next door, and then at I guess it's a half an hour because I think at 5:30 down the lobby, there'll be buses to bring you to the B of A dinner. But thank you, Julianna. That was great. Thank you very much, and thank you everybody. See you at the cocktail half hour.