Barclays 2016 Global Financial Services Conference

Sep 13, 2016

Great. Well, good morning. My name is Matt Keating. I cover the U.S. Mid Cap banks for Barclays. We're delighted to welcome East West Bancorp to our global financial services conference. From the company, we're very pleased to welcome back Dominic Ng, who's the CEO of East West, obviously. This is the first time Dominic's been back to this conference since 2009, so I think you guys are in for a special treat, in terms of the strategic update he'll provide on the company. We will be conducting this presentation via fireside chat format. Really, we want to hear the most about Dominic's update on the business. With that, I'll open it up before we really get into the nitty-gritty questions. Dominic, has there been any changes you've noticed in the operating environment, et cetera, since the company had its July conference call? I know it hasn't been that long, but we have seen the rate environment move up and down on LIBOR specifically. Are there any other updates from a loan growth perspective that you guys have seen? Certainly, the bank did sort of tick down its loan growth expectations a bit for the second half of this year. I really want to leave it more open-ended to you in terms of any developments you've seen over the past month and a half or so. Well, I think overall, if we looked at in the California region, I think that it's still going through some nice steady growth. In fact, I would say that entire U.S. economy has always been going through this steady growth rate. The challenge is really globally, from Brexit and then some of these other more challenging regions that always create, I guess, news that affect interest rate movement. Our position is that since 2009, I've been basically holding our balance sheet to be more asset sensitive and then get all the investment securities in the shortest duration that we can, and then expecting interest rate to rise. It's been seven years in the waiting. Still hasn't happened yet. But the longer we wait, the more likely it's going to happen. So every year, I feel more confident that something good is going to be coming out. As I look at it today, we actually guide down our guidance in terms of not expecting interest rate movement anymore for the rest of the year. Hopefully, that we are conservatively incorrect. As long as rate comes up, it's always going to be beneficial to East West. But without the rate increases, our position is that we still have enough ability to generate record earnings every year. If there are rate increases, it's great. If not, we'll find a way to still get our earnings per share growth to a way that outperform all our peers. That's the direction that we're taking. From a loan growth point of view, we also guided down to 6% because of all this volatility going on around the world. But more so from an East West Bank point of view is that we are putting a lot of focus on operational excellence. We started that initiative in late 2014, and then we continued to build up our entire enterprise risk management. As you know, that we also have BSA/AML issue that we need to get through. And so we're spending a lot of time and efforts to upgrading our system, our procedures, and even people in that operation excellence area. So we feel very strongly that comes, let's say, 12 months from now, we will be in very good shape. And with that, I think that if we take it from that period forward, East West will have a much more likelihood to be able to leverage on the operational excellence and be able to do substantially more business in many different ways, simply because that I think that we have a much stronger back office to back up our growth initiative going forward. So I see that definitely in 2017, that we'll pick up hopefully a little bit of expense reduction. I mean, not as much consultants coming in and not as many systems to convert, and then more so in 2018 and forward. And in the meantime, when you have a strong team that know exactly what you need to do from a procedure, policies, and business-wise, and then with a much stronger risk oversight, I think that we'll be able to actually give ourself more confidence to expand and look into more industry specialties, expertise that we have been doing, and also continuing our mission to be the financial bridge between the East and the West. That's a nice transition, Dominic. So maybe for some of those that might be less versed in the East West story, you've been leading the organization for some time. You became President and CEO back in 1992. Maybe you could talk about maybe what attracted you, first and foremost, to the banking industry generally, and about the East West opportunity more specifically, for those that may be less accustomed to the history of the bank, et cetera. Banking industry. That's a tough question. In fact, I sort of got into the job as a professional duty. I started my career at Deloitte & Touche. In fact, I was one of these foreign students who got recruited by Touche Ross, former Deloitte & Touche, and they helped me to get work permit, green card, et cetera. After five years in the Houston office, I was asked to transfer to Los Angeles. At that time that was because I had a very special technical expertise in SEC accounting and so forth. I was asked to work on the Northrop Grumman account for that technical expertise. This is one of the interesting situation. At the time, the partners that recruited me did not check on my background, was not aware that I was still one year from getting my U.S. citizenship, which I still had a green card at that point. Obviously at that time, it wasn't worked out because going through national security for someone who is a naturalized citizen, just not going to work. I ended up not working on that account. Kind of either on my way back to Houston office and kept doing what I was doing, or find some other industry to work on in Los Angeles. The managing partners, basically that recruited me, talked me into going to the banking industry. That's how I got into the banking industry. I personally look at the banking industry as such that it's interesting because banks works on many different clients and basically have to tap into all different industries. It's a place that really allow me to really get to see whether it's from oil and gas to entertainment, high tech, clean tech, agriculture, et cetera. I think that's exciting. East West wasn't in that position then. When I helped the investor to acquire East West in 1991, it was a savings and loan, a very small savings and loan, and it's focused in Chinatown, Los Angeles, mainly for the Chinese immigrant population. I thought that was a very unique niche business, have strong value proposition. However, I didn't think that I was able to take it from a $600 million asset to somewhere in a meaningful size and to be able to compete effectively in a sustainable manner. For that reason, first thing I did when I became the CEO, I changed the mission statement. Not that I would walk away from the good cause of serving the Chinese immigrant, first-generation immigrant population. We'll continue to focus on that area and be as good as we could be. But on top of that, we started expanding, and we put our mission out as the bridge between the East and the West. We thought that with all the contact we have within the Chinese community, we will be able to leverage on that to help serve some of the mainstream customers who actually will find it very interesting to do business in Asia and vice versa. That is the direction we took. As a savings and loan, we started first in the commercial real estate sector to go mainstream. One year at a time, and then I think as of today, real estate is only about 30%. CRE is only about 30% of our overall portfolio. In the C&I side, we cover industry from high tech, clean tech, agriculture, entertainment, oil and gas. Agriculture. I mean, things that I just talked about earlier. Plus, there are many other opportunities that we can explore going forward in the future. Our core value proposition and the core banking focus, still making sure that we differentiate ourselves from our peers as the financial bridge between the East and West. I think that U.S. and China continue to do many business together, and there is going to be plenty of room for us to grow. Hmm. The bank clearly seems focused on diversifying the mix within its loan portfolio. You talked earlier about the 6% growth for the second half of this year. I guess the question, thinking out more long term, is that a new normal for East West or is that a temporary transition as it gets to the desired loan mix within its portfolio? If 6% growth is the new normal for the organization, do capital return levels change over time? How do you think about managing the capital base, et cetera? Well, I would not call it 6% the new normal. I just think that for our current situation, I think that it makes sense based on the current environment. I think that we also need to take a look at where we are transitioning our balance sheet from one place to another. In fact, two years ago, we have some tremendous growth in single-family mortgages. Because there are many Chinese investors from China actually buying homes all over in California, New York, and in most of the cities that we have our branches. We decided that with that growth, we need to figure out a way to make sure that we can sell down some of those originations. We have done that, and we tested it. I think it worked out well. In 2014 and 2015, we have some pretty good loan growth in CRE area. I think it got the percentage of CRE concentration to capital up to 285%, not anywhere close to 300% yet. We decided that because our focus on diversity, that we will quickly pare it down by selling some of these loans. It is not that we have to pare it down, but I wanted to do this as a fire drill just to see how effective our team are when we need them to sell down the loans. We have done that in the first and second quarter, and now we are down to 260%, 265% of that range. It gives us plenty of room, so it can get us back into normal. When we are doing this kind of strategic fire drill, I think it does have some impact to the normal growth, so to speak. I chose this year as the right year because we are going to be spending a lot more time in the enterprise risk management overhaul anyway. Since our earnings still looking pretty strong, our return on equity and return of assets still above our peers. We just thought that why not just do the right thing in the next year or so, and then get us back into what I call the normal East West type of activities. From that standpoint, I do not know whether we will be at 6% or 8% or 10% growth in the next two years or so. I tell you why. The reason I hedge that is because we do not know what the economy will bear. At East West, we never measure ourselves by putting out like a, we have to be in certain asset, we have to have certain loan growth rate. Let us put it back in 1991 when I bought East West Bank, we had $600 million in assets. I never at that time said that, "Well, we are at $600 million in asset, we need to be in $5 billion one day, or we need to be $10 billion by 10 years from now," or today, $33 billion. What we did was, day one when I became the CEO then, we had a very clear objective, that is that we want to be one of the best performing banks in the country among our peer group. If I were at $600 million, it is going to be banks about $300 million to $1 billion. If I were $10 billion, then it will be banks from $5 billion to $20 billion. Now with this size, it is going to be bank from probably $20 billion to $60 billion or so. That is what we are looking at comparing ourselves with. So far, if I look at three to five years span, and I look back, we have consistently been in the top three every single time. Therefore, our position is that we want to make sure that from a return on equity, return of investment, and if we can even do total shareholder return, and all of that other factors, if you put them all in, I would say that I want to be outperforming our peer group. That is what I focus. You cannot do that every quarter, but you better make sure you can do it every three years and five years. So that's what we've been working on. From that position, if the economy calls for a slower loan growth, and our peers is going to be at 4%, I think 6% is pretty good. If the peer is at 12%, 10% is not good enough. We probably need to be a little bit more. But loans also is just a mean to an end. When you're trying to get your ROI, ROE, and then earning per share growth rate, et cetera, there are different levers that we can work on, whether it's the expense side or the loans or the deposit or the fee income. We're going to do everything we can to make sure we do the right thing. And that's why I looked at. To do the right thing is that you can quickly identify it within 12 months, within quarter, or maybe within 3 years, how do we compare with our peers? And that's what we measure ourselves. That's quite helpful. So within the context of 2016 being a bit of an investment year for East West Bank, can you talk, I think it was back in January, the bank had mentioned that part of the, maybe almost half the expense growth that it was projecting could be related to selective hiring of frontline talent, specifically trying to attract new C&I bankers to the organization. Can you provide an update? Did the company make any progress on that front, or what does this environment look like for hiring the type of talent that the bank's looking for on the C&I banker side at this point? We are still very strategically looking at bankers that have expertise in specific industry sector. For example, we hire a small group of oil and gas lender late last year. So within that group, now we add another one or two, and then we also brought in a decent group, small group of asset-based lending individuals. And so within that group, we also add in another one or two. So what we are doing right now is that we're looking at all the different industry sectors that we have specialized expertise in, and we continue to identify talents in the banking industry and do the fill-in. So I think that in the long run, these sort of very strategically small fill-in is going to be something that will definitely make an impact. Great. Why don't we transition, we're about halfway through the presentation. Why don't we transition to some of the audience response questions to allow for some greater audience participation? If we could please bring up the first question. Take a second here. Maybe while they're working on that, why don't we'll go to something else until that comes up. Maybe you could talk about East West adjusted efficiency ratio. I mean, it's quite impressive for a bank its size, although it is up from, I think historically it had been closer to low 40s range. Now you may be closer to 45% extra tax credit amortization. What do you think? Obviously, there's more investments that banks need to make as they grow. East West is up to $33 billion in assets. What does it look like, in your view, a sustainable efficiency ratio for the organization? Well, I think where we are in terms of the mid to high 40s is definitely very sustainable from my perspective, which is still substantially lower than most of our peers. I think this is one of the areas that maybe people may not pay attention as much. Clearly, a lot of people saw our rapid loan growth for the last six, seven years, double-digit growth, and very impressive. But they neglected to see that actually our expenses control is even more impressive. So it's an area that we would continue to put focus on. I think that this year we spent a lot of money with consultants and system conversion, et cetera, for BSA/AML program, and then plus some of the other enterprise risk oversight programs. I think going forward, there is still going to be more. Because when we get bigger, someday we're going to have to get to deal with that $50 billion threshold. On top of that, we never know what the regulatory environment is going to be like. I think that there may be even more new regulation that comes in. But I'm not too worried about it, because if we have to deal with it, our peers have to deal with it also. So it's all going to be equal footing. But I still think that there is plenty of opportunities for us to work some of the expenses down. I think it's easy for us to make excuse in saying that because we are now over $30 billion, we are being treated like a larger bank. Whether it's DFAST, stress tests, and BSA/AML, and then CRA, everything has to be much more cumbersome in terms of comparing the small community banks that we used to be. That's one. On the other hand, I looked at it as that since we have the size and the scale, there are plenty of way to create better efficiency. There are operational improvement that we can still look into. I still think there are plenty of rooms. I just think that bankers are, in general, not as efficient as folks in the manufacturing industry. The guys who work in the assembly line are substantially more efficient in terms of how to run an operation. Banks don't. Which create an opportunity for us to really trying to dramatically lower the expenses, not any lower than we need to, but lower compared with our peers. I think that we still have room to work on it. Back in the 1990s, we had efficiency ratio in the high 40s, and even reach above 50. I worked it down to 36%, 37%. But obviously when you are going from a more real estate driven type of institution now to where we are with international banking, we have to work back up again. But in time, we will find a way to work it down. Can you talk about the response that the East West employee base has made to the BSA/AML sort of improvements, and how that focus maybe has permeated the organization? How have you driven that down to the level within the organization? I think you have been pleased by how the employee base has responded to this challenge, but you could talk maybe more specifically some examples of how the employees are actually being more vigilant around this process. Absolutely. From a regulatory challenges, we always looked at it as that it cannot be just bringing in the top price consultants and putting the state-of-the-art system and then give us the, what I call brand new, most up-to-date policy, and then everybody follow. That is not going to work. What it works is really a cultural change. East West traditionally have always respected law and regulations. However, we just missed it by not knowing that we actually get to the size and have a different standard. We learned our lesson for the first time in the history that I have been in the bank for 25 years, that we had a consent order. We never had an MOU consent order ever. This is the first time hit. When you talk about a, let us say, a law-abiding citizen suddenly gets sent to jail, that is a big impact. It is not only it is a big impact to me, but it is a big impact to all our associates. They have a lot of pride. They walk around town all day long talking about this is the only banks in town that never had any regulatory blemish, and finally, we got a blemish. It did not sit well with our associates. Anyway, I think the entire organization, we made a decision that we are going to need to have this cultural change. It is a lot of work that we need to do because I wanted to do a more comprehensive fix. It is not in just one area to fixing the system. We basically from human resources area, from policy, from procedures, from system, we are changing everything to get it in the right place. We are still working very hard, making great progress. Not done yet. I think that we're looking at trying to get as much as possible, get everything wrapped up in 2016, then wait for the regulator to come in and then hopefully do the blessing. But with that in mind, our position is that we're not going to try to pass the test. This is not like going through an SAT and then just hopefully get great points and then move forward. This is something that once we're done, if we do get the proper blessing, we wanted to continue to maintain and make this a sustainable program. We think that if we do our BSA/AML program correctly, if we do it right, we actually will become more efficient. Because by just not having problem here, it will save some tremendous amount of cost to have a recurring order in the future. Secondly, I do feel that if we spend enough time to really think through the process and what's best for ourself, to protect ourself and also what's best for the customer, we will end up finding way to better serve our customer. I'm pretty excited about building what I call the best-in-class BSA/AML program. Not just to please the regulator, but I think this is something that if we do it right, it will create better operational efficiency. I think that having a much better transparency and knowledge of this regulation, it actually helps our customer. Because oftentimes customer also don't know what the heck's going on, and then they make mistake inadvertently, and with the banks not alerting them appropriately, it's got everybody in trouble. Mm-hmm. Were the areas of focus from the regulators around BSA/AML, was it more on the commercial or consumer side of the bank, or was it both aspects of the systems? For us, it's really both because mainly, it's not like that we have any At this point, so far, we haven't had any specific accounts that some of these egregious things that you've seen from the newspaper, some of the other banks, we don't have anything like that. We're just like, I would say that our BSA program was just not well done in a way that the system is just inefficient. Also the human resource is inadequate, and then the policy procedures is outdated, and that's the kind of things that we need to fix. From that standpoint, I just think that, once we get that behind us, we will be fine. It really covers both commercial and consumer. Right. No, that's helpful. It's worth noting that it was a written consent, not the more severe regulatory enforcement actions. I think to your point that East West, it sounds like it just needs to upgrade the systems as opposed to actually having real clear issues at this point. Great. Maybe we could move to fee income. At around 12% of East West overall revenue base, the fee income mix is comparatively low at the organization. Is that something that the company is looking to improve over time? How is it planning to go about augmenting that fee income composition? Yes. We will continue to work on expanding in the fee income area. Actually, for many years, if you have an opportunity to look back in our P&L, our fee income growth was actually always growing at a nice pace. It's just that because our loan growth have always been so good, the interest income keep piling in and then causing the fee income growth, because fee income was so small as an S&L, it almost didn't exist. While we just keep having a 20%, 30% growth or something like that, it just couldn't outmatch with the other side of the equation. Let me explain why. Because the fee income's all organic. For the balance sheet, in terms of loan side, we have about maybe 65% of our growth are organic. The rest of them are all acquisitions. Every acquisition we made, we bought another bank, they have zero fee income. That's why it make the fee income growth very challenging as a percentage. But in the dollar amount, it actually been growing. It's just as a percentage to the overall revenue, it has not been that impressive. Now, one way to fix that is to go out and make a big acquisition for an asset management company and things like that. We decided not to do that. We just didn't think that, with the price premium out there, it makes sense for us to be going in that situation. I just leave the percentage, looks a little bit weak, but all in all, as long as I know I continue to grow the business. The areas that I really wanted to focus on, actually, for the fee income, we've always believed that East West will be able to have a pretty consistent, nice growth in international letters of credit, foreign exchange, in these areas. However, I would say that the last 12 months, that growth has kind of slowed down a little bit. I think it's just a little bit of a transitional year in China. I do feel that, at least after a year or so, this is beyond just that China went from double digit growth to 6%, and that is what causing the slowdown. I don't think that it is exactly the fact. What happened is really, is that China is going through a lot of regulatory reform, and going through that regulatory reform, it has a lot of new policy procedure that comes out that cause less of these transaction to be happening. From our perspective, once there is clarity, I think the business is going to be back on again. I do feel that there is still going to be rooms for years to come in terms of growing these areas. Great. Well, at this point, why don't we open it up to questions from the audience, to the extent there is any questions in the room? Hey, good morning. I just had a question on just commercial real estate concentration. I know you did sell more or less, $75 million worth of CRE loans in the last quarter. Just wondering, was that regulator suggested, or was this just purely something you plan to do for your own diversification, give yourself a little more headroom across the various lending verticals? Should we anticipate any further loan sales to come? Thanks. In terms of whether it is regulatory suggestion to sell down the loans, the answer is no. In fact, I am sure that during this conference, you probably will hear from many other banks who said that they are probably way over 300% in terms of CRE concentration to capital, and they just make sure that they have a good rationale to justify why they should be over 400% in CRE concentration and so forth. There are banks that can choose to do that. We could have easily have chosen that path. In fact, as many of you know that I don't think that there are any banks in the country have the CRE like what we have that is at average about 50% loan-to-value with a debt coverage ratio that are very high. However, I think that this is something very East West, that is that we are taking the position that we will continue to have a very diversified loan portfolio. We did not have a very diversified loan portfolio in 2008, and we paid for the price. United Commercial Bank also did not. They paid for a deeper price, which end up helping East West to offset our losses. But all in all, our position now is that we have done really well from a financial performance point of view, year in, year out for the last six, seven years. If you put our numbers up comparing with our peers, you can look at it three years, five years, we probably, if not number one, it is going to be the top three. I looked at it, is that, is it really necessary to push it too hard? Why not just continue to have more risk diversification? The whole idea about once residential real estate gone up a little bit too fast in 2014, we did some sell down. The sell down is not that, well, it is too much there. It is just to prove that we can always have the lever to move it up, move it down. We did that drill for CRE first and second quarter. Obviously, at that 260% kind of range, we have plenty of room, so there is no reason to go out there and do any more sell down. But we have to do the sell down just to prove to myself that when I ask my associates in the real estate department to say, "I want you to sell down now. Go ahead and take care of it now," they can take care of it. They have proven to me that sort of our overall CRE risk management is working as agreed, and that is the whole purpose. Going forward, we really don't think that we have to. However, if we suddenly have a nice pace picked up, I am not going to have my great clients to be rejected by East West because we say we have reached a certain limit. The whole idea is that we wanted to serve our clients. We do everything we can to take care of them, and so we need to sell down more loans to accommodate our clients acquisition of good assets. We will do that. Dominic, do you feel that East West has the appropriate commercial real estate risk management practices and procedures in place to go above 300% if it so chose to? I think that from a risk profile of our real estate today, absolutely. However, is that something that I feel that meet what I call the more ideal standard that I would like to see us going? No. In fact, this is another area that we're working on today. While we originate high quality assets, our clients tend to have much higher equity down payment. Many of our clients actually from Asia willing to even provide personal guarantee. I mean, how often do you find a loan that have 40%, 50% down payment and then they even give you the personal guarantee on top of that? I mean, not very likely in a conventional way in the U.S., but that's what we get. Just because of that doesn't mean that we actually have a strong CRE risk management oversight. Because if you just keep making good real estate every day, but if you do not slicing and dicing them properly, I still think that in the long run, when we get much bigger, when there are thousands of thousands of CRE loans that are spread all over the country, it's going to be a little bit hard for us to figure out what the risk profile, right? From my perspective is that preparing ourselves to be a much bigger bank, even though we have individual underwriting criteria that is very strong, robust, and then we have demand coming from customers that tend to be in that what I call low risk profile. I still wanted to build our CRE risk management system that are data-driven, and that we can always slicing and dicing the numbers in certain way, and then they have a good tie-in between the CRE department to when we run our stress tests and all that kind of stuff. We're working on it. We are making good stride, but I think we're not quite there yet. It'll get there within a year. Maybe just to follow up on the energy lending. Where in the supply chain are you lending? What types of companies within energy, and what's your standard loan-to-reserve value that you assume when you're underwriting oil assets today? Mainly in the reserve area. I would say that so far, we are staying away from the service area, but we are mainly focused on the reserve area because the loan-to-value at this point is. I do not have exactly the average of the loan-to-value because we do not have as many loans like the CRE that we do not have that kind of process. I need to go back and check if you are interested. But the good news is that, obviously, we are coming in at the time when the valuation is the lowest. It allows and when we put in another cushion on top of it makes these loans very attractive. So far we also have not been very aggressive and then just going out and say that, well, with this distressed market, we are just going to go in and then take loans from all the other banks. We try not to do that. We have been very selectively making sure that we only take on loans that have very low likelihood of default simply by just providing a big cushion to the reserve valuation. That is what we are doing. How about you? How do you look at the interest rate risk to the loan portfolio in terms of asset values if rates were to rise 100-200 basis points? Well, from our perspective, obviously, we do our stress tests to see how much, let's say if interest rate go up 100% and then 200 basis, and then also, well, 100 basis points to 200 basis points, how would it affect us in terms of the asset quality? We do some of these simulation tests, stress tests. From our perspective here is that, in general, East West Bank trying to take the position that we need to manage our credit risk, and we don't want to overburden ourselves to manage the interest rate risk. By doing that, and that's why if you look at our balance sheet, all our C&I loans are pretty short duration and also adjustable. Pretty much almost all our CRE loans are adjustable. For any of our customers who rightfully so want to have a fixed rate loans to hedge the risk, we do an interest rate swap. While the customers are having a fixed rate loan, we have an adjustable LIBOR deal. By doing that, I think pretty much for East West, when rates do rise, and I don't see how rates can come down anymore, so when rates do rise, we'll pick up some nice interest income. When I look at our customers also, we underwrite in the way that, for example, currently, our CRE, we underwrite with over 6%, assuming that while, obviously, we're lending at an adjustable at maybe 3.5% to 4% rate, adjustable. But we are stress testing it about 6%, just to make sure that, hey, in case there is that big spike. I don't see that coming anytime soon, but just in case there's a big spike, would the debt coverage ratio still be adequate? We're doing that, and it's worked out. Well, we're actually out of time, but there will be a breakout session directly after in Liberty Room 3. Please join me in thanking Dominic Ng and East West for the presentation today.