East West Bancorp Inc (EWBC) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2006 East West Bancorp Earnings Conference Call. My name is Minotia, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of today’s presentation. [Operator Instructions]

I would now like turn the presentation over to your host for today’s call, Ms. Irene Oh, Vice President. Please proceed, ma’am.

Good morning, everyone, and thank you for joining us to review the financial results of the East West for the second quarter of 2006. In a moment, Dominic Ng, our Chairman, President, and Chief Executive Officer, will provide highlights for the quarter. Then Julia Gouw, our Executive Vice President and Chief Financial Officer, will review the financial details. We will then open the call to questions.

First, I would like to caution participants that during the course of the conference call today, management may make projections or other forward-looking statements regarding the 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. We wish to caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties. For a more detailed description of factors that affect the company’s operating results, we refer to you our filings with the Securities and Exchange Commission, including our annual report on Form 10K for the year ended December 31, 2005. Today’s call is also being recorded and will be available in replay format at at www.eastwestbank.com and www.streetevents.com.

I will now turn the call over to Dominic.

Thank you, Irene. Good morning. Thank you all for joining us at the earnings call this morning. Yesterday afternoon we were very pleased to report second quarter net income for 2006 of $36.6 million, the highest ever in the history of the bank. Diluted earnings per share were a record $0.59 a share, up 26% from the second quarter a year ago, and up 7% from the first quarter of 2006. Shortly, Julia will summarize our financial performance for the second quarter. First, I would like to provide a quick overview of the quarter and then give an update on our outlook for the rest of 2006.

East West delivered strong results for the second quarter of 2006. Total assets reached $10 billion for the first time. Loan growth was healthy. Credit quality remains at very high levels. Our net income for the quarter of $36.6 million was an increase of 44% over the second quarter of 2005. In fact, net income for the quarter was greater than the entire year of net income we earned just six years ago in year 2000, which, by the way, was also a record year. We are pleased with the growth we have achieved in the past and confident that we will be able to continue to grow in the future.

Our performance for the second quarter was driven by the solid loan growth. Despite the change in the real estate market, we achieved double-digit loan growth in all major areas of our lending business. During the quarter, we securitized a total of $334.5 million in single-family and multi-family loans. Excluding the impact of these securitizations, quarter-to-date loan growth was impressive, $551.7 million, over 29% annualized. Quarter-to-date organic growth in commercial real estate loans was $176.3 million, over 20% annualized. Multi-family real estate was $120.3 million, 30% annualized, and single-family real estate was $100.7 million, or 62% annualized. Also, quarter-to-date organic growth in construction loans was $78.4 million, or 41% annualized. Commercial loans was $54.4 million, or 30%. Trade finance was $18 million, or 33%, and consumer loans was $3.5 million, or 7%.

On the deposit front, quarter-to-date total deposits growth grew $103.3 million, or 6% on an annualized basis. Additionally, core deposits grew $73.6 million, or 9% on an annualized basis. The reason that probable future set rate increases continues to fuel strong pricing competition among banks. As such, deposit pricing remains very competitive, resulting in deposit growth that is not as strong as [inaudible].

With that said, we remain very positive on the outlook for the second half of 2006. We anticipate that a high interest rate and a flat U curve may compress our margins in the near future. To be prudent, we have lowered our net interest margin figures for the rest of 2006 to be in the 4 to 4.1% range. Although our net interest margin may be impacted by the current interest rate environment, we believe that our fundamental business is very strong and grows well.

We currently estimate that earnings per share for the full year of 2006 will increase 16 to 17% from year end 2005 and in the range of $2.28 to $2.30. The key factors for increased earnings per shares guidance are low growth, credit quality, and in fact of the larger volume and scale of our business. We continue to project an annualized loan growth of 15 to 17% for the balance of 2006. During the first half of the year we originated $2.6 billion in new loans, already 69% of the total loans originated in 2005 of $3.7 billion. Credit quality continues to remain excellent throughout our portfolio. Our performing assets were a low 11 basis point of total assets as of June 30, 2006. Although we continue to make investments in our infrastructure to support and rise our growth, our larger scale enables us to be more efficient. For the full year of 2006, we expect operating expenses to increase 25 to 28% from prior year, but estimate that our efficiency ratio will be between 36 and 38% for the year.

Additionally, I’m pleased to announce that earlier in the month we successfully completed the full system conversion and integration of Standard Bank. The conversion was smooth, timely, and did not present any operational challenges to our people or customers.

I will now turn the call over to Julia, who will discuss in more depth the results of the second quarter 2006.

Thank you, Dominic. I will provide a summary on the financial results of the second quarter of 2006. The press release contains a detailed discussion of the financial results for the quarter, so I will focus on key points.

We were very pleased to report second quarter earnings per share of $0.59, an increase of $0.12 per share from the prior year period, and an increase of $0.04 per share from the previous quarter.

Our net interest margin for the quarter equals 4.08%, a 7 basis point decrease from the year ago margin of 4.15%, and a 10 basis point decrease from the prior quarter margin of 4.18%. The year end earning asserts were 7.09%, an increase in yield of 109 basis points from the prior year period, and an increase of 19 basis points from the prior quarter.

The average cost of deposits was 2.86% for the quarter compared to 1.65% a year ago and 2.54% a quarter ago. The cost of funds for the quarter was 3.17% compared to 1.94% a year ago and 2.86% a quarter ago. As long as the market competition for both loans and deposits continues, we expect a compression in the net interest margin to remain.

Another factor that led to a 10 basis point decline in net interest margin compared to the previous quarter was the Standard Bank acquisition. Standard Bank closed on March 17 of this year, and this was the first quarter we felt the full impact of the acquisition. The assets acquired from Standard Bank had a lower net interest margin. In order to help offset this lower margin, we restructured the assets acquired and sold low-yielding investments and used those funds to take out higher cost Federal Home Loan Bank advances.

We estimated that 5 basis points of the margin compression came from the acquisition, and the remaining 5 basis points came from our portfolio. When the Fed is done increasing interest rates, we may see that rate competition will diminish somewhat, and if that happens, the margin will improve.

Our loan portfolio is largely tied to variable indices. At June 30, 2006, 53% of our loan portfolio repriced immediately, 11% repriced within one year, and 14% between one and three years. Non-interest income for the second quarter totaled $8.1 million, 2% higher than $8 million earned in the prior year, and 9% lower than $8.9 million earned in prior quarter. Total non-interest income, excluding gains from sale of investment securities, total $8 million for the quarter, a 19% increase from the second quarter of 2005 and an 11% increase from the first quarter of 2006.

We are pleased to report that core non-interest income has risen steadily over the last few quarters, a result of the larger number of customers we now serve and the overall increased size of our franchise. Non-interest expense was $38.5 million for the second quarter, an increase of $10.1 million from the prior year figure, and an increase of $1.7 million from the prior quarter figure. In the twelve months, we added 17 branches through the acquisition of Standard Bank, United National Bank, and also from opening new branches. We continue to anticipate that non-interest expense for the full year 2006 will increase between 25 to 28% from prior year.

Also, we have increased operating expenses in order to support our expansion. We continue to monitor the cost rate carefully. This careful scrutiny of expenses resulted in efficiency ratio of a low 35.31% for the quarter. Credit quality continues to remain excellent throughout our entire loan portfolio. At June 30, 2006, non-performing assets dropped to $10.5 million, or 11 basis points of total assets, a decrease from $13.8 million as of March 31, 2006, and $30.1 million as of December 31, 2005.

Non-accrual loans at the quarter end totaled $7.7 million, or 10 basis points of total loans. Net charge-offs totaled $305,000 for the quarter, down $2.1 million from the second quarter of 2005. Charge-offs for the quarter primarily consisted of two commercial loans totaling $285,000. We anticipate that credit quality will remain at very high levels for the rest of the year and have not seen any recent deterioration in credit. We believe that we will be well within our acceptable risk range of non-performing assets level below 50 basis points and total charge-offs below 35 basis points for the full year of 2006.

Our loan portfolio continued to remain well diversified and secured. Portfolio characteristics include--commercial real estate as of June 30, 2006, had an average balance of $1.2 million, an average loan to value of 56% and average seasoning of 2.1 years. Multi-family loans had an average balance of $601,000, an average loan to value of 61%, and average seasoning of two years. Constructions loans had an average balance of $2.3 million, average loan to value of 65%, and average seasoning of 1.2 years. Finally, single-family loans had an average balance of $328,000, an average loan to value of 59%, and average seasoning of 1.7 years.

I will now turn the call over to Dom.

Thank you, Julia. I would like to thank everyone again for joining the call this morning and for your continued support and interest in East West. I would now like to open the call for your questions.

[Operator Instructions]. And your first question will come from Brett Rabatin of FTN Midwest.

Good morning, Dominic. Good morning, Julia. Congratulations on the strong loan growth and the integration. That’s very positive. A couple of questions. First off, I was just curious on the guidance of 228 to 230. When I look at the metrics that you’ve given guidance for, in particular when I put in the provisioning level of the same in the second half of the year as the first half, it seems like there’s a little bit of a disconnect in that the earnings could be better than the 228 to 230, unless the margin maybe is below your guidance, or fee income is really soft. Is there something I’m missing, or can you give me any thoughts on what I’m looking at?

I think that net interest margin, we want to be very conservative, because the likelihood is that it’s more under 4% than 4.10%. That’s very, very likely that it will continue to drift down. In addition, I think that’s a tax rate, most likely that it will go up to 40%. You know, some people are using lower tax rate, and increase in expenses, and also the diluted number of shares. It’s very likely, as we try to give a conservative guidance, that it’s possible that it’s slightly above the 230, but we would like to provide more conservative guidance.

Okay, that’s good color. And then secondly, on the loans that were securitized in the second quarter, Julia, maybe you could give some additional color, if possible, on if any of those were Standard Bank loans, or if they were all multi-family and what the yields were on the piece that you securitized?

Okay. The $217 million is single-family.

Okay.

All of them are pretty much our portfolio, in ours. And then $170 million is the Fannie Mae mortgage family situation that we have been doing for several years right now. The single-family, the $217 million, the yield on the loan is about 5.4, so it’s loans that we originated about a couple years ago when interest rates were low, were fairly low at 5.4, net of servicing and net of the [inaudible], the securities yield is about 5%. And the multi-family, $117 million is all multi-family Fannie Mae. The yield on the loan portfolio is about 6.4, and net security yield is around 6%. We fell pretty much on that in the portfolio. That’s why you see an increase in our investment securities and mortgage-backed securities.

Right. Would it be fair to say that you would continue to securitize a fair amount of loans going forward for risk-based capital purposes, or can you give us any color on where that might go, going forward?

Yes. You know, we do plan to secure that more. This quarter or, if it’s not in September, in October, we are hoping to do at least $200 million or a little bit more for the multi-family. Because the securities situation, it helps a little on the risk-based capital. However, where it really helps is on the liquidity, because we can repost it at a very good rate, and at higher borrowing capacity compared to if it’s bidding at loan. So that really helps funding our loan core.

Okay, and then just one last question that—Julia, I recall from an earlier conversation, you seem to be one of the few companies in southern California that seemed pretty optimistic on commercial real estate originations, and that played out well in the second quarter. Was just curious on the thoughts going forward, if you saw competitors being aggressive on terms that could maybe gain originations, or kind of where you saw the pipeline from here, just on commercial real estate especially, given the southern California environment.

Actually in the southern California environment, I think the commercial real estate market is actually still very strong. And if you look at the occupancy rate and then also the lease payment rate, and it has been increasing. The occupancy rate has been, I think there’s very, very few vacancy, and the price of commercial real estate, for office building and so forth, is strong, and I can see rent going up. So, in the real estate market itself, I think it’s very strong.

And let’s talk about the lending side, in terms of lending side. I think what we’ve found was, for example, near the fourth quarter and the first quarter, there were lenders out there that were very, very aggressive, pricing loans at fixed rates, 10 years. Now there’s still some of them out there, but it wasn’t as, I would say the competition wasn’t as much as it was the first quarter. The fact is, you never know, in the third quarter or fourth quarter, suddenly another bank out of whatever strategic reason may come in the market. Let’s say by then, the Fed rate goes up to 5.75 or something, and then somebody come in at a 6% fixed rate for 10 years, and that happened, that obviously would affect our origination. But so far I don’t--at this moment, we have not seen that, that’s what. Secondly, our client mainly that invest in commercial real estate are more interested in shorter term type of real estate loans so that they can sort of like improve the property itself within three- to four-year span, and 10 years conduit loans, fixed, that requires huge prepayment penalties don’t really work well with them. So in that regard, I think we are a little bit immune of this onslaught of very, very aggressive pricing, if it ever comes.

Okay, great, Dom, that’s good color. Thank you.

Thank you.

And your next question will come from James Abbott of FBR.

Hi, good morning, and I would add my sentiments on the great quarter. I was wondering if we could just go through the organic core deposit growth number. In the press release, it said that 13% annualized rate. I was wondering if you can just reconcile that. It seemed like that there might have been—maybe if you could just touch on any erosion that took place is really what the core of my question is. Erosion that took place at Standard Bank on a linked quarter basis.

The Standard Bank is pretty small, and most of the amounts that they have on the deposits are CDs. Core deposit we define as everything excluding CDs, and the trend that we saw in our core deposits is in checking accounts. The balance went down because some people would move the money to a higher rate where there’s money market are or CD. So that would be the biggest trend.

Savings accounts also decreased a little bit. But we think that it’s possible that people that wanted to move their excess money to a higher rate have done so. But, you know, you never know. So that’s the trend, and that’s why the big increase on quarter profits would be in the money market accounts.

Okay, okay. And so the number in the press release of $207 million core deposit, organic core deposit growth, that, you’re comfortable with that? That’s not a year-to-date number, that’s a quarter number?

[inaudible] Where?

It says total deposits at June 30 were $7.13 billion, and then a little bit later in that paragraph, those organic core deposit growth for the quarter was $207.3 million, or 13% annualized.

Let’s see. Because for the whole year it’s $400 million. But that includes the--let me take a look what--.

Maybe we can circle back with that. That was just my, my question on that is that it just seemed like that was, the percentage of 13% annualized seems a little bit low if the magnitude of $207 million is correct. But it’s entirely possible I’ve done my math wrong, too.

While we’re, let me move on to another question rather than get bogged down in that. You mentioned that the pipeline on commercial real estate, or at least the environment is still strong. Could you comment on the pipeline compared to April, the pipeline today compared to April for the total company?

It’s a little bit stronger, not a whole lot. I don’t usually spend a lot of time talking about pipeline, because until the long spot, it’s not, it doesn’t do us much good. So what we do, is that if you look at the, if I look at what we expect it to be booking, yes, I would say now we have a little bit more than what we had in April. But it’s not that much more. I think, keep in mind that our loan growth for this quarter is, I can attribute it to two different factors. One is that we are a bigger bank. We have more people. And obviously, each of them do their job, and because we’re more people, we’re bigger sized, we have more volume. That’s one.

The second reason is that what we flagged on the balance sheet in terms of loan growth is really a net loan growth. That is, loan origination minus the prepayment. I think that in terms of balance growth, we actually have slightly better prepayment history in the second quarter versus the first quarter. First quarter we actually had, we’ve seen more prepayment at the commercial real estate area, which in the second quarter, that has eased down. So I think it’s a combination.

Well, it’s, maybe sort of to allude a little bit to what Brett’s question was, was if the pipeline and sort of the backlog of new loan production, et cetera, is even perhaps slightly stronger, but even if it was the same, and prepayments were slowing, I guess I’m trying to get at what the basis is for that loan growth projection of 15 to 17% annualized in the back half of the year. How do you go from almost 30% down to that ratio? What’s the driving variable?

You mean for the second half of the year, right? What you’re talking about is what are we looking at at the second half of the year. Well, here’s what we’re looking at is that in the next six months, a lot of things can happen. If you look at the insight of the economists towards what’s going to happen from the Fed rate and what happened in Middle East, gas price, and all kinds of stuff, I would think that by and large, people are literally more anxious about what’s happening with the market than they were, let’s say, six or nine months ago. And in that regard, I look at it as, as of today, it looks pretty good, but it’s no reason for us to lead to use today’s number and expect that it’s going to be fine and dandy for the next six months.

So, for example, in the first quarter, I would say in February, I was a little bit concerned about the vast prepayment that is happening on the commercial real estate portfolio. But then it didn’t last for too long. Now it’s slowed down a little bit. So my sense is that just because things are going great, I really feel very strongly that comes third quarter or maybe near tail end or maybe in the fourth quarter, there are always going to be two or three banks that are a little more desperate than the others that’s going to do what they need to do. However, from East West Bank standpoint, because we don’t really want to start reacting too much to the market, and we want to stick to our principles, and therefore, by not matching, sometimes it will result in us not having as high a production. So therefore, I looked at it in a conservative manner. We reasonably believe that we will be able to make this 15, 13 to 17% loan balance growth. If things actually get better, I think we’ll do better. But if the economy turn or the competition landscape change, hopefully we’ll barely make it. And that’s what, we wanted to be in that position.

Okay. Fair enough. I appreciate that. And as far as the prepayments go, are there any larger loans that are maybe getting a little closer to their seasoning, or their typical seasoning where they might pay off? Is that a consideration in that, or is everything fairly evenly laddered and stuff like that?

Nothing, really, like a lot of big loans that we know that will be paid off. That come and go, and our loans are fairly granular. We do have a few bigger loans, but it’s not going to make a huge impact.

Okay, fair enough. And then, last question, this is maybe one for Julia. Do you, repurchase agreements on the balance sheet have been increasing fairly significantly, and I think I understand basically what these are. It looks like the cost is just even under 400 basis points at this point in time. Can you walk us through exactly, remind us again what those are and how they work, and particularly since they’re becoming a more material portion of the balance sheet in funding, what are the risks that we should be aware of? What would be a catalyst for some of those borrowings to go away, or whatever that we need to be aware of as we move forward?

It’s the long-term structure repo, so we use our securities and reborrow against it, and the term is long term, between seven to ten years. There is a period that is adjustable, a floating borrowing rate based upon [inaudible]. And then after a certain period, six months, one year or two years, it will flip into a fixed rate, between 4.6 to 5.2%. It doesn’t get called by the counter party. So at this moment, the borrowing gave us a very good cost of funds. So the $100 million additional structure repo we did for this quarter, the cost of borrowing on that is half of about LIFO minus 125, and the other one is LIFO minus 215. So that’s what has been helping us with the cost fund.

But the risk, you asked about the risk. If interest rates go down, they will not be called, because it’s of value to the counter party. But the fixed rate that it’s flipping to, it’s fairly low, to the possibility of being called if extremely high.

If interest rates go down, the possibility of the borrowing being called is high.

No. If interest rates go down, because this is all predetermined. So let’s say it flips into 5%, if the market rate is only 4.5%, then the counter party would not be calling this borrowing, because we are paying a higher rate.

Sure.

Yes. So that would be the risk. The risk that interest rates go down, we have a higher cost of borrowing on the books.

Okay, so maybe in something like 2008, if let’s say the Fed moves down to 200 or 300 basis or whatever, and you’re stuck with borrowing at 5% or 6%, somewhere in that area.

No, no, no. There’s no 6%. We are the, in all of the borrowing, the fixed-rate borrowing ranging from maybe 4.5 to 5.2 is the highest.

Oh, Okay.

So we will not get over 6%. That’s the highest we can get, it is 5.2%, but if I look at the risk right now, we have to pay that for the CDs also. It’s a risk that is—from the adjustable side, the first couple years, the rates are fairly low.

Okay. I don’t know if you’d be willing to do this, but if you could disclose maybe a schedule of when those are flipping to the fixed rate so we can anticipate that for the 10Q’s, that would be a helpful schedule, I think.

Yes, very good. It’s probably in the 10Q. If not, we probably put, it’s probably in the 10K. And we probably put away, so we can do that. That’s not a problem.

Okay, thanks. And then, lastly, cost of deposits for June or for the end of the quarter, something to give us the sense of where things have gone since the average for the quarter?

It would be slightly higher, so for the month of June, the cost of deposit is 296. So cost of deposits will continue to inch up. But the loans also reprice up.

Oh, sure, sure. Okay, thank you again.

Jim, Jim, just answer your question earlier on the core deposits. While you and Julia were talking, I just looked at the number real quick, and actually, that paragraph is talking about comparing June 30 to 12/31. So, what the 13%, it shouldn’t be annualized, should be, actually it’s for six months. So the $207 million of core deposit growth is correct. So from December 31 to June 30, there’s a $207.3 million of core deposit growth, and it’s a 13% increase for that six months. And that’s what it is. It’s not for the quarter, and it’s not annualized.

It’s not quarter, it’s not annualized. Okay. Thank you for the clarification, Dominic. Thank you again, that’s great work.

Thank you.

And your next question will come from Joe Morford of RBC Capital Markets. Please proceed.

Thank you. Good morning. And I bet you thought there weren’t any possible questions after that, but I did have one, just on the reserve. The, I recognize that you’ve had very little loan loss since the start and it may be tough to get the auditors to sign off on higher provisions, but with the reserve-to-loan ratio now down to 97 basis points, is there a point at which, or a level which you don’t want to see it drop below, but you can defend it because of the strong loan growth?

Well, I hate to see it below 1%, but unfortunately, we are using a formula, and it is what it is. The reason that it is coming down is not only that we have very little charge-off, but also the non-performing goes down. We did some securitization. We thought the securitization, it would have been higher, but we took out 300-some million and caught up in loan portfolio. So I like, hopefully, it will not continue to go down. But we don’t have a lot of leeway. We tried to use a formula and calculate, and it is what it is. So, hopefully, it will be not too far below that 1%. At this moment, I think maybe 97 basis fund, I’m not as concerned. But we’ll take a look at it if it continues to drop.

Right. Okay, thanks, Julia.

Thank you.

And your next question is from Campbell Chaney of Sanders Morris Harris.

God morning, Dominic. Good morning, Julia. Can I get a clarification on comments earlier on the call about the improvement of deposit pricing after the Fed finishes? Do you anticipate that that will be an aggressive move down, with flattening out of deposit pricings, or give us some color on what you think the market will look like once the Fed does finish its program?

Well, it’s hard to tell. We just think that it’s possible when the Feds stop increasing the rate, that people will not be fund loading the deposits, even if they need the deposits. But the fear that it may go down, so you don’t want to get stuck with higher CDs. So, it’s hard to tell, because if the banks really need deposits and are willing to pay up, the competition will continue.

Okay, so it isn’t as though you anticipate the market just immediately starting to drop rates.

Probably not, but then it will not be increasing, and also, some of the other accounts, like money markets. Lately the money market rates have gone up. Possibly, not, that could come down, because that’s a very liquid account, that people only stick with the higher rates for the CDs.

Okay, understood. Then kind of moving on to loans. Can you give us an idea of where geographically, first of all, you’re seeing your strength in loan demand?

Well, mainly in Los Angeles County, mainly, simply because in terms of footing, we have much more branch network in L.A., and we have substantially more staff in L.A., so I would say that it had always been most of it coming from L.A. and it continues to be this way. But in the meantime, we trying to grow a stronger base in Orange County, and we’re also picking up some more momentum in northern California, and I think we’ll continue to do that.

So it’s still more or less around your branch network in L.A. County.

Yes.

And what kind of product can you see the demand? What type of collateral is backing you up? I mean, for the recent demand?

In terms of recent, what kind of loans are we making?

Yes, I mean, are you making strip shopping center loans, are you making rehab for warehouse space, I just want to--. Because you mentioned earlier that your clients’ preference right now is for shorter duration loans when they’re rehabbing projects or properties in order to sell. I just kind of want to get come color on what you meant by that and what type of collateral that they’re wanting to buy and rehab.

In fact, all kinds. I mean, we have clients that like to buy office buildings, that have not one leased, and then fix, sort of dress it up well, and so they’ll be getting the lease up to 90%. When they bought it, they maybe 50 or 60% because it’s sort of like a transitional stage, and then they buy it and lease it up. We have clients that buy hotels that are not well run, and then they try to step in and make it a better place, and we have clients that buy shopping centers and those public storage. We have clients that into all kinds of different, we have many different type of clients and many different type of products. And if you ask me in terms of the collateral base, we really have not seen a whole lot of, let’s say, difference today than they were six, nine months, or twelve months ago. They’re still pretty steady.

And you’re not seeing, I mean, you do mention the competition is tough, but it’s not as tough as, say, as what the conduits are trying to get in with the ten-year fixed-rate loans with probably, I would guess, more trophy-type properties?

Yes, that’s one, and secondly, I think that because—we price ourselves out of the market in that ten years fixed. Too, our pricing is so ridiculous in that area, we never really have a chance to compete. So it’s one area that it’s hard for me to comment on is that, like, how competitive, let’s say, are these products or these borrowers? There’s a lot of ten-year fixed rate, and to what extent the competition is going off on the conduit market or for those paying there in that arena. Competing for those loans is hard for us to know because we never entered it again.

Okay, understood. And then finally, it may be a bit early in the game, but what’s your strategy in Texas, with your loan branch out there? Do you see opportunities in both the deposit and lending sides of possibly growing that network, doing an acquisition, all the above? Can you give us some color, if you have some, on just what your strategy is for Texas?

Well, I think the good news is that they’re growing. I mean, they’re profitable, and that their loans growth has been stronger than deposit growth. And actually the loan growth was pretty phenomenal, and deposit growth is still healthy. However, keep in mind it’s only one branch, and in terms of scale and economy of scale and everything, it’s obviously extremely inefficient compared with the branches in L.A. Our strategy has been, we bought United National Bank and we inherit this branch, and so now we have an obligation to make sure that we do everything we can to help this branch to do better.

The easiest thing in my mind to help them to get to a much better position is to, frankly, make a much larger site acquisition so that make this branch part of, let’s say, a $600 million to $1 billion type size of franchise down in Texas, and then go from there.

But on the other hand, we all know that what the going rate right now in Texas when it comes to merger and acquisition is basically the highest premium in the country. So, at this moment, we feel it is not prudent to enter into the market just because that branch is not growing in the kind of support and does not get the kind of efficiency ratio like the rest of us. So, what we think the best thing to do is that, since they’re growing and they’re profitable and they’re more profitable every year than the year before, and everything is going fine, we’re going to let them continue to do what they’re doing, but we’ll keep our eye open and see whether someday, if ever, there’s going to be a chance that Texas will be as cheap as back in the ‘80s or early ‘90s. And if that happen, we’ll be the first one to jump into it.

But in the meantime, with this kind of like the highest premium in the country type of scenario, it would be highly unlikely for us to be able to make an acquisition for them. Now, that being said, we’re not just going to leave them alone and ignore them, because this is a, as I said, they’re growing, they’re doing well, and they’re holding their own, so we will be looking at a niche product, commercial banking type of business, and if there is an opportunity to acquire a group of commercial bankers in a certain industry that have a niche in certain industries, or there are several niche products that we feel is appropriate or complementary to our East West capabilities, we will bring these folks in so that even though it may be small strategically, it can be very good for us. And that is pretty much the game plan for now.

Right. Good color. Thanks a lot, Dominic.

Okay.

And your next question will come from Manuel Ramirez of KBW.

Hi. Good morning. Two quick questions for you. One is, you talked, Dominic, on your thoughts of the sustainability of growth in the construction portfolio. As you recall, it’s fairly heavily weighted residential, multi-family construction, and certainly seems like what’s going on with the homebuilders, that fact that we’re entering a weaker environment.

And then secondly, just on Campbell’s question on acquisitions, maybe a little bit more broadly speaking. You know, when the California, are you more inclined to go south, east, or north within California now that you have building in assets and you’re still fairly confined to L.A. and Orange Counties. And if so, are you a little bit more willing to look at the mainstream banks, perhaps, some that are a little bit off the beaten path and a little bit smaller but nonetheless would get you a little bit more into those markets? Thanks.

Construction loans, I think, I would assume and in fact, right now I see it, a slowdown in residential development. We will pick up, though, in the affordable housing and sort of like government-sponsored type of low-income housing type of construction activity. You know, obviously, I mean, the last two years, the residential side has been stronger, and we expect that the next year or two, that the residential, what I call the entry-level or maybe middle-level or high-end, all of those may slow down, but we will pick up much stronger momentum from the low-income housing, affordable housing, government-sponsored type of activities, because there are plenty of those activities in the planning. And we have not only the expertise, we’re one of the best in terms of that market.

We just have to, the nice thing about it is that in the last year or two, our account officers have worn multiple hats, where there are a lot more developers going to San Bernardino, Riverside, and various other places to build homes, and they work on those projects. When that slows down, they can go right back into the inner city and start working on the other type of projects. So I think that that kind of balance each other out okay, and then we still have other type of commercial type of construction activity.

And if you were in the type of credit risk profile that those people have in construction exposure?

I guess a general statement would be, I’ve been here 15 years, we have yet to have lost one penny, so that’s one thing about East West history, we’ve never lost a penny on construction loans. In fact, that’s one of the big problems about how we establish historical basis for loan loss referral, which is another story. However, I think that in our view, I think that the low-income housing may be a stronger credit from our point of view. Just fundamental, looking at, we have nothing to, historically, in terms of perspective, to show that why something is better than the others, because they all pay as agreed. I just look at in theory, the affordable housing probably will be a better risk. That’s just from our point of view.

So let’s move on to the next question about acquisitions, north, south, middle. As long as we’re in California, we really do not, because we have, it’s so easy for us to move around in California. So we really do not have that much of a preference for one. I would say, though, I would love to see that we would have a bigger presence in, much bigger presence in northern California, or maybe even down in the Inland Empire, or more in Orange County, because since L.A., we have quite a bit, and then the other places do not have the kind of scale like we have in L.A.

But at the end of the day, it all depends on how willing the seller is. I always look at anybody who is willing to let us buy them at a price that is acceptable to us. We’ll do it, and so whatever we’ve done is because we had willing sellers who were willing to sell to us at a reasonable price that is acceptable to East West, and the others that we couldn’t enter into the market is because they weren’t able to come up with a price that makes sense for us. Because, again because of our conservative nature, we really can’t afford to take too much risk to pay a very high premium and then to have to make all kinds of revenue enhancement, assumption, or maybe in case, or maybe a huge consolidation of plant to cut expenses. Those are not the kind of things that we wanted to do, because once we have to make too aggressive of a move, then the model will be kind of dicey.

The lovely thing about doing United National Bank and Standard Bank, we can close our eyes, and we know we’re going to make the numbers, just because of the fact that we do not go out there and take too much of a aggressive move to pay a premium.

Yes.

Now the next question on the mainstream bank was this at [inaudible] Bank, so forth? It’s all pricing. We did Prime Bank back in the year 2000. We did very well with it. We bought Prime Bank with $120 million in assets—actually, $100 million in deposits—and we grew the deposits to close to $500 million today. And so I think that we have proven that we can do really, really well with the mainstream bank, and if they are willing to come down the price.

And, looking back, and then I think the former shareholders of Prime Bank made a great decision, even though they suppressed their ego to come down with the price to meet our level of comfort, the fact is, our price gone up so much and they took so much stock, and at the end of the day they’ve done substantially better than most of those guys that announced three times type of deal anyway. So, but it’s something that requires very sophisticated shareholders to appreciate that, and so we just have to continue to be patient to find those people to merge with.

Yes, it just seems like given your size now, and given arguably your track record, as well as the fact that deal multiples are crazy across the board, but not as crazy in California as arguably they are in Texas, that perhaps there might be an opportunity up there to find an, as you said, a sophisticated shareholder who kind of sees it as a win-win as opposed to maximizing their deal price on day one.

That’s if they are looking for a fixed portion of stock, because if they’re looking for cash, then obviously they have to look for the best cash price. On the other hand, sometimes upon execution I’ve seen people out there talking about deals at a much higher premium, but we finish our deals nine months later that they’re still working on the deal, so it’s, but it’s a decision, we really don’t know what the appetite of various sellers, and that’s something that we will have to—we have to be patient and continue to be in the mode that we’re willing to look into deals, and I think hopefully there will be something that may come in the future.

I want to point out another dilemma we have is that I think our biggest challenge really is not just because we are very, very conservative. Actually, the biggest challenge comes because we have very healthy organic growth. We were very comfortable to bring in talent to join our force, because at the time when we were $3 billion or $5 billion, and today when we are now $10 billion in assets and never once have a quarter that we’re not happy with for the last ten years, I think it’s something that makes it quite attractive to attract talents who want to join force with us. And with that in mind, I think that with the organic growth, it makes it very, very difficult for us to argue that we need to pay a high premium when, in fact, the alternative of hiring people to help us to make things happen is so much cheaper.

So, again, because the only reason we make acquisitions is to help the bank to not only grow, but in a healthy growth way and also strengthen our balance sheet. When we pay too much, then suddenly hiring people one at a time seems to be a healthier way to grow since we’re not in a hurry, anyway. So that’s the kind of thing that I think we’re constantly in dilemma is because of that reason. I would imagine that if we were really, really struggling with growth organically, I think that maybe paying a little bit more premium may not be a bad idea.

I appreciate your thoughts. Thanks, Dominic.

Thank you.

And your next question will come from Andrea Jao of Lehman Brothers.

Good afternoon, and very nice quarter.

Thank you.

Given that number of the 15 to 17% is above the profit growth of 10 to 15%, maybe you could talk a little bit about now how you’re going to fund that loan growth, aside from securitization supported by structured repos, which you talked about earlier. And then afterward, give us an indication, what does that translate into for overall balance sheet growth or overall average earning and growth?

In some of the funding, in addition to the securitization, we have a huge capacity at Federal Home Loan Bank that we can tap into. We have over $2 billion availability. So, that’s what we will do temporarily. And any shortfall in funding coming from deposits, we will just get the advances, and then over time we will continue to securitize systematically and if we securitize, we either can sell or can do a repo at a cheaper price and then pay down the advances, and also, just wait for the deposits to grow.

I don’t think liquidity is a big challenge, only because we can borrow on Federal Home Loan Bank advances pretty easily. But over time, if the deposits do not catch up, we will need to securitize more, and either sell. Most likely we will have to sell the securities to fund the loan growth. And in [inaudible] because as long as the loan yields, the growth is coming from adjustable, commercial real estate, construction, at a pretty decent pricing, it’s still pretty much worth it to just book the loans and fund it with advances because that would give us the growth in earnings assets.

And frankly, deposit growth is actually somewhat easier than loan growth in a way, simply because if we really want to grow deposits, all we need to do is pay, and so it’s more or less of if we do, to get back to the issue about if the loan pricing, as such, is attractive enough that we want to pay up deposits to fund the growth. When you look at our deposit growth at 9% this quarter, and annualized is much slower than our normal way, and also much slower than the loan growth, and mainly it’s because we just have other alternatives that is better than paying up for deposits. Because in this kind of rate-sensitive environment, actually, paying up is a, that’s actually very easy to do, because now for some reason, folks are so focused on deposit rate, that it’s much easier to bring deposits from another bank if we just pay up.

But when we decided not to pay up as much, I think that slowed our deposit growth down, but for a good reason, because we think that the alternative is better as of now. We feel that every one of these is kind of like a search for the loans or deposit type of pricing, eventually they always subside, because also these kind of acts are not sustainable anyway. So we feel that for the long run, actually we’d much rather write a tighter balance sheet in terms of trying to maintain most ratios in a more stable manner.

I want to give you a perspective for this quarter. You know, Dominic mentioned our loan growth is low. It’s only 9% annualized for the quarter.

Deposits.

Deposits, yes. On the deposits. The deposits increased by about $100 million, and the loan, in spite of the high loan growth up 29%, annualized loan growth, but because of the securitization, the loan actually increased by only $200 million. So we are only short by $100 million in all perspective, $100 million, given that we’ve a volume of $2 billion is really not a big concern. So as a result, it is very hard for us to justify paying up big time on the deposits just to get another $100 million to fund the loan growth.

Great. This is very helpful. Thank you.

[Operator instructions]. And your next question will come from Christopher Nolan of Oppenheimer.

Hello? I’m sorry. I noticed on the average balance for demand deposits is $1.28 billion. The period end balance is about $1.4 billion. Would that mean that there was a sudden inflow of non-interest-bearing deposits towards the quarter end and, if so, could you give a little color on that, please?

The TDA always fluctuate. In the very similar past, in fact, for the last few years, is that when it comes to month’s end and quarter end, the [inaudible] rise up, and then it just drop in the middle of the month. And so, particularly around quarter end. So this is pretty typical deposit trend in the DDA side, at least was.

Great. And Dominic, earlier you mentioned a changing real estate environment. You might have touched on it earlier. The changing real estate market. Could you give a little color as to your perspective on how the real estate market itself is changing?

Which, I mean, can you be a little bit more specific?

Oh, no, I was just referring to something that you said in your earlier comments before the q-and-a. You made reference to it.

In the overall real estate market?

Yes.

I would say that, because I wanted to just restrict my comment mainly in California, because that’s where 99% of our business here. I’m not going to talk about Houston. But in California, at this point, I think that there’s clearly a slowdown—again, I want to point out the word slowdown—slowdown in the residential resale market. Price in certain pocket of areas have shown weakness, but there are still, I would say the majority of the area’s still pretty firm. We still see some price increase here and there. So, I think what I would assume that this is the beginning of a trend of even price decrease in residential market, which is about time, simply because it’s been so many years of rising. Residential real estate price, and it’s just a matter of time, that I think it had to come down, and I think we’re at the beginning of that trend in the residential market.

And with that, also, the fact that the new home development market, I think that market actually is hurting a little bit more than the resale at this stage. Now, when it comes to commercial real estate and apartment buildings and so forth, we have not seen any kind of sign of slowdown yet. And simply because there are still job growth, people are hiring more, and companies are making more investments, and so there are fewer scarcity of space. Another reason is that there is just not that much land within the dense populated area to do much commercial development anyway, so therefore in that area, we see that the market is still relatively strong. And so that’s what we see today.

Great. Thank you very much.

You’re welcome.

And your last question will come from Kathy Steinbrecher of Wedbush.

Good morning. Great quarter. Just a question on the salary expense. It seems as though seasonally, the second quarter is lower, but this quarter, it was even lower than it has been historically, and I was wondering if there was something in that, that you can give some color on?

Most of the decrease comes from the payroll tax, and it’s about $450,000. But if you look at every year, last year at the second quarter it’s also lower than first quarter.

Right, I noticed that. But it seemed as though this quarter was even lower than it is seasonally.

Compared to last year?

Yes. Compared to the last couple of years.

Because the salaries have increased, but the payroll tax also increased when it’s backed up in the first quarter.

Oh. And then on security gains, this quarter, just what your thoughts on that, going forward?

Probably pretty small. This quarter is nothing to speak of. I would imagine that going forward, the security gains probably would be very minimal.

Okay, great. Thanks.

There are no further questions at this time.

Okay. Well, thank you for joining our call, and I’ll look forward to talking to you all in October. Thank you. Bye-bye.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation, and you may now disconnect. Have a wonderful day.