East West Bancorp Inc (EWBC) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2007 East West Bancorp earnings conference call.

At this time, all participants are in a listen-only mode.

We will facilitate a question-and-answer session towards the end of today's conference.

(OPERATOR INSTRUCTIONS).

I would now like to turn the presentation over to your host for today's call, Ms.

Irene Oh, First Vice President.

Please proceed.

Good morning, everyone, and thank you for joining us to review the financial results of East West for the third quarter of 2007.

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 you to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2006.

Today's call is also being recorded and will be available in replay format at www.eastwestbank.com and www.streetevents.com.

I will now turn the call over to Dominic.

Thank you, Irene.

Good morning and thank you for joining us in today's call.

Yesterday afternoon, we were pleased to announce third-quarter net income of $41.3 million and earnings per diluted share of $0.67.

For the 18th consecutive quarter, East West achieved double-digit growth in both net income and in earnings per share.

We reached another milestone for the quarter, surpassing $100 million in net interest income.

Julia will provide a summary of the financial details of the third quarter shortly.

But first, I would like to provide a brief review of the quarter and an update on our outlook for the rest of 2007.

Quarter after quarter, East West has been able to achieve success due to our strong core profitability and our strong discipline.

The third quarter of 2007 was the 18th consecutive quarter that our efficiency ratio was below 40%.

We were able to successfully balance maintaining excellent operating efficiency while we continued to strategically invest in the future.

We continue to execute our long-term strategy to grow the franchise both organically and through acquisitions.

During the third quarter, we closed the Desert Community Bank acquisition, which allowed us to grow our business, customer base and market footprint.

East West ended the third quarter with a record $11.6 billion in total assets and a record $8.6 billion in total gross loans.

During the quarter, East West originated a total of $1.2 billion in loans.

Organic loan growth analyzed for the quarter, excluding the impact of securitization and the acquisition of Desert Community Bank, was a strong 23%.

This loan growth was achieved in all areas of our business.

Real estate loans, trade finance and commercial loans all grew at double-digit figures, both quarter to date and year to date, on an annualized basis.

I would like to spend a few moments discussing the current lending environment, the effects of the softening housing market and credit quality of our loan portfolio.

Year after year, in both good and in challenging lending environments, East West has been successful and performed above its peers.

This is largely due to our emphasis and culture of balancing loan growth with sound credit fundamentals.

Overall, we believe that the asset quality of our entire loan portfolio is sound, including our real estate and construction loan portfolio.

With the current market conditions and the downturn in the housing market, residential construction loans are an area of increasing concern for the bank.

However, we feel that our asset quality is above average and stronger than our peer banks.

We believe that any potential future charge-offs will be manageable and that we will be able to weather the current downturn in the real estate market.

We have systematically reviewed our entire loan portfolio for potential weaknesses, particularly our residential construction portfolio.

At this point, we believe that our residential construction loans in the Inland Empire area are the most significant area of potential weakness, if the downturn in the housing market continues to extend.

As of September 30, 2007, we had a current balance of $124 million in residential construction loans in the Inland Empire.

As of September 30, 2007, we actually had no nonperforming residential construction loans located in the Inland Empire.

However, given the increasing inventory of unsold homes and ongoing weakness in the Inland Empire, there may be nonperforming residential construction loans in this area in the future.

I would like to point out that 75% of our residential construction loans are in urban areas of California such as the city of Los Angeles, the San Gabriel Valley and San Francisco, where there is currently stable demand.

Despite the fact that most of our residential loans are in areas where there is still demand, we are still proactively and methodically reviewing our entire portfolio.

I would also like to confirm that we have a long-standing tradition of not making predatory loans.

We have never made any subprime loans and do not have any subprime loans, securities or warehouse loans to subprime mortgage bankers.

For the third quarter, nonperforming assets as a percentage of total assets increased to 37 basis points from 23 basis points at the end of the prior quarter.

Of the total $42.8 million in nonperforming loans at the end of the third quarter, $25.6 million or 60% were residential construction loans.

This $25.6 million in nonperforming residential construction loans as of September 30, 2007 is primarily due to two condo construction loans.

One is a 32-unit condo construction loan located in San Francisco with a balance of $11 million.

As of today, this loan has been brought current and is expected to pay down to approximately $1 million by the end of the year.

The other loan, with a balance of total $7.8 million, is a 20-unit condo in Los Angeles.

We believe the value on this property is holding up and that we will experience minimum losses, if any, from this loan.

In the third quarter, we continued to experience low levels of charge-offs in all lending areas and had net loan charge-offs of 4 basis points or $853,000 for the quarter, an increase of only 1 basis point from the previous quarters.

However, we recognize that the increase in nonperforming loans may lead to a higher level of charge-offs in the near future if the downturn in the housing market continues.

We believe that we're well-positioned to handle this challenging credit environment and are proactively managing our risk exposure.

The $3 million provision for loan losses this quarter, compared to no provision in the prior quarter, reflects the increase in delinquent and nonperforming loans and [also] the higher-than-expected loan growth.

We currently believe the loan loss provision for the fourth quarter will also be approximately $3 million.

Now I would like to shift to a discussion on our outlook for the rest of 2007.

Based on the performance year to date and our expectations for the rest of the year, we have increased our estimate for earnings per share for the full year of 2007.

We are now projecting that earnings per share for the full year 2007 will be approximately $2.65, an increase of $0.30 or 13% from 2006.

We believe that overall, our core business and profitability remains very strong and will allow us to close 2007 as our 11th consecutive year of record earnings.

I will now turn the call over to Julia, who will discuss in more depth the results of the third quarter of 2007.

Thank you, Dominic.

I will provide a summary on the financial results for the third quarter of 2007.

The release contained a detailed discussion of the financial results for the quarter, so I will focus on key areas.

Third-quarter diluted earnings per share was $0.67, an increase of 16% or $0.09 per share from the prior-year period and an increase of $0.01 per share from the previous quarter.

Our net interest margin remained stable at 3.95% for the quarter, a 2 basis point decrease from 3.97% in the second quarter of 2007.

Due to the recent 50 basis point cut in the Fed funds rate, our net interest margin will be impacted for a short period of time, as many of our loans immediately repriced downward after the rate cut and it takes a couple of quarters to reprice all the term deposits.

As such, we expect the net interest margin to be approximately 3.90% for the fourth quarter of 2007 and approximately 3.93% for the full year 2007.

We anticipate that this decrease in margin will only be for the next quarter, that our net interest margin will stabilize in the first quarter of 2008.

Our loan portfolio is largely tied to variable indices.

As of September 30, 2007, 58% of our loan portfolio repriced immediately, 7% repriced within a year and 16% was tied to intermediate index, between one and three years.

For the third quarter of 2007, the average volume of earnings assets was $10.5 billion, and the deal was 7.54%, an increase of $0.5 billion or 3 basis points from an average volume of $10 billion and a yield of 7.51% for the previous quarter.

The cost of deposits for the third quarter of 2007 totaled 3.35%, a decrease of 7 basis points from 3.42% in the prior quarter.

During the quarter, we were able to actively lower the cost of deposits by reducing higher-cost money market and time deposits.

Non-interest income has been growing at a double-digit rate the last several quarters.

Non-interest income for the third quarter rose to $14 million, 73% higher than a year-ago level of $8.1 million.

This includes a net gain a $2.8 million on the sale of investment securities and a gain of $1.3 million from the sale of an office building previously used to house part of our back office.

Excluding the impact of these gains, core non-interest income for the quarter was $10 million for the quarter or 34% higher year over year.

This increase in non-interest income is driven by growth in branch and loan fees and increased demand for letters of credit.

Non-interest expense was $47.1 million for the third quarter, an increase of 9% or $3.9 million from the prior-quarter figure.

As the Desert Community Bank acquisition closed on August 17th, the third-quarter operating expenses only partially factor in the added cost associated with the additional nine branches.

We anticipate that the fourth-quarter non-interest expense will grow about 5% from the third-quarter figure, as we continue to carefully manage all expenses that do not directly correlate to earnings growth.

Our loan portfolio continues to be well-diversified and secure.

Additionally, our loan portfolio has become more seasoned and predictable.

Portfolio characteristics include -- commercial real estate loans as of September 30, 2007 had an average balance of $1.2 million, average loan-to-value 55% and seasoning of 2.5 years.

Multi-family loans had an average balance of $777,000, average loan-to-value of 61% and average seasoning of 2.2 years.

Construction loans had an average balance of $2.4 million, average loan-to-value of 68% and average seasoning of 1.5 years.

Finally, single-family loans had an average balance of $335,000, average loan-to-value of 61% and average seasoning of 1.6 years.

Year to date, we have securitized a total of $1.1 billion in single-family and multi-family loans.

This securitization plan has enabled us to improve our liquidity and also improve our margin, as we have been able to replace lower-yielding securities with our MBS securities.

For the fourth quarter, we intend to securitize about $150 million additional loans.

For 2008, we expect to decrease our securitization platform and continued to grow our balance sheet, as we will have sufficient collateral.

I will now spend a few moments to discuss capital.

As of September 30, 2007, stockholders' equity was $1.2 billion, an increase of $181.6 million or 18% from the year-ago figure.

During the third quarter, we issued approximately 2 million additional shares of stock and $30 million in trust-preferred securities in conjunction with the Desert Community Bank acquisition.

As of September 30, 2007, our Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 8.88%, 8.98% and 10.57%, respectively.

During the quarter, we repurchased $7.3 million of our common stock, and as of September 30, 2007, we had $26.9 million of repurchase authorization remaining.

Our strong capital levels and high profitability give us the continued ability to provide strong returns for our shareholders.

I will now turn the call back to Dominic.

Thank you, Julia.

Thank you, everyone, for joining the call this morning and for your continued support of East West.

I will now open the call to questions.

(OPERATOR INSTRUCTIONS).

Andrea Jao, Lehman Brothers.

Just thinking about loan growth and how you will manage the balance sheet in the fourth quarter and into 2008, could you tell us what deposit growth ex-acquisitions was this quarter and kind of your outlook for that, and then how you are going to fund loan growth as you move into 2008?

For this quarter, our organic loan growth excluding the acquisitions -- it dropped about 2%, about (multiple speakers).

Deposit growth, you mean?

-- on the deposits.

But most of those are the high-rate money market and CDs that we, on purpose, tried to reduce.

Some of the reductions also came from the escrow title balances, which, at this moment, really at the low level of about $165 million, given the nature of the escrow title and the reduced activities that's expected, plus at this moment our escrow title balance is at a very low level.

The impact in the future would be a lot less.

So deposit growth continues to be challenging, especially at the low-cost deposits.

We will continue to work to get the deposit growth.

In terms of the loan growth, this quarter it's a pretty high growth, because the payoffs have slowed down dramatically in the third quarter.

So we will continue to have some securitization in the fourth quarter.

Going forward, we are projecting that the loan growth may not be that high, because there's a possibility also that the activities in the real estate, in the markets slowed down on commercial real estate and other lending products.

So if the loan growth is more in the 12-13%, we can still support some of the loan growth through borrowings or, potentially, selling some of the loans to get liquidity or further securitizing some [more] -- not to the same level in 2008, most likely not to the same level as with we have been doing this year.

But we may continue to do some of that.

I want to add why we think that loan growth would not be at this sort of 23% analyzed rate in 2008 is that, for example, like construction lending -- we were able to (technical difficulty) plenty of them, the last few years, which now -- they are drawing down still, currently.

Therefore, I think that we continue to see construction lending loan balances increase.

However, in 2008, 2009, I would assume that there are are many developers who are going to be holding tight, who are not going to start new projects.

For that reason, the likelihood of -- you know, so what we will be seeing in 2008 will be paydown in that construction loan balance without adding much additional new origination.

That, in general, would help pretty much offset while the commercial C&I and trade finance and some of the other real estate lending may still be growing, but then you have one that will be paying down faster than the norm for the last few years, and that will result in loan growth maybe in the low teens, rather than the 20-some-odd percent that we are currently experiencing.

I always looked at it as that, when it comes down to deposits, we can always get more deposits if we're willing to pay the rate.

But in a very, very interesting situation the last two months, when we're seeing Countrywide or IndyMac, they are paying 5.5%, 5.7%, even after the rate cut, and for us to try to get deposits to pay above Fed fund rate, it just doesn't make sense.

So what we do is that we will get deposits as long as we can get it below Fed fund rate.

But if we have to pay up to get Fed fund rate just for window dressing, we would rather just borrow.

That has been the philosophy that we have been going on, and we try -- as much as we feel that having a lot of deposits to fund a loan looks really good, but they have to be good deposits, not window-dressing deposits.

So that's the reason why we have not emphasized to go out there in this moment, because it just happened the market is a little bit unusual, I think, the last two months because of the liquidity issue that affects some of the other banks who need to do what they need to do, which they did the right thing for them.

But for us to go and match today is not the right thing, and therefore we're just going to hold out for a few months.

But these kind of temporary incidents will get back to normal, I believe.

So when things get back to normal, we will be able to go out there and get deposits again.

Yes, perfect, very helpful.

Thank you.

Brett Rabatin, FTN Midwest.

Wanted to get an update on the exposure in the Inland Empire.

I think last quarter you talked about $144 million, and then obviously you added Desert Community Bank.

So I'm curious to get an update on exposure to the area, both in outstandings and commitments.

Then, secondly, going through your loan-to-value ratios, I'm basically hearing that there's not very many bids out there for land, presently.

So I'm curious to hear how you are doing your appraisals on valuations on some of those properties out there.

The question about exposure in Inland Empire -- are you referring any type of -- are you talking about residential?

Residential construction loans --

Right.

We currently have $124 million of residential construction loans.

That includes both Desert Community Bank and East West, and I can give you even a further breakdown.

Desert Community Bank, outstanding balance of residential construction loans, approximate $30 million, and the rest of them are East West Banks, before DCB.

So all combined together is $124 million, total, of residential construction loans.

And the question of LTV?

Well, Dominic, it sounds to me like you obviously have worked one NPA off the balance sheet after the end of the quarter, the San Francisco credit.

But it sounded like in your prepared comments that you were expecting that there might be some NPAs from the Inland Empire.

So I'm curious -- I just hear out there that there's just not -- in terms of raw land and some residential construction units, there's just not a lot of bids.

So I'm curious how you evaluate the market and how you sort of appraise things, if there's just not a lot of transactions occurring.

It's challenging right now, because since August, the market just kind of just went dead for a little while.

So now it's started picking up a little bit.

However, still, I think it's very -- the whole sort of like new home development area is having a lot of liquidity crunch from the lack of mortgage availability and also the concerned about subprime and all of that kind of stuff, and I take that are affecting the market.

I am hearing the same kind of stories like to do about the large homebuilders that we've seen it on the newspaper like Lennar, KB Home, et cetera.

They're all taking massive write-downs by not taking those options to acquire certain land, and then also taking charge-offs for their residential development.

So we are seeing that is happening.

What we are doing right now is that at this stage, interestingly enough, like I said, because it only started in August, when this sort of market changed dramatically.

So I think it's a little bit too early for us to tell.

Therefore, my position is that -- and sort of the bank position is that we really feel that, with all this turmoil going on in the Inland Empire, eventually something has to happen, even within our portfolio.

So we are waiting.

So that's something that we just wanted to send cautionary note, in terms of we don't know when it's going to happen, but I just think that -- for example, I'll just share with you that we have $124 million of residential construction loans there.

Now, while our loan-to-value is lower, that have helped us to get through this turmoil better than other banks who are announcing a lot of charge-offs lately.

But you never know, because if it continues to go south, or the market does not correct itself and continue to have [sort of no] bid, then we would need to address some of the clients who may become problem assets.

Secondly, I think that what I wanted to also share with you is that we do not want to do a very drastic approach that is that, the minute you see the market going haywire and then the next thing happens, which is just aggressively charging off and dump all the assets with no regard of maybe in two or three months things may get better.

So I think that the advantage of East West is that we do not have the kind of major problems like some of the other financial institutions have, and there's really no reason for us to panic.

So what we do is that, if there is some problem asset come out, we worked on it with the clients to make sure that we took care of these problems, one after another.

Hopefully, it does not get any further south in terms of the market, and we will be able to manage it really well.

But if it does go further south, in terms of deterioration of the market value and so forth, I still think that overall we should be able to do better than others.

But if market continue to go south, we will be impacted, without any question.

I've heard some people comment that the commercial real estate market -- it's still too early to tell.

But with conduits out, and it would seem like there's less yield seekers out there, potentially the pricing could be more favorable going forward, on a relative basis, anyway.

So I'm just curious to hear some comments on the commercial real estate market as you see it, and any opportunities that may be arising, given the change in risk profiling by --

Are you talking about loan pricing?

Yes, just loan pricing and then just generally how you see the CRE market.

There's no question that we feel that it will become more positive, that is that -- obviously, in the past, there are conduits originating many commercial real estate loans at fixed rate at a very, very low rate that we couldn't compete.

Many of our very good clients that have a plan to hold on their properties for long term, rightfully so, chose the conduit to refinance their commercial real estate loans, because we're talking about we're charging like 8% or 8.25% at adjustable, while others are doing 10 years fixed at 6.5%.

Just no way for us to compete.

In fact, to be fair with our clients, we actually encouraged them to do something like that, because what's good for the client is eventually, in the long run, good for us, anyway.

But, fortunately, we always felt that this is not a sustainable type of scenario.

Low and behold, I think as of today, almost all of these conduits are gone now.

So with that, now we are basically just competing with other banks.

So I think that would help the loan pricing coming back in a more reasonable margin, and I think that would help us in the next year or two.

So whenever there's something bad -- like, for example, you look at -- I expect the construction lending in the next two years is going to slow down dramatically.

However, if we do not get the volume, maybe commercial real estate we can make up with the price, one way or the other, and we still come back even, hopefully.

Joe Morford, RBC Capital Markets.

Following up on China Minsheng Bank's investment in UCBH, there's been comments that some of the other Chinese banks are interested in investing in the US as well.

Is that something that appeals to you all, and have you had any discussions along those lines?

Or just broadly speaking, what's your thoughts on that kind of partnership?

I think it's a good trend.

I think what I like about it is that many times you have one historical transaction, it opened up for more.

I looked at it as that we really do not have an urgent need to do anything, and we really -- currently, we do not have a strategic reason that we need to do anything.

However, I always look at it as that East West Bank's focus has always been long-term shareholder value.

So when I look at long-term shareholder value, it's more not just long-term in the way that don't worry about now and then I'll worry about it five years from now kind of long-term.

But it's sustainable, ongoing increase of core earnings.

If you look at our sort of going to be soon 11 consecutive record earnings, that's the kind of example that I'm talking about.

If someone can help us to have sustainable, reoccurring core earnings for many years to come and make our life easier, we welcome them.

So when it comes down to strategic partnerships with mainland Chinese banks, our position will be -- obviously, we are well sought-after.

But the fact is, we would want to do it if we know there is very, very clear, meaningful strategic potential for us to increase our, let's say, maybe core deposits or increase our fee income and et cetera, et cetera.

Anything that can help us to grow our balance sheet better and to create core earnings better, we will more than welcome.

We have no -- I mean, I look at it as having an institutional investor to put 5% or 9.9% is no different than having a mainland Chinese bank to put in the same percentage.

But I would love to have that kind of arrangement only if we have very clear understanding that there will be very strong potential for future sustainable core earnings.

One thing that we want to be sure is that not only that the arrangement will give us a strong comfort that we can get that kind of future core earnings, but we also want to make sure that signing up something would not cause us to have less desirable relationship with all the other banks that we're doing business with.

Because currently, we have a substantial number of corresponding banks that we are doing business with in China.

Our position is that if we're going to enter into any kind of arrangement, we want to make sure that arrangement is substantially outweighed the benefit that we currently are getting from the rest of the other financial institutions in China.

So that's basically the kind of very logical, commonsense approach on what's best for our shareholders.

If there's something that makes sense, we obviously would be more than interested to entertain.

So that's where we are right now.

Makes sense.

Thanks, Dominic.

Aaron Deer, Sandler O'Neill & Partners.

I just wanted to follow up on the expenses.

They seemed to be up fairly sharply this quarter.

Obviously, a big part of that was due to the acquisition.

But if I heard you correctly, it sounds like you are again calling for expenses to be up an additional 5% in the fourth quarter.

Just confirm if that's correct.

Then, what's driving this?

I'm sure some of it is production-related, but are there also any costs related to the acquisition, specifically, that you can pull out?

Actually, 5% sequentially compared to the third quarter is about right.

Mostly is Desert Community Bank only came in 1.5 months for the quarter.

So some of those expenses will increase in the fourth quarter because it's a full quarter.

Right, I understand that.

But in the third quarter, then, here the expenses were up pretty sharply.

Is most of that, then, just due to the higher production levels that you saw?

Or is there anything else going on there?

Mostly it's still the Desert Community Bank, in addition to some of the East West expense growth.

Lastly, given your current capital levels and growth outlook, what do you expect in terms of share repurchases going forward?

Well, when our loan growth was 23%, we are not increasing our total risk-based capital.

So, as long as our loan growth is high, we probably would hold off the stock buyback.

If the loan growth is less than 15%, we will be accumulating excess capital.

Manuel Ramirez, KBW.

Could you talk a little bit about where delinquencies were outside of NPAs in the quarter -- as might be expected, with a particular focus on the construction side?

In terms of the overall delinquency, we -- hang on.

Let me get the total.

Comparing to June, the 60-day delinquency is still pretty small, about $18 million compared to $8 million.

We do have increase in 30-day delinquent, but sometimes some of them are just a temporary -- people that just -- a few days, 30 days, and then make it up.

So that's what the delinquencies are.

Usually, we really watch over 60 days, because that's the one that potentially will go to 90 days.

So that was the 60-plus number that you gave me?

Correct.

Lana Chan, BMO Capital Markets.

On the construction loans detail that you gave us, Julia, before, it looks like versus the second-quarter numbers, the average LTV increased from 62% to 68%, and the average loan size went down, though.

So I was just wondering -- is there anything happening there in particular that's driving the LTVs up?

The average loan dropped because Desert Community Bank is like pretty small, the average loan size.

So it brought it down.

They also have slightly higher LTV, and some of the construction loans that got paid off had some of the lower LTVs.

So right now, in total, about 68% is the LTV for the construction portfolio.

My next question is on the margin.

You said your thoughts are that may stabilize in the first quarter of 2008.

Is that based on any other rate cuts, either, I guess, by the end of this year?

Or if we get another rate cut, will it still take some time for the deposit rates to catch up?

That does not include, since we don't know whether it will be cut or not.

Every time there's a cut, it could be an immediate -- the first quarter may have some hit.

But sometimes, if the cut is close enough, some of the CDs may not reprice to the first level, so it may reprice down, like assets reprice, so that the impact can be minimized on the subsequent rate cut.

But our assumption is based upon no further rate cuts.

James Abbott, FBR Capital Markets.

My question was on the loan to values as well, so that's been answered.

But I might ask, if I can, on interest reserves for these loans, are you experiencing -- and you probably are, but can you quantify it in any sort of fashion how much your developers are digging into or utilizing their interest reserve, as opposed to selling the home and using the proceeds to pay down the loan balance?

Can you give us a sense of that?

Well, like most of the interest reserves are used during the construction period.

So if the absorption rates go down, there are two things that could happen -- they use up the interest reserves, and have to come up with their own cash to keep the loans current; or, if they get some proceeds fast enough, then they will be able to keep the loan current and make a pay-down.

A good example is sometimes the value is still good, and we don't expect losses at all, like the $11 million condo construction in San Francisco.

It was nonperforming, because the sale did not close fast enough to keep the interest current.

But it has been brought current by now, and we expect a major pay-down on that loan and no losses for that loan.

So a loan can still be nonperforming and not making the interest payments, but if later it can be made up by the sale, and we will be paid off without any problems.

Do you track the number of loans that have maxed out the interest reserve?

In other words, they have utilized all of interest reserve at this point, and the payments are being made?

Well, I think that it's not just the interest reserve.

I think we basically track all loans that have potential problems.

That's why we have classified assets.

An asset gets classified for many different reasons.

I think interest reserves being used or interest reserves being used up and now being funded by the developer's own pocket money -- those are all signs of stress that may require classification of loans.

So I think, to that regard, because we do ongoing classification of our loan portfolio, and obviously interest reserve will be one of the elements that we looked at for construction loans to see whether they're stressed.

The other thing that, besides just interest reserve -- you may have a developer who does an incredible job, who actually were able to get the construction project finished without using any interest reserve.

Very rarely -- but we do see that happen -- they actually come out under budget, and besides they have interest reserve as a cushion.

They may also have, because of the under budget, have additional cushion.

But if we made the loan at a high LTV, and on top of that happen to be in a market today have sort of like nothing going on, and this developer needs to sell fast, and they may still run into a potential loss situation even without using up.

Because, if the value of the sale dropped dramatically, because of the very unusual market conditions today, and on top of that, the interest reserve -- even though they did not use it, we know that it's not adequate enough to offset against that value difference between the potential sale and the cost of the loan, then I think that you still may have loss.

So I think that we do look at interest reserves very much as a key ingredient for our classification of assets.

But it's not the only thing that we will sort of like track how many loans that have interest reserves fully extended, so to speak.

On the sales rates, can you give us some insight into the monthly sales rates of homes in the Inland Empire versus what you're experiencing in infill construction, say, in some of the subdivisions in Los Angeles, or just what you would otherwise categorize as urban?

We don't have the specifics how many -- but like definitely in the Inland Empire, the sales are slower than here.

But even like every area, the sales are not as fast as like what it used to be, like it is -- the demand is higher.

The Inland Empire has been overbuilding for the last few years, so it makes it harder for people to sell, because there's just so much inventory out there.

Maybe another way to ask the question, then, if you don't track that statistic, is classified assets of urban properties versus classified assets in the Inland Empire.

Is it dramatically skewed towards the Inland Empire?

Is it balanced?

What can you tell us there?

Well, not really, because our portfolio in the Inland Empire is not -- it's a small part.

Like we mentioned, 75% are in the L.A./San Francisco area.

Also, the timing of the development is different, so the newer projects usually have not shown any stress yet, so most likely they are not being classified yet, until they are further along that you see problems with those properties.

Erika Penala, Merrill Lynch.

I was wondering if you had any sense that the asset quality issues that you're seeing right now in your residential construction portfolio will eventually bleed into commercial construction or certain segments of [term] CRE.

If so, what kind of lag do you expect?

It should not -- well, you know, what you're asking is really a very macroeconomic question.

From my sense right now, I don't see that happening.

But if we take an assumption, let's say we take an assumption that (technical difficulty) lending, [you know] the residential market is not only just going to be restricted to these new home development area, but permeate throughout the state of California and continue to [go] more and more depressed and finally hit the consumer in the head and say that, well, you know what, stop buying.

I think, next thing happened, jobs are being cut from major corporations and small business.

Then I would assume that at that point, commercial real estate market was also start slowing down and then was also start having their valuation coming down.

I think that will be the most likely scenario, when that happens.

Obviously, I think the whole country's economists are all struggling with that question, is that, with the subprime market and with what's happening with some of the housing situation, why are consumers still spending?

Why are jobs still created?

Why are companies still making record earnings?

We don't know, and that's something that we just have to play by the ears and be proactive, and our position is always be proactive and then also, during good times, try to leave some money on the table during the good times.

That's why our capital ratio is always pretty solid.

When it comes down to underwriting loans, having a little bit lower loan-to-value so that -- I mean, the overall characteristics of the market are pretty much the same, bank to bank.

However, if we have a little bit more cushion, then we can sort of like deal with that slowdown maybe a little bit better than the others.

That's where we are right now.

Given your cautious commentary on the local housing market, do you expect to be more meaningfully building reserves from here?

We didn't hear your question.

Can you speak louder?

Sure.

Given your cautious commentary on the housing market, do you expect to be more meaningfully building reserves from here?

I think building reserves is all based on how many classified assets we have, how many delinquency, how many non-performing and how much potential losses that we expect.

Obviously, I think for the last 5 to 10 years, we -- banks do not just build reserves based on whatever we feel like it.

So therefore, everything is based on the financial models that we put together and get review by outside auditors.

So in that regard, I think that if you asked me to make a general comment, and I said it many times, I think that based on what's happening in the market, I would say that I'm very cautious about what the market will look like in a few months down the road.

But we would only be able to build the provisions primarily based on whatever we have on our balance sheet.

So I think that if we see a trend of more non-performing loans coming up in the pipeline in the future, you bet we will have more provisions.

Because, by then, we have much more justifiable reason to set a higher provision for loan losses.

If the values continue to come down further, we have more reason to book additional provisions.

So this is something that is why we have to look at it very diligently, at this point.

Maybe a year ago or two years ago, you can look at it once every few months, and then now we look at these construction real estate portfolio, we need to look at it a little bit more closely.

That's what we're doing right now, because if the market can change value on a monthly basis, that will affect our outlook in terms of classification or provision for loan losses differently.

That's why taking a proactive approach and looking at the construction portfolio very diligently is the only way to go.

Then what we do is that whenever happens, happens, and then we just -- if there's more losses, more delinquency, more non-performing, we just have to book more provisions.

That's what we need to do.

So that's what we're going to be looking at in the future.

Then if next quarter comes back, we have very few NPA, and then also it is what it is, and then we will book the provision according to what the number is.

Did you experience much deposit attrition after the Desert Community deal closed, and are you expecting any more attrition?

All together, 5% as of today.

The 5% are primarily due to a major deposit campaign from previous management.

At what percentage?

I think it was like 5.5% or something like that.

We didn't want the 5.5% to stay on, and so the majority of them -- so, for those that [are hot] money, that [4% to 5%] that are not really core customers and then pretty much have left.

So, as of today, [it's] exactly 5% reduction in the Desert Community Bank deposit balance.

Christopher Nolan, Oppenheimer.

Should we expect the percentage of construction loans relative to total loans to decline in the coming quarters?

No, I don't think so, because we continue to [disburse for projects who are] in the midst of it.

So I think that actually, my sense is that there a likelihood that it would actually increase by the end of fourth quarter.

But then, as I said earlier, I would expect that maybe in mid-2008 you may start seeing a reduction of the balance, because if we are not booking much now and going forward in future, because not many people are doing anything, then most likely the new origination would not be enough to offset against the payoff.

So I would expect that by 2008 that that's going to happen.

But as of today, I look at it as that the continued -- when we originated these loans a year or two years ago, they're still being disbursed on a monthly basis.

So I would expect that by fourth quarter, there's likelihood that that may still be some increase.

But I'm not sure, because you never know.

Sometimes, some projects pay off really fast.

(OPERATOR INSTRUCTIONS).

Jennifer Demba, SunTrust.

If you covered this, I apologize.

But Julia, I was wondering if you could give us -- you mentioned the Inland Empire residential construction portfolio is about $124 million.

What is the entire portfolio?

The residential construction outstanding balance is about $888 million.

That represents about 55% of the total construction balance -- 45% nonresidential, 55% residential.

The Inland Empire is $124 million, about 14% of the total residential, compared to $888 million.

How much of that $888 million is acquisition development versus single-family homes or on condos?

Most of the $888 million would be condo and single-family residential, very few acquisition development land loans.

Are you seeing any other geographic submarkets that give you cause for concern, other than the Inland Empire, at this point?

Not in our portfolio, in terms of -- because we cover the geographic area primarily in California.

At this stage, I think that in terms of sort of a sudden change of valuation in terms of the single-family home market really are primarily restricted to the Inland Empire area, and I think for good reason.

This sort of like big price cut comes from new home development.

Only Inland Empire have a lot of new home development.

They are major builders.

Major companies always like to take a big charge-off so that they can say, get it over with, and start booking a lot of the income in the next few quarters, that kind of stuff.

But if you talk about small developers, it's their money.

They are not going to just go ahead and say, well, just go ahead and let it go.

It's their money; they are going to work very hard to make sure they got their money back.

So I think if you talk about the Inland Empire, because there are major builders there who are taking major charge-offs and stuff like that, so that the market value is really going into a seesaw battle, it's no different that if you look at, right now, commercial paper.

On Wall Street, it's going haywire, because nobody wants to bid because you don't know what the price is.

So that's kind of happening in the Inland Empire.

But when you get into like City of Los Angeles, City of San Francisco and in the San Gabriel Valley, where we have the bulk of our branches, all the developers can do in these areas is just a little bit of an infill, for a little plot of land that they can build maybe 10 homes, 20 homes and stuff like that.

So whenever in that kind of situation, you do not have a neighbor who is a major builders, who says, I am doing a massive fire sale at 20% discount, and if you don't, then you can sell.

You just can't find these big builders sort of like right next to you, adjacent to you, are selling like 300 homes and they have to get out in a heartbeat.

So whenever you have that kind of situation, now, the builders are building 20 homes, 40 condos in West Los Angeles and stuff like that.

They do have a lot more leverage in terms of, well, there's the demand.

I know that the buyer is now saying, well, price is supposed to come down because all the newspapers say price needs to come down.

So I need a bargain.

So therefore, the developers now in West L.A.

or maybe in San Francisco may come in and say, okay, I'll give you a 5% discount.

But you still need the home, I still need to sell, and then let's just get the deal done.

I think you see more of that happening in the urban areas.

But when it comes to in the newer developed areas that have a lot of land, have a lot of big builders, then the situation may be different.

So that's what we see right now.

Andrea Jao, Lehman Brothers.

Could you tell us when the conversion of Desert Community is scheduled for and remind us the cost savings, as well as talk about expense growth after that?

It will be the first week of November that we will consolidate and convert all the system to the same platform.

We expect some cost savings.

It's not a tremendous amount of money, but then there's some -- you know, like there have been duplicative expenses by running two different systems.

Is it too early to ask about expense growth projections and drivers for 2008?

Yes, I think so.

Fair enough.

We have to -- but the likelihood is that if we don't experience high growth in 2008, probably we'll make sure that we control the expenses well.

Yes, I think one thing you can expect is that we just do logical, commonsense stuff.

So we spent a lot of time talking about these residential construction loans and real estate market, residential real estate market.

When the market continues to affect the economy, obviously, we have to -- we would expect a slower growth, and therefore expense will be tightened up.

But if this is just a blip for a two quarters kind of situation, and things going better again, and we start experiencing the kind of growth similar than we have in the past, then we will expect that we will need to further invest in people and continue to provide infrastructure to support that kind of growth.

So everything just goes proportionally and logically, and that's what we're going to do.

Our plan is always that we will talk about the 2008 guidance at the fourth quarter release time.

So it will be January of 2008.

James Abbott, FBR Capital Markets.

I thought I would see if I could focus on a little bit of positive for a second here.

There's been a lot of dislocation in the jumbo mortgage market.

Particularly in California, that's a very important piece of the market.

Is there something that you have thought about doing strategically to get involved there?

It may not be a permanent involvement, but maybe a 6 to 12-month opportunity here.

Is there something that you've considered there (multiple speakers)?

(multiple speakers) offering the jumbo single-family, as long as it's low loan-to-value, because we just don't -- like our portfolio high loan-to-value.

So there are certain markets of people that have 60%, 65% loan-to-value that have come to us.

But the difficulty about like jumbo market is that we do not want to portfolio 30-year or 15-year fixed.

So when we offer the jumbo that we portfolio, it will be three-year, five-year or seven-year fixed, at most.

So we'll capture some, but it's not going to be something that is a dramatic amount.

It will be immaterial.

The reason is that when you do mainly adjustable rate, there's only so many that you can capture.

If we do want to take advantage of this sort of like current opportunity to actually do a lot more origination for these fixed-rate loans, then we would need to build a much bigger infrastructure to support the secondary market operation.

The problem is that, as we have already seen, mortgage business like farming; it just go by season.

We're just not going to be very comfortable to build up an infrastructure to support the business that, maybe in another time, it will go another direction and then, therefore, it will affect our consistent core earnings.

So that is an area that, unfortunate for us, I think that will pick up some additional business, but not going to be material.

As that was your final question, I would now like to turn the call back over to management for closing remarks.

Thank you all for joining us for the call, and I look forward to talking to you again in January of 2008.

Thank you.

Thank you for your participation in today's conference.

This does conclude the presentation.

You may now disconnect.

Have a great day.