East West Bancorp Inc (EWBC) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 East West Bancorp earnings conference call.

My name is Nora, and I will be your coordinator for today.

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

We will be facilitating 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 conference, Ms.

Irene Oh, Senior Vice President of Corporate Finance of East West Bancorp.

Please proceed

Good day everyone, and thank you for joining us to review the financial results of East West Bancorp for the second quarter of 2008.

In a moment Dominic Ng, our Chairman, President, and Chief Executive Officer, will provide highlights for the quarter, then Tom Tolda, our Executive Vice President and Chief Financial Officer, will review the financials.

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 events or future financial performance of the Company within the meaning of the Safe Harbor Provisions 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, 2007.

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 afternoon for those in the East, good morning for those in the West.

Thank you for joining us on today's call.

Yesterday afternoon we announced preliminary financial results for the second quarter of 2008.

We reported a net loss for the quarter of $25.9 million, stemming from a provision for loan loss of 85 million for the quarter.

Tom will summarize the financials later in the call, and discuss some of the details of the financial performance.

With that said, I would like to put our results in context for you, and discuss the business.

The current economic cycle has proven to be challenging for the entire financial services industry.

The continuing deterioration in the overall economy, the difficulties faced by Fannie Mae and Freddie Mac and many financial institutions, have all increased the volatility and the uncertainty in the banking industry.

Although East West is certainly not immune to the impact of these unprecedented declines in real estate values and market turbulence, we believe that East West's business model and balance sheet are very strong, and position us quite well as this cycle bottoms out.

Now I would like to share with you key points and accomplishments for the quarter, including the timely capital issuance in April, our strong capital levels, strong liquidity, and a summary of the comprehensive loan portfolio review completed during the quarter.

I am also pleased to share that we are returning to providing earnings guidance, which I will provide for the remainder of 2008, and for full year 2009.

First, we successfully raised 200 million in a convertible preferred stock issuance during April of this quarter.

This increase in capital resulted in a substantial increase in all regulatory capital ratios as of June 30.

Our total risk-based capital ratio was 13.01%, Tier 1 risk-based capital ratio was 11.04%, and our Tier 1 leveraged capital ratio was 10.01%.

These capital ratios are among the best in the industry.

Additionally, our total tangible equity to tangible asset ratios increased to 7.96%, one of the highest tangible equity ratios among our peer banks.

Second, we strongly believe that our current capital levels and strong core earnings, will enable East West to weather this economic cycle, without having to go back to the capital markets to raise additional capital.

We announced on Tuesday that we are maintaining the quarterly common stock dividend at $0.10 per share, or a 6.3 million dividend payout.

Recently, there have been announcements by many financial institutions on dividends, cuts, as market valuations have decreased, and capital preservations have become critical.

We performed a thorough analysis of our capital, balance sheet, liquidity positions, and forecast earnings, and are confident that with our robust capital levels, maintaining the dividend payment in August is the appropriate course of action.

We realize that the volatility and the stock price have been challenging for our shareholders, and believe that the dividend payments reflect our commitment, to return value to our shareholders, and reflect our confidence in the future of East West.

Third, the overall liquidity of East West Bank remains very strong.

As of June 30, 2008, we had $1.7 billion in excess borrowing capacity, and we will be increasing this further.

We are continuing to reduce our land and construction loan balance to reduce to reduce credit exposures, and focus on the deposit growth as a way of freeing up capital and increasing liquidity.

Fourth, during the second quarter, we completed a comprehensive review of all loan portfolios.

Let me start by discussing the two loan portfolios that have been most significantly impacted by the real estate crisis, land and construction loans.

I will also address each of the other loan portfolios, and how they are performing.

As part of the loan review we ordered new third-party appraisals for our land and residential construction loans, and hired a national accounting firm to perform an independent review of our land and residential loan portfolios.

Loan by loan, management at the bank reviewed 100% of all of these loans.

During the quarter, we recorded provision for loan losses of 85 million.

Of this amount, 65.3 million, or 77%, was allocated to the land and residential construction portfolio.

As of June 30, we had 625 million in land loans, and about 1.5 billion in construction loans.

Out of that 1.5 billion in construction loans, 1 billion are residential construction projects, and the remaining 500 million are commercial construction loans.

Our underwriting standards are conservative, and average loan to values were 47% for land loans, and 69% for residential construction loans, at the date of loan origination.

Some loans in the portfolio have been impacted by the downturn in the residential real estate market, and as a proactive measure, we obtained new third-party appraisals for these loans.

We have calculated new updated appraisals, based on the current bulk sale value.

Bulk sale appraisal value takes the estimated retail sales, subtracts expenses, to derive expenses, net cash flows, discount cash flows using market discount rate, and then factor in developers profits.

Based on these discounted values, the current average market loan to value is now approximately 70% for land loans instead of 47, and approximately 84% for residential construction loans instead of 69%.

Although there has been deterioration in the market, the effects have been minimized in our portfolio, because the original loan to value was so much lower.

So even today, we still feel that the loan to value as of today with this new appraised value, is basically at a level that will be able to minimize the losses much better than many other banks.

In addition, almost all land and construction loans require a personal guarantee from the borrowers, and that also helps to reduce problems in our overall portfolio.

Additionally, as part of our ongoing internal analysis of credit risk exposure, we have performed various stress case modeling scenarios for our land and residential construction loans.

These stress tests include assumptions on probability of default, and further decline in real estate values in the next few quarters.

Based on the results of the credit review, the updated appraisals received, and our internal stress case analysis, we are comfortable that as of June 30 we are well reserved, and will be able to meet future credit challenges, with significantly less credit provisioning than the first half of the year.

To continue the comprehensive review of our loan portfolio, we have also ordered new third-party appraisals on all of our commercial construction loans.

This project is well underway and as of this morning, we have received approximately 77% of the new appraisals, and an independent review of almost all of the loan files have been completed.

We are pleased to report that collateral deficiencies and credit concerns are very minimal in our commercial construction portfolio.

Additionally, if you look at that table attached to the press release, you will see that we have zero charge-offs and zero non accruing commercial loans during this quarter.

Now let's go to commercial real estate, CRE.

Currently we have 3.4 billion, or about 40% of our loan portfolio in commercial real estate.

Again, if you look at any credit metrics for this loan category, you will find that our CRE portfolio is performing extremely well.

We had zero charge-offs in this portfolio year-to-date.

In fact, we have not experienced any charge-offs in our commercial real estate portfolio since 2005.

As of June 30, 2008, we had only 18 million, or 21 basis points of non-accrual.

Additionally, we have obtained updated appraisals for virtually all of our non-accrued and problematic commercial real estate loans, which indicate a potential loss count of only about 1.4 million, and we have already reserved for this potential loss as of June 30, 2008, and feel very comfortable that our income producing commercial real estate loan portfolio is holding up very well.

C&I and trade finance loans.

We have experienced a slight increase in C&I loan delinquency.

Of the total 7.7 million loans delinquent 90 days or more, 3.5 million were SBA loans.

So the remaining of C&I over 90 days, only 4.2 million.

As of June 30, 2008, total SBA loans were only 21.9 million.

And the increase in the 90 days or more delinquency was primarily due to one loan.

Excluding SBA loans, non-accrued C&I loans were a mere 4 basis points.

Our trade financed loan portfolio is performing very well.

Non-accrued trade finance loans are virtually nonexistent at only 621,000.

Again, we have already reserved for any potential losses or deficiencies at the end of the quarter.

Let me go to single family residential, multifamily, and consumer portfolio.

At East West the credit performance of our single family, multifamily and consumer loan portfolio is substantially different and much healthier than many other banks and institutions.

Total non-accrual loans were only 8 basis points for each of the single family, multifamily, and net charge-offs were very low at only 5 basis points for our single family and multifamily.

Additionally, many banks are currently faced with an extremely challenging consumer and home equity portfolio.

We have had a very low level of charge-offs in the consumer portfolios and the delinquency rate of our consumer loan portfolio extremely low, with non-accrual loans at only $476,000.

We were recently recognized by S&L as having one of the best performing HELOC portfolios in the nation's [SRN] portfolio.

We are pleased to report that at the end of the second quarter this still holds true.

I have spoken extensively about our loan portfolio, balance sheet, and capital strengths, and hope I have addressed concerns from investors, that may have about the loss content of our loan portfolio.

Given the unprecedented market conditions facing the industry, we understand these concerns.

East West Bank has a firm understanding of its credit exposure, and has been aggressively and actively managing this risk.

We are building reserves, proactively and aggressively dealing with all loans, with an early signs of business, and is working diligently to quickly resolve problem credits.

Additionally, we are actively reducing our loan portfolio as of today.

The land and construction portfolios are about 16 million lower than June 30.

On a final note, I would like to discuss our expectations for the remainder of 2008, and provide an early indication of what we expect for 2009.

We currently estimate that earnings per share for the third quarter of 2008 will range from $0.08 to $0.10, and that earnings per share for the full quarter will range from $0.11 to $0.13.

This guidance is based on the projection of net interest margin of 3.11 to 3.16 for the remainder of the year, with a full year net interest margin ranging from 3.28 to 3.32.

Additionally, we believe that over the remainder of the year, provision for loan losses will be at a reduced level from the first half of the year.

We currently estimate the provision for loan losses will be about $30 million per quarter for the remainder of 2008.

At this point we also feel comfortable in providing initial guidance for 2009, in light of market conditions and our strong capital base, we believe we are about a quarter and a half ahead of our competition in dealing with problem credits, and recognizing the appropriate provision for loan losses.

We anticipate the real estate market decline to continue through year end, but at a slower pace than what we have been dealt with as of today.

Given this, we believe there will be ample opportunities for us to potentially acquire one or two small banks in the second half of 2009.

An acquisition in conjunction with organic loan growth in 2009, will likely increase assets in low double digits year-over-year.

Consequently for full year 2009, we believe that earnings will range from $1.35 to $1.40 per share.

Now these are very challenging times for bankers, and industry volatility is often accompanied by investment opportunities.

At East West we have much work to do for the remainder of 2008, yet I am confident that we will come out of this cycle a better bank, and one that is poised to capitalize on future market opportunities.

With that, I would now turn the call over to Tom, who will discuss our second quarter 2008 financials in more depth.

Thank you, Dominic, and good morning or afternoon as appropriate.

I would like to start with our second quarter reported net loss of $25.9 million, or $0.41 per share.

Our net earnings are only preliminary, only to the extent that we are determining whether a goodwill impairment charge, if any, is required at June 30th.

Due to the volatility in our stock price, a goodwill impairment analysis is necessary at this time.

This analysis is currently being reviewed, and will be completed very shortly.

If goodwill impairment were to occur, it would be a non-operating, noncash event that has no impact on the bank's regulatory capital levels, cash, or liquidity.

This is the first reported loss for the Company since 1981.

And the primary driver was an outsized $85 million provision for loan losses for the quarter, and a $9.9 million charge for other than temporary impairment on certain securities within our investment portfolio.

East West started building the allowance for loan losses in the fourth quarter of 2007, elevating the provision in the first quarter of 2008 to 55 million.

The higher levels of provision are a significant departure from the low level of provisioning in the not too distant past.

We long for the good old days to return.

Dominic already discussed in-depth the extensive loan review that was undertaken as we were coming out of first quarter.

Given the challenging market climate in conjunction with the loan review, we felt that it was very appropriate to increase our provision for loan losses in second quarter.

In second quarter, we booked the $85 million provision, and charged off $34.8 million, of which 32 million related to land and construction.

The only significant distressed geographic region we had loans in, continues to be the Inland Empire.

In fact, $29 million of the $32 million in land and residential construction charge-offs were for land and construction located in the Inland Empire.

Our total charge-offs of 34.8 million for the quarter compared to 25.4 million earlier in the first quarter.

We have built our allowance for loan losses to 168.4 million, almost twice what it was at the year end 2007.

The allowance is now 1.95% of total loans, versus 1.32% at the end of the first quarter.

Non-accrual loan balances are $170.8 million, up 112.9 million, with the largest change coming from the land and residential construction portfolios.

We have discussed that we are continuing to aggressively manage our balance sheet.

Since December 31st, 2007, we have decreased our total loans outstanding by 189 million to $8.7 billion.

We have encouraged some weaker borrowers to refinance elsewhere, and intentionally slowed new loan production.

We feel that this is a prudent course of action during this challenging and difficult environment for all the industry.

We anticipate that these portfolios may continue to trend downward for the remainder of 2008 if the market continues to drag.

I am going to shift gears for a moment and discuss trends in deposits.

Although the market competition for deposits remains intense, East West grew it's deposit base 200 million, with average deposits increasing from 7.3 billion during the first quarter, to 7.5 billion during the second quarter.

During the second quarter, we introduced several deposit campaigns and promotions, which helped increase and retain customer balances.

As we continue to focus on de-leveraging and reducing credit risks and exposures, the generation of core deposits will remain a strong focus for all East West Bank team members.

As of June 30th 2008, our total loan to deposit ratio decreased to 115%, from a high of 120% in December 2007.

By decreasing loans and increasing deposits, we are freeing up capital, and further strengthening our balance sheet.

In second quarter East West total revenues including net interest income and noninterest income totaled $105.6 million, in comparison to $115.5 million in first quarter.

Net interest income was $92.2 million in the second quarter, down 7.4 million from prior quarter.

This decrease is attributable to net interest margin that declined from 3.63% in first quarter, to 3.33% in the second.

The 30 basis point squeeze in the margin is primarily due to the recent substantial Fed fund rate cut.

The pricing of deposits lagged the resets on our variable rate loans, until any interest rate reduction initially negatively impacts our margins, until the downward repricing of deposits catch up to the loan resets.

Further, higher interest reversal on non-accrual loans and lower margins on the reinvestment of loan payoffs into lower yielding treasuries, also contributed to the margin squeeze.

As liquidity continues to build for the remainder of 2008, our strategy will be to use excess cash to reduce costs, reduce higher costs long term FHLB borrowings.

We have 190 million of long term FHLB borrowings maturing before the end of the year.

We will be paying these off with more to come in 2009.

Second quarter, we sold 234 million of agency mortgage-backed securities from our available for sale investments portfolio, and recognized a gain on sale of 3.4 million.

At the same time, we also recorded other than temporary impairment of securities in our investment portfolio.

As noted in our press release, these maturities were comprised of Fannie Mae and Freddie Mac preferred stocks, which were written down 8.4 million.

We also experienced a charge of 1.5 million on full trust preferred securities, also determined to be other than temporarily impaired.

We are confident that the charge-off on the agency preferred stock will be recovered as Fannie and Freddie continue to pay their dividends.

Now noninterest expenses were 65.6 million in second quarter.

Excluding the impact of the noncash OTTI charge on agency preferred stock, expenses were 55.7 million.

This compares to the first quarter 52.9 million that was favorably impacted by a 3.2 million expense accrual reversal.

Adjusting for this in first quarter, on a comparable basis expenses were down 400 million, after absorbing higher costs of credit cycle expenses.

For the quarter, credit cycle expenses totaled 3.6 million, and included appraisal and consulting costs of 2 million, legal costs of 1.3 million, and subsequent REO write-downs of 504,000 for the quarter.

Management is maintaining focus on expenses, and anticipates overall costs to decline for the remainder of 2008.

Included in our income tax line is the write-off of a 7.1 million tax receivable, for a tax refund claim, stemming from a Regulated Investment Company, or RIC.

The California Franchise Tax Board denied our claim.

This write-off does get the benefit of a Federal tax deduction, therefore second quarter's tax credit against pretax losses is reduced by 4.6 million, and is included within the preliminary net loss reported for the quarter.

I would like to conclude by briefly discussing some of the key initiatives that we are undertaking to manage the balance sheet.

We remain focused on growing core deposits, and reducing our risk exposures.

As of June 30, 2008, our total risk based capital reached 13.01%, or $331 million more than the 10% regulatory requirement for well capitalized banks.

That is a large cushion.

Generating and preserving capital will remain a focus for management, as we steer the bank through this challenging market, and gear up for new growth and opportunities in 2009.

I will now turn the call over to Dominic once again.

Thank you, Tom.

Again I would like to thank everyone for joining the call today.

And now Tom, myself, Irene, and Julia are all available to answer your questions.

Ladies and gentlemen, (OPERATOR INSTRUCTIONS) Questions will be taken in the order received.

Your first question comes from the line of Brett Rabatin.

Wanted to first ask, in the past you guys have given the number for, I guess you call it substandard, but was curious if you could give any color on, additional color on delinquencies, or however you want to say it, special mention, substandard, watch list loans?

Brett, this is Julia.

As expected, in terms of the trend on the delinquencies, we do expect delinquent loans will continue to go up in the third quarter, and possibly fourth quarter, but so far if you look at the delinquencies as of June 30, the majority of the nonperforming are in the land and construction, which we already account for all of the portfolio, the entire portfolio in the reserve.

So if the nonperforming continues to go up in the same categories, land and construction, we do not need to increase the reserve dramatically, because it has been accounted for.

Let me just also highlight that we currently already know exactly which specific loans, like land or residential construction loans, that potentially may be impaired.

Now many of those that we actually set up specific reserves today, frankly is still paying as agreed, but since we have already identified that there are maybe collateral deficiencies, and we go ahead and set the reserve for it.

It is for that reason that is why the provision is substantially higher than the charge-off, because while we don't really know exactly what would happen for some of these loans yet, we go ahead and book the reserve now.

Now here is what is going to happen.

If some of these loans, somehow the borrowers decide to get that taken care of by showing up additional equity, then we have no problem.

There are other possibilities that there is a likelihood that they just work with us, and somehow we can just through loan sales, or maybe work out a discount, or maybe there are other ways that we have got it resolved, or they would quickly we are able to foreclose.

There are other scenarios, if we get into a situation that the borrower is not able to make the payments, or show additional equity to cover the deficiency, or for whatever reason, because there is so much equity that they have put in, and they really wouldn't want to let go, then it gets messy, because they may file bankruptcy to delay it, to stall, and then we would not be able to foreclose.

Now under the different circumstances it will affect our NPA.

Because if there are more properties that because customers have so much equity tied into there, they wouldn't want to let go, and they would rather use legal process to slow the process down, then we may have more NPAs sitting there, and we are not able to foreclose on it, and therefore not we are able to sell it.

And on the other hand, if the process is smoother, so far what we have found, whenever we get REO coming in, we are able to get it out pretty quickly.

So we have got five REO coming in, and we have sold five out.

Currently as of today, we already have two or three of three of the REO sitting in here right now under contract that we will be able to get out.

On one hand we are trying as best as we can to get these inventories moved, or lower the NPA, but I think to certain degree how the third quarter and fourth quarter NPA would look like, would depend on how quickly we can take these properties in, or to a certain extent, whether we can actually work some of these problems out, without even, or cure them to be current rather than be chronic.

But all-in-all I would say that in terms of loss potential, the bottom line is that we either have specific reserve, or we have already charged-off.

One way or the other, we have them covered.

Okay.

Maybe we can follow-up off-line a little bit about substandard and impaired loans.

The other question I wanted to ask was just the charge-offs you did take were obviously concentrated in the Inland Empire, and I was curious if the reduction in the land, the 625 million, if that was almost all a function of the charge-offs and reductions that you had in the Inland Empire, and what that portfolio looked like at the end of the quarter?

Obviously we had charge-offs for the land loans.

In fact -- How much?

We charged off total 35 million out of that.

Land and construction is 32 million.

And for the land and construction, 90%, 29 million, came from the Inland Empire.

So you can see that Inland Empire is the most distressed area.

But I am pleased to show you the riskiest portfolio would be residential construction and land loans in the Inland Empire.

The residential construction and Inland Empire has gone down from last quarter 160 million, to only $86 million, and we only have $122 million in residential land in the Inland Empire.

So in total, the $200 million would be what we consider the riskiest portfolio.

And also, Brett, specifically to your question, the land loan, we have a $16 million charge-off in the second quarter, but the land loan balance has dropped much more than 16 million.

So we have pay down plus also charge-offs that reduce loan balances.

In fact, we expect the land loan balance will go down even further in the third quarter, and the fourth quarter.

Okay.

Great.

Thanks for the color.

Thank you.

Your next question comes from the line of Andrea Jao from Lehman Brothers, please proceed.

Good afternoon, everyone.

Hello.

Can you hear me?

Yes.

I would like to start with just the total land loan exposure as of the end of June 30?

Did you say 620 million?

Yes.

With nonperformers at 72.6.

How much reserves do you have allocated to that portfolio?

In total, our allowance we have 90 million for the land and construction portfolio.

We have a substantial reserve allocated to the land and construction.

Okay.

And then as I understand, will you continue to look at your loan portfolio on a file by file basis.

So what happens in the third quarter, and is there anything else to do in the fourth quarter, such as the commercial business book?

Well, the commercial business loan, actually we started the process of looking loan by loan since the beginning of the year.

And that is much tedious process.

In fact, that is something that we continue to even on a weekly basis, our lending officers and our Chief Credit Officers, together with a few of the senior management have continued to review those loans, and in fact, that is the reason why the C&I loans and the trade finance loan balances have reduced since December 31st 2007, gradually to where we are today, and because what we have done, when we identify C&I and trade finance loans that we feel that is weaker than our expectation in a very difficult and challenging economic environment, we have asked the account officers to help the customers to move on to other financial institutions.

That has been very successful because in today's environment everyone wants C&I and trade financed loans, and obviously it is much harder to do that for land and construction.

So in fact, that is also a good reflection why we have so little delinquency and over 90 days for C&I and trade finance, is because of this active process for the last six months to get them down, and we will continue to be vigilant and because C&I loans and trade finance loans is something that you just can't put them off for three or four months, and then come back and look at it.

So it is just a continuing review cycle, and loan by loan.

Andrea this is Tom.

What I could also add to domestic Dominic's comments is just that given the appraisal updates that we have received, first off, we do get a number of appraisal updates over the course of quarters, and in addition, our intent is to index those appraised values that we have thus far obtained for which we do not have newer appraisals coming in, say third and fourth quarters.

So we are going to try and keep those as fresh as we can with using an index.

Great.

Thank you.

Your next question comes from the line of Joe Morford from RBC Capital Markets.

Good morning everyone.

I am still just a little confused.

The provision guidance for the second half of the year is around $30 million a quarter.

Just trying to understand exactly what is driving that.

Is it just replenishing the reserve for what is expected, in terms of net charge-offs, or maybe is there more to the stress test that you can talk about?

We have basically, we feel that we are very adequately reserved right now, so we have got every loan marked down that we need to be marked down, whether they are performing or not performing.

We see some deficiency, we mark them down.

So that is what we have done so far.

However, we look at the current market condition today.

We don't see this market improving.

We don't even see this market stabilizing.

We see this market is still going to be declining.

And with that in mind, we just think that it is only prudent for us to set additional reserve, to cover some potential market deterioration that would go further.

Now keep in mind what we see at this point is that this is our analysis, is that the first six months market decline, in terms of real estate values in Inland Empire, and the throughout the California region has been very, very severe.

We do not expect the market to drop as dramatic of a fashion.

Frankly, some of these land loans that we have, if it dropped any further will go negative.

So it can't drop any more.

So what we expect, is that maybe there's another, if we analyst about a 10 to 20% decline, and we take that into consideration, we stress test our model, and we feel that because of that, we will need to have some reserve to cover further deterioration of the real estate market.

That is one.

Then we obviously need to have some more to cover any other miscellaneous for the economic conditions.

So that together, we need 30 million each quarter, and that is what we decided what we have.

But not to say that we have actually more loans that we think have distressed that we haven't covered yet.

This is a one-time provision to take care of where we are today, and then the future 30 million is an expectation of further market deterioration.

Actually we feel that because we reviewed the portfolio 100%, and used recent appraisals, in theory, if the market does not deteriorate any more, we reserve for all the collateral deficiencies for every single one, not all of these borrowers are going to default and we have not taken the losses.

So you would think that $85 million reserve is the upper limit, the maximum limit in the event that the market does not deteriorate.

Because in addition to not all the borrowers will walk away and defaulting, just because there is a collateral deficiency, we also use the opportunity having the new appraisal value that is lower, to go back to the borrower and ask them for more paydown, more collateral, which will result in some of the loans will end up having no losses.

However, for the guidance, we wanted to incorporate additional deterioration in the market values, the housing prices to give the guidance.

So we hope for the best.

If the market does not go down that much, then we probably would not be booking even $30 million provision.

Okay.

That makes sense now.

In the guidance for '09, what kind of provision have you been assuming there?

Joe this is Tom.

So in '09 what we assumed is a provision of 20 million in the first quarter, kind of tailing down to about the 10 or 15 million level by fourth quarter.

60 million.

20, 20, 10, 10, so the total is 60 million, which if the market has recovered, we probably don't need to provide for that much.

Right.

so it really depends on the market, because in the past, when the market was good, we never have had to book that kind of level of provision, even when we had 35% loan growth.

Let me just give you the assumption, Joe is that the assumption is that the third and fourth quarter 2008, the market is still a mess.

The first quarter of 2009 is still a mess.

Then what we will do, we hope that by the latter part of the second quarter, things finally bottom out, and then everything stabilizes, and people actually see the light at the end of the tunnel, going forward the second half of 2009, and that is, now, why then we do not need 30 million just like the fourth quarter is that, in the third quarter 2008, is because 2009, we will ratchet down so many of these construction and lands loans, we charge them off.

We are going to have them paid off, there is going to be not a whole lot left.

Therefore, at that point, I mean, we just don't need that much reserve.

It is not that there is not going to be the severity of decline that would cause deficiency.

It is just that that the magnitude of the size of the loans would drop dramatically, because we know there is going to be a substantial number of loans which we will be paying off in the third and the fourth quarter, and there will be a continuation that movement in the first and second quarter, and therefore by then, we ought to have a well coverage situation, even with 20 and 10 million.

Right.

I also add to what Dominic said about reducing the exposure on the construction and land loan, I also want to provide our committment on construction peaked in February at 2.560 billion.

It is not at 2.140 billion.

So we are reducing the commitment balance by 400 million, which is a substantial decrease in the exposure to the construction portfolio, and we expect that it will continue to go down.

And that is why if you look at our outstanding balance on construction, it has been leveling off at 1.5 billion.

A few months ago when we had the commitment of 2.5 billion, you would expect that the balance will continue to inch up as the expirations paid out, but as it turned out because we are reducing the commitments, so either the sale of the properties or refinancing when the projects are done, so we reduced 400 million on the commitments in the construction portfolio.

One of the reasons why it helps having a full review and then on the appraisal, and then full review of the credit on these construction loans and land loans, is that our account officer can use the appraisal as a tool to go out there and work with the borrowers, because a lot of times we as lenders need to help advise borrowers to let them know that, look, are you sure you still want to go forward with this project?

Because it doesn't look very good right now, and without having the most up to date appraisal, without doing a full analysis, if we were on cruise control, we would be totally relying on our borrowers, to at their discretion to whether they would continue to get disbursed or not get disbursed, and then I think that would create more problems.

So that is why we have more than $400 million of reduction in the commitments.

And as of today our lenders continue to be out there talking with borrowers, to help reduce the commitment further.

And I believe that that will continue to trend down, in addition to the loan balances trending down.

Okay.

That is all really helpful.

Thanks.

Just one housekeeping thing for Tom, I guess.

What kind of tax rate should we be using, beginning in the third quarter?

Yes, I think beginning in the third quarter we can probably go back to the statutory tax rate.

We do have some tax credits that continue to accrue to us, but I don't think you would be far off if you used that.

Okay.

Thanks so much.

Sure.

Your next question comes from the line of Erika Penala of Merrill Lynch, please proceed.

Hello.

Hi.

I just wanted to, wow this is quite an echo.

The NPAs that you booked on your land and your construction book this quarter, how much of that was Inland Empire versus other markets?

We don't have the NPA in the Empire.

We can get back to you later.

Okay.

I just wanted to confirm, once you classify the loan as nonperforming, do you write it down to the newly appraised value, and write it including the disposition discount that you determine?

Yes.

In fact, not only for nonperforming, we do 100% mark to market.

Every single loan we look at, every single land loan we look a the new appraisal, and we looked at whether there is deficiency or net, and then we mark them down.

When we mark them down, we also add disposition and commission costs at 8%.

So to give you an example, if you have a loan that, let's say, has a $1 million dollar balance, and have $100,000 deficiency, so now we have $900,000 new appraised value, so we have a $100,000 deficiency, what we do is we take that $900,000 new appraised value, times 8%, and then to get down to $828,000, then using that as the net value, and then with the $1 million going against it, we have to book a reserve for 120-some-odd thousand.

That is how we do our formula.

I am sorry if I didn't catch this in the prepared remarks, but what was the average divergence in original appraisal and updated appraisal in land, lot development, and vertical construction?

For land, it is about 47% at the date of origination, to now 70%.

7-0.

For residential construction loans, construction, it went from 69% up to 84%.

The calculation of land LTV at origination, is the value calculated on just the value of the raw land, or is the value calculated based upon the value of the project with the build-out with the structure on top?

I think the majority of them are based core asset value, and then there are a few of them that sort of based on whatever project they are working on, there is some assumption that the appraiser used.

They never put the structure as a value, but some of the land they are valued if they are going to be built on, which the reason that some of this land value now goes down dramatically, is that assets are down, because the property prices have gone down and this land is in an area where there was no electricity, sewer, utilities.

They cannot, or it is not feasible to have bond financing to get the infrastructure in place, so the development gets stopped, and that is the land the values drops dramatically, but we never put the value of the structure as the value of the land.

Usually the land is assumed that it is for development, so if the development cannot be done for different reasons, for economic reasons, then the land value for a buyer, then it would be a lot more.

I think the most important thing is that the current value we have is all assets.

There is no assumption.

So most of them actually were a great piece of land for development, and now all becomes raw land, and that is what we have right now, because what we are doing is that we looked at the asset value, and the current value that we use is what matters, because that is what we provide reserve to, and that is what we use to determine, value for if we entertain offers for selling this as an REO, or as a note, et cetera.

One more question, if I may.

Could you share with us under your stress scenario, what you are assuming for probability of default, and a loss severity upon default?

Erika, it is Irene.

For our stress case what we looked at are a couple of scenarios.

One, a 10% annualized decrease in the value, and another 20%.

In severity and defaults, the probability we have done that based on, obviously we have very detailed information about the loan on a loan by loan basis, also classifications.

I would just say that the probability of default will vary by portfolio, will vary by geography, and therefore answering that question directly makes it a little bit more challenging.

We do a one by one, loan by loan kind of review on the land and the residential construction, so we really are looking at it at a very different way, than using any kind of extrapolation, and now, because the fact is we actually are looking at these loan by loan.

One more thing, Erika, I want to clarify is our analysis would show that we need total provision of about 30 million a quarter, factors in that all of the loans that show deficiency, a decrease in value, the probability of default is 100%.

So we will see in actuality if the market comes out a little better.

Maybe that will be a little lower.

Okay.

And one more housekeeping question, if I may.

The $620 million land total that you gave, does that include land for commercial development?

Yes, for land, we looked at both commercial and residential.

Thank you.

Right around 50/50.

Okay, thank you.

You are welcome.

Your next question comes from the line of James Abbott from FBR Capital Markets.

Please proceed, sir.

Yes, hi.

Good morning to you.

Question on the REO sales.

Could you give us a sense as to what the gain or loss has been there, relative to the valuation marks that you had taken?

James, the REO sales that we are getting off the book here is going off as essentially the written down value, so we are not taking much of a haircut at all, once we have written it down at the inception here.

So they are going off at the carried value at that point.

Okay.

And the ones under contract, that would apply as well there?

Yes.

Definitely.

What we have on the REO as of June 30 that is currently under contract, they are all either slightly, I think most of them are slightly above.

We have seen some gain, and we have seen some loss, but on the average, it is generally coming in very close to the book.

Okay.

Sounds good.

And then a couple of questions on the sensitivity of the provisions.

I think I understand the 10% and the 20% concept.

If it were to be less than that, how sensitive is that?

Does it go from 30 million to 20 million?

In other words, if you used the 10% number --?

Sure.

My recollection was that 10% we were looking at potentially 13 million, in that range, and at the 20% level, we were at roughly 20 million.

This is for land and residential construction.

The remainder of that provision forecast would be for other portfolios.

For whatever is needed.

Okay.

That is helpful.

That is very helpful.

Last question is on the bank trust preferred portfolio.

Could you give us some detail about what that is, and how that is structured and how much that dollar amount is?

It appears in the 10-Q, but there wasn't a lot of detail in the 10-Q on that.

What the tranches are, how you are valuing that?

A question that a lot of companies are having this quarter.

Yes.

The majority of the full trust preferred we have a small amount of single issuers, B of A, that we bought a long, long tame ago.

The majority are the full bank trust preferred, and we have about 128 million in total.

Because those adapt with maturity, we would book impairment if we believe that is not collectible, so we have performed analysis that incorporated all the deferrals as of June 30, assuming that they are all default, and that is what we booked is a $1.5 million impairment charge.

We believe that some of them will get back, because one of the default was a bank that has been sold.

So when the new buyer assumes, and pays all of the back interest, there will be some recovery on those traunches.

And the tranches on those?

Can you break down the 128 million by traunch?

A lot of them are mostly the BBB or single A tranches.

Yes, we can get back to you with that breakdown after the call, if you would like.

Okay.

There is a lot of concern, a lot of banks haven't maybe deferred or defaulted at this point, but there are various ratios, maybe their risk-based capital ratios or the nonperforming asset to equity ratios, et cetera, are climbing very quickly.

And so some banks have used that as a guide, to try to value stuff that hasn't been technically deferring or defaulting.

Any considerations on doing something like that going forward?

Well, we would probably rather than make assumptions of all the defaults, because many of them still have support from the cash flow and the subordination.

We would assume that anybody that has deferred to default 100%, because when it comes to the accounting, you don't do credit impairments until you see that the bank has potential failing as a result of deferring the trust preferred.

Usually they would defer first before they default.

Okay.

We have anticipated some default in the guidance that we have provided.

Okay.

We have got some in there.

Thank you very much.

Thank you.

Your next question comes from the line of Aaron Deer from Sandler O'Neill, please proceed.

Good morning everyone.

I was hoping you could comment a bit more on your review of the commercial construction portfolio.

It sounded if I heard you right that you said that there is no deficiencies, or no changes in your gradings, as a result of the review thus far?

And I am wondering what kind of trends you are seeing in terms of appraisals on those properties, differentiated between the more urban market, versus the more outlying areas?

Aaron this is Tom.

So what we have been doing, we went out and solicited for all new updated appraisals, that process got going, probably in the early part of June.

I believe roughly 45% --

No, no.

Almost all are now done.

And based on what has come back is that we have seen that the deficiencies in those appraised values versus the loan is actually quite minimal, to the tune of maybe 1 to $2 million kind of range.

So quite small overall.

So that is where we are.

We feel pretty good about how those values are holding up.

What is it that, I guess, is holding up that?

Because I was just down there recently driving through some of those markets, and we saw quite a few newly completed strip malls, and small office buildings, and that sort of thing, particularly out in Ontario and some of the further out markets.

I guess I am surprised seeing the vacancy that we saw to hear that the appraisals are holding up that well.

I guess a lot had to do with how we underwrote it.

If we have got a low loan to value at origination we would be protected by, not to say that there hasn't been devaluations out there, but as long as we underwrote it well, we would be protected in part.

Yes, as for commercial construction loans, East West Bank underwriting guidelines has substantially lower loan to value than residential.

Clearly on the residential side, we have banking social pressure, in terms of helping first time homebuyers to get into their new homes, then obviously when we work with developers in the Inland Empire we tend to go with a high LTV if they were building tract homes for first time homebuyers, but contrary to that, when it comes to developers building like maybe a Walgreens, and one of these big box tenants, we still are going to go with the 60%, 65% loan to value.

So you have one situation that is that the appraised value did not come down as much, first of all, which is very important.

Secondly, our cushion is higher.

So when we have a 30 to 40 or 45% cushion, and the value only came down like 15 or 20%, we are in the position to see that, well, it looks like overall LTV may have inched up, but then we don't have deficiency, which is a little different than our scenario in the residential tract home developments in the Inland Empire area.

Because in those area on the residential side we have a high LTV, 75% plus, and then the value drops maybe 35%.

So suddenly we have more than 10% of deficiency, and that is what happened.

Sure.

That is very encouraging.

Thank you, Dominic, thank you, Tom.

Thank you.

Your next question comes from the line of Julianna Balicka from KBW.

Please proceed.

A question about the Inland Empire exposure.

You had referenced the outstanding loans in residential construction and land.

And I was wondering what the commitments in Inland Empire were?

We don't have the commitments.

We can get them to you.

That would be balance for the residential construction, go down from 116 million to 86 million.

Right.

Yes.

So what would be the outstanding commitment behind that still?

We don't have that with us right now.

No we don't have it.

The only thing I was thinking is that these loans are aging, they are pretty short-term assets, they are getting older with each quarter that passes.

So I would suspect that the drawdown is pretty high on these things at this point.

Right.

And --

We will provide that for you.

Most of them has been drawn down, or they are not proceeding any further.

They are frozen otherwise.

(laughter)

Very good.

I see.

Thank you in advance.

The rest of my questions have been answered throughout the call.

Thank you.

Thank you.

And your next question is a follow-up question from Andrea Jao from Lehman Brothers.

Hello again.

Hello.

I was looking at the different drivers of the balance sheet in coming quarters, and perhaps into the first half of '09.

How much more do you think loans would run off?

Do you see yourselves holding securities books stable from here, ex the securities you use to pay down, full of advances in 4Q and 1Q, and then what does that translate in to terms of overall balance sheet growth?

Andrea, this is Tom again.

Hey, Tom.

In putting the guidance together we do anticipate that our loan balances would trail down to about the level of 8.1 billion at year end, let's call it 8.

We think that is a reasonable projection, and as we head into the new year, as Dominic had mentioned earlier, early part of the year, sort of continuing to be quite troublesome, but then we are anticipating turnaround in the latter part.

So we do think we can begin to get back into the sort of turning on the loan generation at that point, and that would be a particular timely moment, because we do believe that the market will have largely stabilized at that point.

So loan runoff until mid-'09, and then you go back to growth mode, hopefully by the back half, depending on the--?

Maybe a little bit earlier.

Maybe the decline earlier than that.

A little bit earlier than that.

Okay.

Securities flat ex --

No.

Securities will build as long as we are de-leveraging here, and taking down the loans at the same time.

So I do see the securities continuing to increase.

Okay.

And you saw some of that in second quarter.

Right.

So that translates into relatively flat earning assets?

Yes.

However, that will start to actually work to our advantage, where some of the higher cost borrowings from FHLB will begin to mature.

We have some maturing in the fourth quarter, more maturing in 2009, and the trade-off between the short-term overnight investments, and then substituting that with the matured borrowings would actually give us a margin increase.

So in 4Q, as in 1Q '09, a couple hundred million dollars coming off, on both the borrowings and the security side per quarter?

I think that is reasonable to assume.

Okay.

And then separately, and my last question, what is the statutory tax rate to use for the full year?

The statutory tax rate is 42% for Fed and state, but we have about 6.5 million in tax credits.

That is not dependent upon whatever rate.

So because of the losses that we book on the provision.

So the total pretax income would be lower, so the effective tax rate will be pretty low this year.

Only because the tax credit of 6.5 million that we use no matter what--

So somewhere between 10 to 15% effective?

Very low.

For this year.

We will give you the number later on.

Okay, fair enough, thank you so much.

You are welcome.

Your next question comes from the line of [Atif Patella] from SuNOVA Capital.

Thanks for taking my questions.

First a clarification.

Andrea and Joe kind of alluded to this.

Your provisions --

Hello?

Cut off.

Hello?

Hello?

Can anyone hear us?

I can't hear you, this is the operator.

It looks like he dropped off.

Can you hear us?

Yes, I can hear you.

Okay.

Why don't we get the next person.

You actually have no further questions at this time.

Okay.

There are no further questions?

Okay.

If that is the case, again, I want to thank everybody for joining our call, and we look forward to speaking with you again on the next quarter's conference call.

Thank you.