East West Bancorp Inc (EWBC) 2016 Q2 法說會逐字稿

Good morning. Welcome to the East West Bancorp second-quarter 2016 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Ms. Irene Oh, EVP and CFO of East West Bancorp. Please go ahead.

Good morning, and thank you for joining us to review the financial results of East West Bancorp for the second quarter of 2016. Also participating will be Dominic Ng, our Chairman and Chief Executive Officer. We would like to caution you that during the course of the call, 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 provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties.

For a more detailed description of risk factors that could affect the Company's operating results, please refer to our filings with the Securities and Exchange Commission including our annual report on Form 10-K for the year ended December 31, 2015. Today's call is also being recorded and will be available in replay format at eastwestbank.com.

I will now turn the call over to Dominic.

Thank you, Irene. Good morning, and thank you for joining us for our earnings call.

Yesterday afternoon, we were pleased to report our financial results for the second quarter of 2016. Net income for the second quarter of 2016 totaled $103.3 million or $0.71 per diluted share, a decrease of $4.2 million in net income or 4% from the first quarter of 2016 and an increase of $4.5 million in net income or 5% from the prior year quarter. The lower net income in the second quarter of 2016 compared to the prior quarter was largely due to an increase in provision for credit losses as a result of stronger loan growth and a higher tax rate.

For the second quarter of 2016, East West achieved a return on average assets of 1.27% and a return of average equity of 12.71%. Additionally, we are pleased to state that tangible book value increased 3% quarter to date and 12% from a year ago. At East West, we are committed to creating long-term value for our stockholders. We believe that our competitive advantage as the bridge between the East and the West, together with strong financial return metrics and growth in tangible book value, quarter after quarter, year after year, enable us to provide a differentiated value proposition for our stockholders. Overall, we deliver a strong second-quarter earnings performance. We increased total revenue 2% quarter over quarter to $297.8 million while keeping our expenses in check with an efficiency ratio of 44.6%. In addition, despite an ongoing challenging interest rate environment, we were able to maintain a stable net interest margin of 3.31%.

Heading into the second half of 2016, our focus will remain on growing our business profitably and prudently in conjunction with our efforts to advance our risk management infrastructure and technology while being mindful of expense control. Total loans receivable as of June 30, 2016 reached a record of $24.3 billion, an increase of $490.8 million or 2% compared with $23.8 billion three months earlier. The gross loan growth during the second quarter of 2016 was largely driven by increases of $345.6 million or 4% in commercial loans and $82.6 million or 3% in single-family residential loans.

Within the commercial loans portfolio, we experienced good growth from the factors of energy, specialty finance, private equity, capital call lines, asset-based lending, and life sciences. Loan balances in greater China remain stable at $1 billion as of June 30, 2016 or 4% of our total loans receivable.

Also during the quarter, second quarter of 2016, we sold or participate out $166 million in loans largely comprised of $78 million of commercial real estate and construction loans, $46 million of multi-family loans, $21 million of SBA loans, and $20 million of commercial loans for a gain of $2.9 million. Similar to previous quarter, we continued to sell commercial real estate loans to ensure diversification, expand our secondary market channels, and reduce exposures.

As of June 30, 2016, our commercial real estate concentration to risk-based capital ratio was reduced to 265%, well under the 300% threshold as defined by the FFIEC for commercial real estate concentration. Excluding the impact of loan sales, the year-to-date loan growth was 8% on an annualized basis. In our earnings release yesterday, we revised our loan growth guidance for the remainder of the year downward to 6% annualized growth for the third and fourth quarters.

We are on pace with the 8% loan growth year to date; however, given the challenge in market competition in this prolonged low rate environment, we felt it was prudent to moderate expectations for the second half of 2016. Although the loan pipeline is strong, we have been experiencing an increasing payoffs and continued pricing competition as we remain disciplined about pricing and profitability.

Turning to the liability section of the balance sheet, total deposits were $28.2 billion as of June 30, 2016, a decrease of $379 million or 1% from $28.6 billion of as of the prior quarter end. Core deposits remained approximately the same at $22.5 billion at the end of the second quarter. The quarter to date decrease in deposit was primary due to a decrease of $332.4 million or 5% in time deposits and $227.9 million or 3% in money market deposits.

These decreases in deposits were due to intentional efforts to reduce broker money market deposits and higher cost public fund time deposits. Year to date, deposit was still up $741.3 million or 3% due to the unusually high level of deposit growth in the first quarter of 2016. Our liquidity remains strong. Our loan-to-deposit ratio as of June 30 was relatively stable at 86%.

Next, I would like to spend a few moments to discuss our ongoing remediation efforts to improve our Bank Secrecy Act and anti-money laundering program. As previously discussed, as part of the written agreement we entered with one of our primary regulators last year, we have developed an action plan outlining the steps that we will be taking to ensure compliance with the BSA/AML rules and regulations. At this point, we are on schedule with our action plan, and I am pleased to state that many improvements have been made in our BSA/AML software systems and controls. We still believe that the core function of the new BSA/AML software systems we are implementing are on schedule to be fully operational by the end of this year.

For the second quarter of 2016, total consulting expenses were $6 million and approximately 75% of it or $4.5 million of these costs were BSA/AML remediation related. Although the remediation related consulting costs are still elevated, we are encouraged that for the second quarter of 2016, these consulting expenses were $2 million less than the first quarter. We now estimate that for the remainder of 2016, BSA/AML related consulting costs will decrease to approximately $3 million per quarter resulting in full-year 2016 consulting costs of approximately $17 million, a decrease of about 24% from our previously estimated $20 million.

Although maintaining strong profitability is important to East West Bank, equally important is ensuring that our balance sheet, operations, and the compliance programs are strong. We are committed to making all necessary investments in people and systems to strengthen our BSA/AML program and meet regulatory expectations.

With an entrepreneur spirit, we have always been a part of our philosophy. I believe this attitude and approach have helped us embrace the changes we have been making and will continue to make in order to improve our BSA/AML compliance program and strengthen our operations, as we continue to grow.

With that, I would now like to turn the call over to Irene to discuss our second-quarter 2016 financial results in more depth.

Thank you very much, Dominic. I will spend a few minutes to go over the income statement items for the second quarter of 2016.

Starting with net interest income, net interest income of $253.6 million for the second quarter of 2016 was $1.4 million or 1% higher than the first quarter of 2016 and $26.1 million or 11% higher than the second quarter of 2015. Net interest margin for the second quarter of 2016 was 3.31%, 1 basis point lower than the prior quarter.

The deposit cost of 29 basis points for the second quarter of 2016 was 1 basis point higher than the first quarter of 2016 and the same as the second quarter of 2015. Cost of deposits was 35 basis points for the second quarter of 2016 compared to 34 basis points and 43 basis points for the first quarter of 2016 and second quarter of 2015 respectively. In the second quarter of 2016, we had total accretion income of $13.3 million of which approximately $4 million was due to accretion income recorded as a result of a large recovery of one loan.

For our guidance for the remainder of 2016, we are assuming a more normalized accretion income of $8 million to $10 million per quarter. The average loan portfolio balance for the second quarter of 2016 was $23.9 billion compared to $23.8 billion and $21.9 billion for the first quarter of 2016 and second quarter of 2015 respectively. Loan yield of 4.28% for the second quarter of 2016 was the same as the prior quarter and 1 basis point lower from the prior-year quarter.

Moving on to noninterest income and expense. For the second quarter of 2016, noninterest income was $44.3 million, an increase of $3.8 million or 9% from $40.5 million for the prior quarter, an increase of $3.7 million or 9% from $40.6 million for the prior-year quarter. The sequential quarter increase in noninterest income was largely due to increases of $1.8 million or 22% in other fees and operating income, $1.4 million or 15% on letters of credit fees and foreign exchange income, and $1 million or 50% in net gain on sales of loans.

These increases were partially offset by lower net gains on sales of available-for-sale investment securities of $1 million or 26%. During the second quarter of 2016, the Company also recognized a gain of $2.2 million mainly related to the sale of a [bank] premise, which resulted primarily in the increase in other fees and operating income.

Noninterest expense for the second quarter of 2016 was $148.9 million, $2.3 million or 2% higher than $146.6 million for the first quarter of 2016 and $28.7 million or 24% higher than the second quarter of 2015. The sequential quarter increase in noninterest expense was largely due to increases in compensation and employee benefits, legal expenses, and occupancy and equipment expense, partially offset by a decrease in consulting expense.

Overall, our actual operating expenses incurred are slightly better than we projected and that is reflected also in the lower operating expense in our current guidance as compared to the previous guidance. As Dominic has already discussed, the BSA/AML remediation initiatives are moving forward and the costs are tracking moderately better than we had previously anticipated.

The efficiency ratio for the second quarter of 2016 was 44.59% compared with 44.53% and 40.36% for the first quarter of 2016 and second quarter of 2015 respectively. The Company's effective tax rate for the second quarter of 2016 was 27.7% compared with 25.7% for the first quarter of 2016 and 31.6% for the second quarter of 2015.

The tax rate for the second quarter was slightly higher due to adjustments in our calculation for [M40A] and also adjustments for a tax credit and tax losses for low income housing tax credits. For the remainder of 2016, we expect that the effective tax rate will be 26%.

Now, I would like to spend a few moments to review our credit quality. For the second quarter of 2016, the Company recorded a provision for credit losses of $6.1 million compared to a provision for credit losses of $1.4 million and $3.5 million for the first quarter of 2016 and second quarter of 2015 respectively. Net charge-offs for the second quarter of 2016 totaled $619,000 compared with net charge-offs of $5.1 million in the prior quarter and net recoveries of $4.1 million in the prior-year quarter. The increase in provision for credit losses in the second quarter compared to the prior quarter was largely due to the loan growth during the second quarter.

East West continues to maintain a healthy allowance for loan losses of $266.8 million or 1.1% of total loans held for investment as of June 30, 2016, compared to the March 31, 2016 allowance for loan losses of $260.2 million or 1.09% of total loans held for investment. Nonaccrual loans were up $171.6 million as of June 30, 2016, an increase of $9 million or 6% from $162.6 million as March 31, 2016. Nonperforming assets as of June 30, 2016 were $176.5 million, an increase of $7.8 million or 5% from $168.7 million as of March 31, 2016. Similarly, the nonperforming assets to total assets ratio increased slightly to 54 basis points as of June 30, 2016, up 3 basis points from March 31, 2016.

Lastly, I would like to provide some additional color on our guidance for 2016. In the first quarter earnings guidance, we had assumed that the federal funds target rate would increase 25 basis points in September 2016. We generally use the federal funds for rate curve to model earnings forecast and are now assuming there will be no change to the federal funds target rate in 2016. Based on this revised assumption, we are forecasting for the remainder of the year that the net interest margin will range from 3.21% to 3.24%. We also assumed organic loan growth of approximately $365 million per quarter or 6% annualized for the remainder of 2016, provision of loan losses of $5 million per quarter, and that noninterest expense will be approximately $155 million per quarter including the amortization of tax credits and other investments of approximately $17 million per quarter.

Finally, we are also assuming an effective tax rate of 26%. Based on these assumptions, we estimate that diluted earnings per share for the full year of 2016 will range from $2.83 to $2.87, an increase of $0.17 to $0.21 or 6% to 8% from $2.66 for the full year of 2015 and a small decrease from our previous disclosed guidance. The reduction in the guidance from what we previously had estimated is largely driven by the impact of eliminating the rate increase from our guidance and lowering the loan growth guidance from the remainder of 2016.

These reductions in income are partially offset by a current estimate that we will be able to tighten up slightly on our expenses for the remainder of the year compared to before. Further, management currently projects that based on these assumptions, fully diluted earnings per share for the third quarter and fourth quarter of 2016 will range from $0.69 to $0.71.

I will now turn the call back to Dominic.

Thank you, Irene.

In summary, we remain focused on growing our balance sheet and business profitably and prudently while taking the appropriate risk management measures. We are also pleased that while we are progressing well with our risk management and controls, we have also been able to make good strides in our efforts to contain expenses.

So now I would like to open the call to questions.

(Operator Instructions)

Jared Shaw, Wells Fargo Securities.

Good morning.

Good morning, Jared.

When you were looking at the investment in the BSA/AML system, thanks for the color on the trends on the consulting side. Is there any shifts to higher headcount or higher compensation costs as you're building out the system or will it truly just really be more of an operating system that you will be able to handle with the current personnel?

Clearly the -- in terms of headcount compared to what we used to have, it was definitely higher because with the additional, much more sophisticated system that we have and we have to hire the appropriate personnel to have the experience and the technical expertise to support that. Not only at the implementation stage but going forward in the future, we will need to continue to have more senior-level executives to help manage the program going forward.

However, as of today, I would expect that beside the consulting expenses, we also have temporary employees that we bring in just to help out on the remediation program. So those type of expenses will turn off in 2017 and in fact most of them hopefully would not be there in 2018 and forward.

Okay. So when we look out at 2017 and forward, there should be a significant net savings from that run rate of -- on the consulting side?

That's correct. We do expect that.

And just maybe to elaborate on what Dominic said, I think from where we started with the BSA team, we have definitely at this point in time increased the staffing and the cots have gone up. It's in the run rate and the compensation right now.

Okay. Shifting a little bit to the reduced loan growth guidance. What's really driving that?

Is that more what you're seeing from a competitive standpoint from the yields or is that that you're reluctant to get closer to that 300% concentration while you're going through this investment in the BSA/AML? What's the biggest driver of the lower outlook on loan growth?

It's a few different things. One is that if you looked at the current rate, particularly on the commercial real estate side, first of all I think we have done really well just for the last six months that we have quickly participate out and sold no commercial real estate loans. And that the idea is not necessarily that just because even at the time in the last six months, we never once really once sort of like reached beyond the 300% concentration threshold set up by the FIECC, but we wanted to always act ahead of schedule.

So we were using the last six months to quickly test our ability. That is that if we do need to sell down loans, can we do that? And we will quickly be able to participate out a bunch of loans to other banks.

That has proven our secondary market channel is working very well. And by doing that, we are now down to 265% so we definitely have a lot of cushion. If we wanted to make loans, we will but we're not going to go out there just to go loan buying, doing some very low rate and depress our margin and then hurt our profitability. It's just a matter of trying to balance profitability to growth.

And we have pretty healthy growth for many years. East West has always been a growth organization. We have always been consistently for many, many years growing our earning per share and loans and deposits and so forth. So we're not worried about the growth, but we wanted to make sure that we continue to have some pretty strong discipline in the margin.

Recognizing with the Brexit and the rate coming down like this, we're just being prudent. And at this point, making an assumption that our rate will continue to stay low.

Now, if for some reason as the Wall Street Journal yesterday talking about, maybe the Fed is ready to hike the rate in September, that would change the dynamic, right? So -- but I mean from my perspective right now, I'd rather be prudent at this stage and that's one.

The second part is that overall as we look at our loan utilization -- commercial loan utilization, I look at it -- if I looked at December 31, 2015, the utilization is at 76%. And it's now dropped to 69%. This is a common phenomenon throughout the entire country. Most of the business out there are not actively looking to aggressively expand and to borrow more money to expand or to borrow money to invest or to borrow more money to purchase more inventory or equipment and so forth.

Business are very prudently watching their fiscal condition and trying to adjust accordingly. So in that regard, despite the fact that we continue to grow our customer base, we are seeing our customers continue to slow down in the utilization of the line of credit that they have. So that's another part.

So far, that's been the direction. We have not seen any signs that in the next six months that will change. In fact, it is the same way throughout the country. I don't think it's going to be any different than any of the banks.

And third, what we've seen also is that this is a little bit more particular East West. There are many customers that we have that are working on certain deals that we are actually in the process of closing certain deals. Just could not get it closed in the second quarter.

So from that perspective, until we get lucky that maybe some of these deals that we are supposed to close in the second quarter will happen in the third or the fourth. We don't know. We don't know the specifically sometimes is it just a matter of luck or is it a matter of because everybody is being a little bit more cautious.

So they take a little bit longer time to get some deals done. I guess time will tell.

At this stage right now, since some of the deals have not been closed, the pipeline is really strong, it's just not getting funding. From that standpoint, we just think that it is just prudent to guide down the number. And then so I looked at it. Hopefully, we get lucky and we'll change the direction, but in the meantime, I think that we're comfortable with a 6% annualized growth rate.

Great. Thank you very much.

Jennifer Demba, SunTrust.

Good morning. Just wondering if you could give us an update on your energy loan portfolio and what you've seen in terms of growth, if any, in that bucket? And overall, what you're seeing in Texas and what that market is providing you in terms of growth opportunities outside energy?

We are moving along prudently. In fact, as of March 31, in the end of the first quarter, we had $53 million outstanding balance and $65 million commitments. And then the end of the second quarter, it went up to $103 million in outstanding and $132 million in total commitments.

So the team is continuing to make strides. I expect that in the third quarter, we are going to see another bump again. So in terms of -- since we started with zero so the growth rate is very high. But then relatively speaking, the number is not that big.

We intentionally asked the team not to jump too fast because while we enter the market at a very opportunistic time, in November of last year, and our expectations were that if we came in at such a very depressive environment, chances are the downside risk is very low and the upside potential is very high. So as of today, it turned out exactly what we expected.

And -- but still, we didn't wanted to go in, jump in too quickly because we want to make sure that we get ourselves organized. And then not only that the team to understand the business quickly go out there and do what they need to do to capitalize on the opportunity. But in addition to that, we wanted to make sure that the rest of the organization that have anything to do with lending so to understand and appreciate that business, and that do take a little bit more time.

And so from that standpoint, if we wanted to grow that business by like another $100 million, $200 million, it's actually very easy to do, but we chose to do it slowly and prudently so that to make sure that we get it right. And then also to establish our name appropriately in the market.

Thank you very much.

Dave Rochester, Deutsche Bank.

Good morning, guys. Quick question on the expense side. Do you have any additional insight into the total expense trend heading into 2017? Do you think it could be possible to keep overall expenses flat with 2016 ex that tax credit amortization [sent]?

Yes, I think so at this point. Certainly, with every quarter and moving forward on our BSA/AML remediation effort, we have a little bit more clarity. That's also why we are able to kind of reduce our expense guidance for the second half of 2016 as well.

I think at this point, I would say -- although as every quarter progresses as you know, we will come out with our guidance for 2017 in January of next year. But I do think we have more clarity and if you look at the run rate, certainly ex the $62 million were actual and estimating for the tax credit amortization. I do think we could be in line.

Great. And then just switching to loan growth guide, you made a comment about rates playing a role in your decision to grow. Are you anticipating that this will be more of a temporary slowdown, where you ultimately end up raising that growth rate again as we head into 2017? Or given what you're seeing that you think this will be more a permanent adjustment?

This is really depending on the overall economy. We have -- there are a lot of the news out there. Like this Brexit, it's something that this is quite unusual for 2016.

And quite frankly, if you look at just whatever happened for the last few weeks, it looks like always much to do about nothing. But I think from my perspective, I would expect that life may not be that easy in Europe. And so it maybe just a -- I mean, it look like a temporary setback for a few days and then the market rebound. But I do feel that those slowly gradually, there will be some ripple effect and in Europe and also in the global market.

Now, I do wanted to point out, though, that from an East West perspective, as a financial institution, we are substantially in better shape than many other banks because our sort of like the European exposure is almost none. We mainly focusing on US and China, and so, therefore, there's not going to be any sort of like very direct impact to us.

But on the other hand, it will have an indirect impact in the overall economy, and it will therefore affect interest rate and also the sentiments of many businesses throughout the country. And with that, we just have a little bit more cautious and prudent mindset in terms of how to deal with that. And then who knows what's going to happen in 2017 and after the presidential election.

So a lot of things are happening, so we don't know what's going on and so at this point that's what we take the position. But on the other hand, the minute the market come back strong and people -- I mean, let's say business sentiment coming stronger and then folks start utilizing our -- just when folks start utilizing our line of credit more in a normal manner, we would immediately pick up substantially in terms of loan growth, let alone that we will have many more deals closing. And so I think that right now, just looking at the amount of slowdown utilization, make a huge difference in terms of growth.

Okay. So this isn't the situation at all where the regulators have either remotely made a suggestion that you should slow growth, right?

No, no. Not at all.

Again, our BSA issue have nothing to do with the loan growth. In fact, it's really us trying to be prudent.

And then the other thing is that -- I could easily make that 10% or 12% loan growth if I just go on out there and doing more -- whether it's lower the pricing on our CRE or multi-family or single-family mortgage, we just lower the rate. I can easily do 10%, 15% loan rate growth.

Growing is not hard but growing with intentional diversification and growing with new sectors such as what we have been doing if you look at the last five years of East West Bank, we have been able to continue to develop business in new sectors that we were not in before using our strategy of being the bridge between the East and West.

We've done really well in the entertainment business. We've done really well in the private equity, I think, particularly in the capital call line. We've done really well in cross-border transaction, and high tech, clean tech, life science, and now energy.

Now -- and then I look at this quarter. Interesting enough, I've been talking about entertainment, high tech, and so forth in the past few quarters. And those two names were missed in this quarter because while they were slowing down a little bit, not that they were slowing down there, the deals are now getting closed. And then we turn off all deals that got pay off because when certain movies finish and then we got pay off.

But then we turn around and then this quarter, that the one who picking up the slack are the energy, are the specialty financing, are the life science, and the asset-based lending. So we have enough sectors that will continue to grow more and more of this different products or industry or this type of business to allow us that at any kind of particular economic environment, we will be able to continue to grow in a healthy manner.

So, and I think it's very critical for us to continue to have that kind of diversification and continue to expand in that direction. So if we look at some of our compensation, headcounts, and so forth as we talked about last year, why would we have expenses growth if we have, let's say, challenges with spending more money on regulatory issues or why would we still want to hire more lenders.

What the fact is, if we find strong bankers that can help us to diversify our portfolio even more and then help us to grow our business in a more healthy manner, we'll continue to go in that direction. And so far it's been working out really well. So we would not be stuck that if one day suddenly real estate market is not good and then we run out of room.

So keep in mind that East West started as a savings and loan. We went from a savings and loan to become a commercial bank. As a commercial bank even about seven or eight years ago, we were very real estate concentrated with our commercial real estate of being the lion share of our portfolio.

And now we have not ratchet down by keep selling this commercial real estate. In fact, we continue to grow our commercial real estate. The only difference that we grew our commercial C&I loans much faster and with a diversification on many different areas.

So with that, I think it allow us in a position today to have a much healthier balance sheet. So that's the direction we're going, and we're going to sticking -- we're sticking with it.

Okay. That was a lot of great color there.

I really appreciate that. Just one last one, if I could real quick on fee income. You had a nice uptick there after the asset gains and the securities gains. Are you thinking you can continue to grow the fees from here, or is this at least a good run rate in the back half of the year?

I think on the fee income, it does vary depending on the number of transactions, and quite honestly, the size as well. If you look at the individual line items, LC, FX both of those increase ever so slightly so they were down a little bit in the first quarter. But I think between $34 million, $35 million the first quarter and where we were for the second quarter today, $39 million. I think it's achievable.

Thanks, guys. Appreciate it.

Ebrahim Poonawala, Bank of America Merrill Lynch.

A couple of questions were asked. Moving to capital, my understanding is that until you resolve BSA/AML, you are unlikely to be doing any buybacks or M&A. Does that restrict your ability even in terms of increasing the dividend? And if growth is slowing and given your profitability, could you see the dividend payout going much above 30%?

Maybe I will just clarify, with the written agreement, we are essentially prohibited for any expansionary activity. Expansionary activity includes acquisitions and also de novo branching.

We really don't have any limitations from a capital perspective. We have strong earnings, and I think there's a fair amount of clarity in our earnings as well along with our capital ratio.

So the dividend, buybacks, that's really a function of where we see the growth and where we see opportunities. Certainly, I think with the dividend payout ratio, that's something we internally and with the Board have discussions. Can we redeploy those funds better and create better return for our shareholders if we deploy that or in a buyback.

So that's something that we evaluate on a -- and discuss it with the Board and really make that decision on an annual basis. Does that help, Ebrahim?

That's helpful. I'm sorry if I missed it but have you disclosed in terms of where the China and Hong Kong loan and deposit balances were at the end of the quarter?

For China and Hong Kong, the loan balances were about the same as of the end of the first quarter, $1 billion or so. Deposits also, I don't think in total they change that much.

Got it.

About $1.2 billion or so.

Understood. Is Dominic's comments at all sort of compilation of what's happening in terms of as a resulting slowed growth in CRE and the other areas also translate to what you're seeing in terms of the China business, too?

In China, it's interesting. I think that China is actually slowing.

China is also going through a direction that they wanted to make sure that they have healthier GDP growth. So they are slowing down the growth and making sure that they are growing in a direction that would have a long-term sustainable benefit.

So from that standpoint and they going through a very aggressive reform. So as you can -- as I talked about in the past, they have for years been carrying the country with double-digit growth in the heavy industries, let's say in the manufacturings and then the heavy commodity business, whether it's the steel and coal mining and steel manufacturing and also a lot of those, let's say, or making garments and toys and electronics products, and so forth. That was the bread and butter business, export driven business for a few decades.

And as the country continued to grow in a new direction and trying to go from an emerging country to a developed country, and they're going to need to have stronger domestic consumption. And also service industry has to be a primary driver.

So we have witnessed now in China is that the business are completely changing direction. The high-growth business are the one in social media, in the service-oriented business, and in domestic consumption type of areas. And then the business that are going through a hard time and really going in a negative direction in terms of growth rate are the one in these heavy manufacturing and export driven business.

So from that standpoint, we at East West Bank and also are transitioning. And years ago, we had a lot more business that are exporting to United States. So the trade finance that we were involved with were in that direction, and so lately, we are actually helping movie the studios from China investing in Hollywood and so forth.

And then also company are looking into life science and technology business, and then business are looking and buying fresh fruits and a high-quality food products from United States. And so that direction is changing, and we are adjusting accordingly. And in addition to that, if you look at China, what we witnessed is that, for example, the last two years, we've done a lot more cross-border transaction requiring standby letter of credits from major financial institution in China.

And just the last six months, that business has slowed down and mainly because many of the financial institutions in China currently because of reform and from the government direction. And they are slowing down in terms of their liquidity and supporting and standby letter of credit. So from that standpoint and that slowed down our business on that hand.

But on the other hand, we are picking up a lot more business by helping oversea direct investment from China, investing in the United States in various kind of business. Whether they're investing in the clean tech sectors, or maybe actually in automobile industries in Midwest, or in California particularly in the movie industries. And we are actively engaging in that direction.

Now, but when it comes to helping, these companies do acquisition and then provide financing for the acquisition, we have to so sometimes put out the term sheet but just stand on the sideline waiting for the deal close in order for us to get funding. So in that standpoint, as I mentioned earlier, it's not that like, for example, entertainment sectors are just losing any business to the competition. Quite the contrary, we are gaining as much business like we ever had before.

The only thing is that we are sitting on the sideline waiting for some of the deals close and until that happen, we're going to have some challenges in terms of growing our business. And it's a lot of time is timing. It just happened that sometimes there are quarters that deals that we've done a year or two ago, now finally got pay off. And then the deals we're supposed to book, we haven't been able to book, as I mentioned earlier.

So that's one thing, and that's the part of China. Let me go back to maybe qualify what Irene just talked about on the BSA part.

We are not prohibited to open branch or make acquisition but we are because of this consent agreement, we are required to seek regulatory approval before we move forward. So as -- I mean like for the last 25 years, I've been a CEO here that we always just do what we need to do that is right for the stockholders. And so now for the first time, I think that we do need to get approval ahead of time from the regulator before we consider like a major -- these expansion like opening branch or making an acquisition and something like that.

Understood. Thanks a lot for that clarification.

Joe Morford, RBC Capital Markets.

Thanks. Good morning, everyone.

Good morning Joe.

I understand the lower margin guidance. Are there things you can do to help defend the margin be it mix changes or running off more higher cost funding? Do you see it more of just an issue of not exacerbating it by booking lower-priced credits?

Joe, I think you listed out all the options of what we can do to defend the margin and those are exactly all things that we are working on. As far as trying to keep the pricing up, running off some higher cost deposits with our kind of loan to deposit ratio, and the liquidity. We are comfortable doing that.

And then also on the security side, it does help a little bit but not that much candidly given where rates are. Our duration is pretty low so that is something that -- we would be okay extending that a little bit as well. All of those will help incrementally. And all things that we are looking at and actively seeing what we can do to improve that.

All right. Okay. I understand.

The other question is just on the expenses, given the expectations that consulting costs will be coming down in the second half, what's driving the increase in the overall run rate to that $155 million level other than obviously the tax credit investment amortization stuff.

Sure. So as to the tax credit, basically what we're looking at is $138 million a quarter. The consulting, we do expect to go down, consulting in general, and then also specifically consulting for BSA.

We do still expect the comp and employee benefit will continue to increase for the remainder of this year. Some of it because of what we talked about as far as pulling in the full run rate of additional hires for BSA. Additionally, we are assuming as well a higher FDIC assessments with the surcharge for banks over $10 billion. Those are probably the larger components.

Other things here and there. If you look at second quarter, some a little higher, some a little bit lower but relatively speaking, they net out.

Okay. That's helpful. Thanks, Irene.

Aaron Deer, Sandler O'Neill & Partners.

Good morning, everyone. Just wanted to follow-up on the -- what's going on with the loan portfolio.

Dominic, you had mentioned that you guys have been doing some sales -- or on the participation of some of the commercial real estate production. I'm wondering if given the strength that you've had in C&I if you've been doing any of that on the C&I side or conversely, if you've been doing any participations yourself where you're not the lead bank and if that's contributed at all to the growth.

Yes. In fact, we actually last -- just in the second quarter, we participated out $20 million entertainment loans. Again, this is to test the market.

We want to make sure that because the size of the entertainment group are getting larger and in addition to that, we are now having the opportunity to be the syndicators. As our name gets more and more established in the field. We think that there will be plenty of opportunities, particularly in the future if there's any kind of like potential acquisitions of deals from China to the United States. We feel very confidently that we have the capability to be syndicators and we've got to make sure that we have the network set up properly.

So we've done one about selling $20 million to another bank, and then we'll continue. You would expect that we would do more of that going forward just because the fact that that will be to make a direction that we'll be going.

And in addition to entertainment field, I think in the private equity capital call line and maybe some of the high tech area, we're going to see larger deals coming to us. And -- but with our discipline about staying focused and not trying to stretch ourselves in that have too big of exposure per individual borrower, we most likely will find participants to support us.

Okay. And then the residential book also was a big contributor to the growth. I'm wondering, is that still predominantly in the kind of non-QM products? And also curious how much of that is being been driven today by foreign purchasers versus say what it was a year or two ago?

It's a combination. We started also the Fannie Mae products.

We are always going to have a -- the lion's shares of what I call our portfolio products for our retail customers. And in addition to Chinese investors that are coming to this country and buying homes. And so we have a combination of that and our traditional core retail customers, and then with our additional sort of like Fannie Mae products, so those are the combination of residential mortgage that we are making right now.

Okay. And any change in the mix of customers in terms of foreign versus domestic that as the trends have changed and the restrictions on capital flows?

No, it's really not that much. We never really were that sort of like active in terms of like every single one of these foreign investors in homes come to East West for loans. That's actually not quite the contrary, that's not the case because most of these foreign buyers pay cash to buy their home.

So now, we do have plentiful of what I call Chinese investors that have made the decision to move the family here that establish their household in the United States whether it's in California or New York or Texas, et cetera, or up in Seattle. We do have I would say the lion's share of that kind of business. But these are customers that are not like a one-time deal with us. They actually have made a commitment to make a home purchase here.

Now the husband often times is still traveling back and forth doing business between US and China, or maybe doing most of the business in China but the family moves to the United States. We do a lot of that type of mortgages for these type of households.

But then in terms of folks that coming out here like on a tour bus like a whole bus of folks buying properties in San Bernardino and then Las Vegas and things like that or Florida, we haven't been actually fortunate to do any business like that. Most of those folks are buying homes with cash.

Sure. I understand. Okay, great. Thanks for taking my questions.

Matthew Clark, Piper Jaffray.

Thanks. Just a couple quick ones. SBA gains, any expectations for those gains to step up here in the second half?

I'm sorry. I didn't quite hear your question. What gains?

Your SBA gains. Just wondering -- I know a lot of the gain on sale this quarter came from portfolio loan sales. Just curious what you might be seeing in SBA in the second half.

SBA during the second quarter, I believe we sold about $21 million of SBA loans. That contributed largely to the gain of $2 million or so. Overall, I would say that what we have been seeing, we've been hearing is that for the secondary market for SBA, and these are the 7A loans, Matthew.

The gains are in general coming down. Let's say even last year, we were talking about a double-digit gain and now we are seeing lower level. I don't think as a percentage of loan origination, you're going to see an increase in that. Certainly, we are encouraging the team to increase originations of those and I think that there is some more opportunity there for us, but I don't think that the gain percentage is going to increase that much.

Okay. And then do you have the trade finance balance in terms of loans outstanding at the end of the quarter?

I don't know if I have that right off the top of my head. We could give you that at the end of the call. I think in overall, it was down a little bit from where it was in the end of the first quarter.

Thank you.

Chris McGratty, KBW.

Good morning. Thanks for taking the question. I may have missed it in the prepared remarks.

The security yields went up a decent amount this quarter. Wondering if there's anything unusual maybe this quarter or maybe in the first that we should be considering for the back half?

Nothing that usual. Overall, if you look at point to point, the duration actually decreased from March 31 to June 30 of the portfolio. But the yield, it was also a mix of we had during the quarter of the first quarter much more liquidity in which we knew some of that would exit during the year. That impacted the yield more so.

Okay. So the $155 million is -- that's a good number for perspective.

Yes. That's right.

How should we be thinking given where rates are, the overall size of the portfolio? Are you putting -- I know in your prepared remarks, you said you may be extending a little bit but should the size of the book kind of maintain or weeded fund loan growth or the liquidity?

We've really -- I think the size of the loan book, I don't think we are expecting it to change substantially. I think as we continue to grow the balance sheet, we look at the mix as far as the earning assets, loans versus securities, and then also obviously from a funding perspective and try to balance that out and maintain that possibility as well.

A lot of the excess liquidity that we have is what we deploy in the securities book, and by securities I mean available-for-sale or repos and short term as well. But that overall mix shouldn't change that much. First quarter was a little unusual given the high volume of deposits that we had had.

Okay. That helps. Maybe one more, if I could, on the reserves.

We're approaching 1%. Obviously your credit numbers look really, really strong. How should we be thinking about ultimately a trough in that ratio as we head out to the back half?

Yes, so the allowance ratio, certainly it is a mathematical equation. We are given that generally speaking, credit trends are positive, it has continued to kind of creep downward. We would realistically like to keep it above 1 but certainly, it's a function of what happens to the overall kind of loss rates, the migration, et cetera.

Great. Thanks a lot.

(Operator Instructions)

John Moran, Macquarie.

Thanks. I just hear you on the caution around CRE, I think in your prepared remarks you said BC call lines and life sciences were good pockets of growth in C&I for you this quarter. I guess some of the competitors that you guys have in that space have sort of been a little bit more cautious saying that there's some froth there. I'm wondering if you're pulling back there, too or do you sort of continue to see an opportunity to take share and good risk-adjusted returns there.

In terms of the private equity capital call line, we have -- we've been having some pretty healthy growth. And at this stage right now, again, we are not going to be expecting some extraordinary high growth in that area. Because mainly from -- it's an internal discipline point of view because we really would not allow any particular sector within our overall loan portfolio to just suddenly charge up and grow in a substantially higher rate than the rest simply because we don't want to create a dramatic imbalance.

Our position has always been that we will continue to make impact in the market. And then keep in mind is that we have a very unique value proposition. Many of the banks out there if you look at from a private equity capital call line, from a what was entertainment, or a lot of the other business sectors they are in, they come in from a more generic angle.

And we on the other hand, we pride ourselves as the bridge between East and West. We always have a unique value proposition. Our knowledge about the greater China region, the business that coming from China. In fact, instead of decreasing as everybody talked about that China is slowing down economy and slowing down GDP and so forth, but actually have increased more dramatic than ever had before.

There more money coming from greater China region to The United States and they are investing in many different sectors. So we naturally have the advantage of being one of the first to greet these potential investors and to get into various kind of business. With that in mind, I think with our unique value proposition, we are a little bit different kind of angle.

When we win business, it's not like a traditional way in going out there and then lower the pricing or world's traditional way and trying to do it a little bit more aggressive. But actually, we provide unique value proposition that the other banks were not able to offer. And with that, and then we are able to win some business.

So we're going to grow in that direction. Whatever we can get.

In that general direction is what we end up growing and then with the discipline to making sure we don't get out of control. Because as I said earlier about the energy, in that kind of like with no burden from the stress, energy credit, and to go out there in the Texas market with the capital and with the balance sheet to be supported. We could have grown substantially a bigger portfolio today than a 100-some-odd millions commitment as of today. But we try to do it prudently. We are going to be following the same kind of pattern with all of the areas that we have been, we'll be working on.

Great. Thanks very much. The rest of mine are asked and answered.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Dominic Ng for any closing remarks.

Thank you all again for joining our call. I and Irene are looking forward to talking to you again in October. Bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.