East West Bancorp Inc (EWBC) 2020 Q2 法說會逐字稿

Good day and welcome to the East West Bancorp Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Julianna Balicka, Director of Strategy and Corporate Development. Please go ahead.

Thank you, Alison. Good morning, and thank you, everyone, for joining us to review the financial results of East West Bancorp for the second quarter of 2020. With me on this conference call today are Dominic Ng, our Chairman and Chief Executive Officer; and Irene Oh, our Chief Financial 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. Forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties. For a more detailed description of the risk factors that could affect the company's operating results, please refer to our filings with the Securities and Exchange Commission included in our annual report on Form 10-K for the year ended December 31, 2019.

In addition, some of the numbers referenced on this call pertain to adjusted numbers. Please refer to our second quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures.

During the course of this call, we will be referencing a slide deck that is available as part of the webcast and on the Investor Relations website. As a reminder, today's call is being recorded and will also be available in replay format on our Investor Relations website.

I will now turn the call over to Dominic.

Thank you, Julianna. Good morning, and thank you, everyone, for joining us for our second quarter 2020 earnings call. Before we go into our financial results, first off, I would like to thank all of our 3,200 associates for their dedication to providing our customers with seamless service during these unprecedented times. Our team's commitment to putting our clients first is a true reflection of our values. As a government-designated essential service, we remained open, and our branch associates were out there every day to help customers.

Back in early April, out of 125 locations, we strategically closed 13 branches for the purpose of creating excess resource capacity as part of our business contingency plan under the pandemic. All branches were opened and resumed normal hours at the end of June.

As an organization, our #1 priority is to provide a safe operating environment for both our associates and our customers. To that end, we adapted all of our locations with enhanced safety and cleanliness measures. We continue work-from-home plans for nonbranch associates, and the transition to remote work has been very successful in terms of productivity. We have developed a detailed return-to-office plan with gradual, phased returns for associates.

Now mindful of our mission to support our customers and communities that we serve through these challenging times, we funded $1.8 billion of SBA PPP loans during the second quarter for over 7,200 small to medium-sized business and nonprofit organizations that cumulatively support over 170,000 employees. Median loan price -- the median loan size that we funded was $60,000, and over 60% of the loans were under $100,000 in size. In addition, over 1,200 of the customers we provided PPP loans to are new customers for East West Bank.

For East West, the bottom line is that our customers were thriving before this crisis and that we will help them through the crisis to thrive again when the pandemic is over. To that end, we offer various payment accommodations and deferrals for impacted commercial and consumer customers.

At the second quarter end, 8% of our total loans received a COVID-19-related payment deferral. Of these modifications, 90% are 3-month deferral, as you can see the details on Slide 3. As of June 30, 2020, only 1% of our C&I loan portfolio was subject to deferral. The deferral rate at the total commercial real estate portfolio was 6 -- was 10%. Of the $1.6 billion in C&I and CRE loan deferrals, $700 million or 45% are still making partial payments during the deferral period.

Lastly, the deferral rate of our residential mortgage loans consisting of single-family mortgages and a home equity line of credit, HELOC, was 14%. You can see from the low weighted average loan-to-value associated with the deferred loans, which are 53% for CRE and 51% for residential mortgage, our customers have a lot of equity in their property. These deferrals have been to our core customers who are committed to maintaining their homes or projects despite temporary shortfalls in cash flow. The volume of requests for commercial real estate loan deferrals peaked in May. And for residential mortgage, it peaked in April. For C&I, it has been idiosyncratic by loan and industry.

Now I will move on to review our financial condition and the results of this quarter on Slide 4 of the presentation. This morning, we reported second quarter 2020 net income of $99 million or $0.70 per share compared to first quarter net income of $145 million or $1 per share. Second quarter results include a $102 million provision for credit losses, which negatively impact organic net income. Despite the challenging circumstances, our financial results continue to be solid, reflecting the resilience of our business model, resulting in a return of tangible equity of 9%.

In the second quarter, we generated total revenue of $402 million and earned pretax pre-provision income of $249 million, equivalent to a pretax pre-provision profitability ratio of 2.08%. In the bottom chart of Slide 4, you can see that our PTPP income and PTPP profitability ratio have withstood the steep drop in interest rates with relative stability. At over 2%, our PTPP ratio remained strong and reflects the fundamental recurring earning power of our franchise and provides ample cushion to absorb credit costs during this economic uncertainty.

An important variable helping us maintain our pretax pre-provision profitability is our industry-leading low efficiency ratio. In the second quarter, our adjusted operating efficiency ratio was 38.1%.

Let's move on to Slide 5 for a summary review of our balance sheet. From an enterprise risk management perspective, we are navigating this crisis from a position of strength. Our balance sheet is strong. We have high levels of liquidity and capital, and our loan and deposit portfolios are well diversified.

In the second quarter, we grew total loans by 15% annualized and deposit by an impressive 21% annualized. Our loan-to-deposit ratio as of June 30 was 91.5% compared to 92.8% as of March 31. The quarter-over-quarter decrease in the loan-to-deposit ratio reflects the strong deposit growth in the second quarter. Also, our Greater China balance sheet include loans of $1.2 billion, which were down 2% quarter-over-quarter; and deposits of $2.2 billion, which grew by 7% since March 31.

Additionally, we funded the PPP loans through the PPP liquidity facility by drawing on $1.4 billion, strengthening our already substantial liquidity and bolstering our balance sheet capacity to serve our customers.

Turning to Slide 6. You can see that East West capital ratios are strong and growing and are some of the highest among regional banks, particularly for common and Tier 1 equity. Our book value and tangible equity per share were both up 2% from the prior quarter. Book value at the end of June was $35.25, and tangible equity per share was $31.81 -- $31.86.

You can see from the chart that our risk-based capital ratios, common equity Tier 1, Tier 1 capital and total capital all increased quarter-over-quarter.

Our Board of Directors has declared third quarter 2020 dividends for the common -- company's common stock. The common stock cash dividend of $0.275 is payable on August 17, 2020, to stockholders of record on August 4, 2020. We did not do any buybacks during the second quarter.

Now let's move to Slide 7 to have a discussion of our loan portfolio. As of June 30, total loans received a record $37.2 billion, an increase of $1.3 billion or 15% linked quarter annualized. Average loan of $37.1 billion grew by 23% linked quarter annualized.

During the second quarter, loan growth came from PPP loans as well as from our commercial real estate and residential mortgage portfolios. Average total CRE loans grew by 11% linked quarter annualized, and average residential mortgage loans grew by 12% linked quarter annualized. This mix of growth demonstrates the benefits of East West's well-diversified loan portfolio, providing us with the ability to generate responsible and attractive growth, even under challenging economic conditions.

As of June 30, PPP loans were $1.7 billion, and the average balance during the second quarter was $1.5 billion. At this point, we expect forgiveness of PPP loans to begin later in the third quarter, resulting in substantial reductions of these loan balances before the end of this year.

Excluding PPP, C&I loan balances decreased. Payoffs were distributed across the C&I portfolio. Recall that at the end of the first quarter, we saw a run-up in drawdowns from our C&I clients, reflecting market liquidity fears present at that time. Thanks in part to the sizable federal intervention, liquidity fears subside and some of those draws reversed. You can see this in the utilization statistics.

As of June 30, our C&I line utilization was 72%, moderating from 75% 3 months ago and in line with 71% as of year-end of 2019. The rate of decrease in our C&I loan portfolio was highest in April and May and moderated in June. Noticeably, C&I loan pipelines have picked up since June. And we are seeing broad-based deal flows from across our portfolio, including in private equity capital call lines, cross-border business and entertainment.

During the second quarter, we also undertook a vigorous review of our loan portfolio, evaluating credit exposures for sensitivity to prospective weakening of economic conditions. Through this process, we've reviewed over 50% of our C&I and CRE loans, with a particular focus on sectors that are of high risk during the pandemic. The reviews focused on up-to-date financials and information from our customers, how they were adapting operations to the pandemic conditions and what were the sources of stress for them, giving us better visibility into their current situation.

Overall, many of our customers are in positions of financial strength, have high liquidity, collateral value and equity and have made the business changes necessary to adapt to the new environment. However, due to the shutdowns some businesses experienced and the broad impact of the global pandemic on consumer behavior, we downgraded a small percentage of these loans that we review. Overall, the increase in criticized loans was primarily from the oil and gas industry. These loan reviews were in addition to our normal loan review practices, and we will continue this heightened iterative process for the duration of the credit cycle.

Continue on Slide 8, we show a detailed breakdown of our C&I loan portfolio. C&I loans, excluding PPP, were $11.7 billion as of June 30 or 31% of total loans. As you can see, our portfolio is well diversified by industry. Our oil and gas exposure as of June 30 was $1.3 billion of loans outstanding and $1.6 billion of total commitment. From March 31 until July 19, our total oil and gas commitments decreased by 11%, following the spring borrowing base redetermination period as well as through exits of certain workout loans.

Now within the E&P portfolio, 73% of our E&P clients' oil production is hedged for 2020, and 46% is hedged for 2021. Furthermore, of their gas production, 74% is hedged for 2020 and 61% is hedged for 2021. As of June 30, 2020, the allowance for loan losses coverage of our oil and gas portfolio was 9%. We feel comfortable with this level of reserve for potential losses, especially in light of current commodity prices, which have recovered from their trough.

Moving on to Slide 9. As of June 30, our CRE portfolio was $14.5 billion, equivalent to 39% of total loans. The portfolios were well balanced across the major property types of retail, multifamily, office, industrial and hotel. The geographic distribution of our portfolio generally reflects our branch footprint. And as of June 30, owner-occupied CRE was $2.2 billion, equivalent to 6% of total loans or 15% of total CRE loans.

Including unfunded commitments, our total exposure to construction and land loan is small at under $1 billion. Our construction portfolio is well diversified by property type with a weighted average loan-to-value of a low 52% based on total commitment.

You can see on Slide 10 that the weighted average loan-to-value of our total CRE portfolio was 52% with an average loan size of $2.3 million. Nearly 90% of our CRE loans have a loan-to-value of 65% or low. In the chart on the right, you can see that the weighted average loan-to-value of our loans are similar high property type.

Our history of consistent underwriting to low loan-to-value has resulted in low credit losses through many credit cycles in our income-producing CRE portfolios. Furthermore, a high percentage of our CRE loans have full recourse and personal guarantees from borrowers who have long-term relationship with East West Bank.

On Slide 11 and 12, we provide additional details regarding our single-family residential and HELOC loans.

On Slide 11, you can see that the geographic distribution of our single-family residential mortgage portfolio follows our branch footprint. Our single-family residential mortgages are primarily originated through our East West Bank branches. The average loan size in our SFR portfolio is only $385,000, and the weighted average loan-to-value is 53%. More than 90% of our loans have a loan-to-value of 60% or less. We have a long history of minimal credit losses from our single-family mortgages.

In the second quarter, we originated a combined $777 million of residential mortgage loans comprising $567 million in single-family mortgages and $210 million in home equity lines of credit. The combined second quarter residential mortgage origination volume increased 6% quarter-over-quarter. Production dipped in April but regained pace in May and June. In fact, residential mortgage production in June was the strongest on record for East West Bank. Contributing factors to the growth were increases in HELOC originations and in refinance transactions. In the second quarter, refinance transactions increased to 68% of volume compared to 62% in the first quarter. Based on the current pipeline, we expect strong residential mortgage origination volumes for the rest of the year.

On Slide 12, you can see the geographic distribution and the loan-to-value distribution of our HELOC portfolio. Similar to single-family residential mortgage, our HELOC are primarily originated through East West Bank branches. As of June 30, we have $1.5 billion of HELOCs outstanding, plus $1.6 billion in undisbursed commitments, translating into a utilization rate of 48%.

East West, the HELOC we originate are very similar in credit profile to our SFR loans. As of June 30, we're in a first lien position for 84% of our HELOCs. The average loan size of our HELOC commitment was $362,000, and the weighted average combined loan-to-value was only 49%. 97% of our HELOC commitments have a loan-to-value of under 60%.

Lastly, I would highlight that the rates of single-family origination have been fairly stable. The weighted average yield in the second quarter was 4.3% compared to 4.4% in the first quarter. First lien HELOC rates are priced at the prime rate plus a margin of 50 basis points.

I will now turn the call over to Irene for a more detailed discussion of our allowances and asset quality, deposit and income statement. Irene?

Thank you, Dominic. Turning to Slide 13 for a review of our allowance for loan losses and Slide 14 for a review of other asset quality metrics.

Our allowance for loan losses was $632 million as of June 30 or 1.7% of loans held for investment compared to $557 million or 1.55% of loans as of March 31. Quarter-over-quarter, the allowance coverage of the oil and gas portfolio increased by 112 basis points to 9%. The coverage of all other C&I increased by 28 basis points to 2.6%, and the coverage of CRE increased by 38 basis points to 1.5% driven by increases in reserves for hotel and retail commercial real estate loans.

During the second quarter of 2020, we booked $102 million provision for credit losses compared to $74 million in the first quarter. The quarter-over-quarter increase in the provision expense was primarily driven by a more adverse macroeconomic forecast as of June 30, 2020, relative to March 31 as well as loan risk rating downgrades during the quarter. All else equal, as the macroeconomic outlook stabilizes, we would expect the provision expense to decrease from current levels.

As you will see on the next slide, excluding oil and gas loans, we are not seeing significant deterioration in our portfolio by any particular industry or asset class. The low loan-to-values of our real estate portfolio provide a buffer against losses, and the rate of deferrals remain manageable.

Net charge-offs in the second quarter were just under $20 million, and the net charge-off ratio was 21 basis points of average loans annualized. Charge-offs in the second quarter were primarily from oil and gas, which accounted for $14 million or 64% of gross charge-offs.

Turning to Slide 14. Criticized loans were 3.4% of total loans as of June 30 or $1.25 billion. You can see from the chart on the slide that the largest single industry component of our criticized loans are oil and gas loans, nearly equal size to the criticized loans of all other C&I. Oil and gas loans made up 24% of our special mention loans and 41% of our classified loans as of June 30.

Special mention loans were 1.5% of total loans as of June 30 or $576 million. This ratio was stable quarter-over-quarter. 11% of our oil and gas loans were graded special mention as of June 30, up from 5% as of March 31. For all other C&I, CRE and residential mortgage loans, the special mention ratio was essentially stable quarter-over-quarter.

Classified loans were 1.8% of total loans as of June 30 in the amount of $674 million compared to a ratio of 1.2% as of March 31. The quarter-over-quarter increase in classified loans was largely driven by downgrades of oil and gas loans. The classified percentage of our oil and gas loans was 22% as of June 30, up from 4% as of March 31. For all other C&I loans, the classified loan ratio improved from 2.3% to 1.6% quarter-over-quarter. Outside of oil and gas, the rest of our C&I loan portfolio remained stable as evidenced by these asset quality ratios as well as by the low deferral rate of our C&I loans.

The classified loan ratio for commercial real estate was 1.4% as of June 30, up from 0.7% as of March 31. The largest inflow into classified commercial real estate in the second quarter were from office and retail CRE segments. The classified ratio of residential mortgages was essentially stable quarter-over-quarter.

Nonaccrual loans were 48 basis points of total loans or $179 million as of June 30. The quarter-over-quarter increase was largely due to inflows of nonaccrual status of oil and gas and commercial real estate loans, partially offset by payoffs and charge-offs of C&I loans. Lastly, accruing loans 30 to 89 days past due were 30 basis points of total loans or $113 million as of June 30.

Now moving on to Slide 15 for a discussion of deposits. Total deposits grew to a record $40.7 billion as of June 30, 2020, an increase of $2 billion or 21% linked quarter annualized. Average deposits of $39.9 billion grew $2.4 billion or 26% linked quarter annualized. Growth in average noninterest-bearing demand deposits was $2.4 billion quarter-over-quarter or an impressive 87% linked quarter annualized. Average DDAs increased to 34% of total deposits in the second quarter, up from 30% in the first quarter.

Average deposit growth in the second quarter was driven by strong growth from consumer and small business commercial customers as well as from PPP funds held in deposit accounts, partially offset by intentional runoff of higher-cost deposits. We attribute this growth to customers choosing to remain very liquid in this environment and to lower levels of business spending during the shutdown periods. While we expect customer liquidity to remain elevated during the course of the pandemic, we also expect balances to trend down as business and consumer activity resumes.

During the second quarter, we also intentionally reduced some higher-cost deposits given the strong growth in deposits. The average total cost of deposits was 47 basis points in the second quarter, and the spot rate as of June 30 was 39 basis points. The average cost of interest-bearing deposits was 71 basis points in the second quarter, and the spot rate as of June 30 was 59 basis points.

We expect to continue to decrease deposit costs for the rest of the year from the repricing downward of maturing CDs as well as from further runoff of higher-cost balances. As of June 30, spot rate on domestic CDs was 1.08%. Future maturities of CDs with the interest rate over 1% are $2 billion in the third quarter at a blended rate of 1.56%, $1.4 billion in the fourth quarter at a blended rate of 1.45% and $1.3 billion in the first quarter of 2021 at a blended rate of 1.26%. For context, the blended rate of CD originations and renewals in the second quarter was 43 basis points.

And now moving on to a discussion of our income statement, starting with Slide 16. I will share highlights not discussed in detail elsewhere during this presentation on this slide.

We purchased investment securities during the market dislocation earlier in the quarter and sold $132 million of municipal bonds for a gain on sale of $10 million. We also prepaid $150 million of repo liabilities to help improve our future funding costs, incurring a debt extinguishment cost of $9 million during the second quarter. The effective tax rate was unchanged at 12% for both the second and the first quarter.

Moving on to Slide 17 for a discussion of our net interest income and net interest margin. Second quarter 2020 net interest income of $344 million decreased by $19 million or 5% linked quarter, and the net interest margin of 3.04% compressed by 40 basis points from the prior quarter. Second quarter net interest income included $21 million of PPP loan income, net of interest expense on the PPPLF. Excluding this PPP-related income, second quarter net interest margin was 2.96%.

The changes in the net interest income and the net interest margin reflect the quarter-over-quarter drop in the average prime and LIBOR rates. 31% of our loan portfolio is tied to LIBOR, predominantly the 1-month rate, and 27% of our loan portfolio is tied to prime. Accordingly, the average loan yield in our portfolio compressed by 73 basis points quarter-over-quarter to 3.98% in the second quarter from 4.71% in the first quarter. Against the backdrop of materially lower interest rates, declines in earning asset yields were partially offset by decreases in the cost of funds.

The quarter-over-quarter change in our net interest margin is as follows: 65 basis point decrease from lower loan yields, 10 basis point decrease from lower yields on other earning assets, an 8 basis points decrease from balance sheet mix shift, all of which were partially offset by a 35 basis point increase from lower funding costs and a positive impact of 8 basis points from PPP.

We expect that our net interest margin, excluding the variability from recognition of PPP loan fees, will stabilize around current levels in the neighborhood of 3%. Our loan portfolio has largely already repriced, and the repricing was front-loaded into the second quarter. The yield on residential mortgage loan originations have been more resilient to rate compression. And as Dominic mentioned, loan pipelines are rebuilding, which will continue and contribute to a favorable earning asset remix. We expect to continue to improve our cost of deposits with the downward repricing of CDs to current market rates as well.

Now turning to Slide 18. Total noninterest income in the second quarter was $59 million compared to $54 million in the first quarter. Fee income and net gains on sales of loans were $52 million in the second quarter, down by $2 million or 4% quarter-over-quarter. This decrease reflects lower customer transaction volume across several fee income lines of business.

In other fee income categories, lending fees of $22 million in the second quarter increased by $6 million primarily due to increase in the valuation of warrants received as part of lending relationships.

Moving on to Slide 19. Second quarter noninterest expense was $188 million, an increase of 5% linked quarter. Excluding debt extinguishment costs for the repos, amortization of tax credit and other investments and the core deposit intangible amortization, our adjusted noninterest expense was $153 million in the second quarter, a decrease of 5% quarter-over-quarter and a decrease of 4% year-over-year. The largest linked quarter change was a $5 million decrease in compensation and employee benefits expense, followed by a $2 million decrease in other operating expenses and a $2 million decrease in legal expense. Notable decreases in other operating expenses include marketing promotion expenses and travel expenses.

Our second quarter adjusted efficiency ratio was 38.1%. Over the past 5 quarters, our efficiency ratio has ranged from 37.7% to 38.5%. As an organization, we remain committed to controlling expenses across the board.

With that, I'll now turn the call back to Dominic for closing remarks.

Thank you, Irene. While this has been a quarter like no other, given not only tough economic conditions but also the toughest of health and social circumstances, I'm proud of the way our associates have handled the challenge and deliver for our clients, exemplifying East West values and culture. As an organization, we remain vigilant about credit risk management and maintaining a strong balance sheet with above peers' capital ratios. We are committed to delivering responsible growth, managing controllable expenses and building sustainable profitability.

I will now open up the call to questions. Operator?

(Operator Instructions) The first question today comes from Ebrahim Poonawala of Bank of America.

I guess first question, Dominic, thanks for going through all the details on credit, but if you could just spend some more time there after the review that you talked about. Talk to us just in terms of the downside risks to your reserve levels. When you think about, one, the energy portfolio, you saw one of the banks take a 50% mark and sell some of these loans. So if you could address your energy book in the context of that.

And then also on the CRE book, like is the 50%, 55% LTVs, which look relatively low, are those a good kind of buffer when we think about certain hospitality properties that may never recover from the pandemic? Just give us a sense of your comfort around both those portfolios, if you could, please.

Okay. First, on the oil and gas, when you -- we -- I mean I can't really comment much about Hancock Whitney because our portfolio is quite different to a certain extent and why the motivation of selling at such a steep discount. We'd done pretty much most of our spring redetermination. We do not see the type of deficiency like -- that will be causing us to want to take this kind of asset discount.

And basically, we are going through just loan by loan and looking at the current situation and the most updated financial information and the engineering report from the spring redetermination and come up with the reserve that is needed. We feel that we have very adequate -- very adequately cover our oil and gas portfolio as of today with that 9% of reserve coverage. So we feel pretty good at that, and we have appropriately classified the loans that need to be classified and so forth.

Now let's go to the CRE. Yes, the 50-some-odd percent loan-to-value is very -- I think is very good in terms of asset cushion to help against losses. We have 30, 40 years of history at East West in many different credit cycles that year in and year out, when it comes to income-producing properties, the low loan-to-value makes a big difference.

I think for the hotels, it also add that we are doing business with hotel operators that are very experienced in this trade. And these are high-quality operator. And also, many of them have substantial liquidity. There are -- many of them also have put in their personal guarantee. So yes, there are some hotels -- there's going to be having some challenge because of the current pandemic that causing the occupancy rate dropping very low. But the fact is, so far, what we have seen is that some of these hotels have gradually reopened. I know that there are going to be always some setback with certain state and certain cities that may have to shut down for a brief period of time. Eventually, the economy has to open up. And we just have to find a way to protect ourselves while still working.

So I would expect that some of these hotels will gradually still open back up. And we do have our borrowers who have more liquidity and have their personal financial network at stake that I think will be substantially more motivated. So from that standpoint, we want to look at pretty much almost all of the hotel loans. And we do feel pretty comfortable right now that we have more than adequate reserve to cover the commercial real estate portfolio.

The next question comes from Jared Shaw of Wells Fargo.

I guess for the first question, sticking with credit, when we look at some of the most troubled, I guess, CRE loans, whether that's hotels or retail or restaurants, how are you looking at sort of the long-term resolution of that? Should we assume that those just stay on sort of a continued deferral that's allowed under the CARES Act? Or would you expect to see more of an active restructuring of the most troubled loans before year-end and try to get them onto a new system or a new structure?

Well, first of all, I think that, as I had mentioned earlier, over 90% of our payment deferrals are actually only 3 months. So based on our conversation with the customers, the ones that requested deferral really don't anticipate that they will need another 3 months or 6 months deferral and so forth at this stage. While granted some of them have support from PPP loans, so we'll have to see whether beyond the PPP what the stimulus package that may be coming from the government or maybe some of them possibly qualify for the Main Street Lending Program and so forth.

So there are many different sources of support, but all in all, when I look at particularly for the hotel and some of the retail customers, when we go through loan by loan, so many of them did not even ask for payment deferral. I mean keep in mind, though, the vast majority, if you look at it, only 10% of our CRE customers asked for payment deferral. The vast majority of our customers don't even need that because they have the personal liquidity or for whatever reason, the nature of that particular income-producing property allow them to still have enough cash flow to service the debt. And that's the beauty about having first trustee, low loan-to-value loan because the mortgage payment for P&I combined are not as taxing as those, what I call, conventional borrowers who borrow 70%, 75% and struggling a little bit.

So I think from that standpoint that there's no question that we're going to have a few more customers potentially may have to come back due to whatever various reasons that we have to do maybe somewhat of an additional modification, and we'll work with them one by one. But at this stage right now, I think, overall, it's looking pretty good for us.

And then on the C&I loan pipeline, last quarter, you seemed, I guess, a little more cautious on growth. This quarter, it sounds like the pipelines are starting to boost again. Are you -- how are you looking at underwriting in this environment? And I guess what's the -- what do you view as the opportunity for near-term C&I growth as you finish out the year here?

Yes. I think ever since -- in fact, ever since late January, when the pandemic first happened in Wuhan, we have implemented internally the COVID-19 review. Every single loan that we approved has to go through the sort of like evaluation about how does COVID-19 affect this particular business. So that in addition to looking at the -- like, for example, like back in February and March. So in addition, just looking at the financial statement as of 12/31, and then everything looks fine and dandy, we look at the situation as it and say that, hey, with the pandemic, how would this business going to be able to carry on in the next 6 months, 12 months? Do they have enough liquidity to get by? Are they in a business that actually are benefiting from the pandemic because they're in the e-commerce business or they are in certain type of business, they are making facemask that actually are helping them.

So we look at all of the different factors. Or if there is something that is positive, to what extent this positivity can only last for 6 months and so forth? So we look at all of those different factors to determine the creditworthiness and making sure that we do not go in here now and go in to make a loan using a formula pre-COVID-19 and then end up getting ourselves in more problem a few months down the road.

So that's the kind of rigor that you will use. And so far, I think that we find business that we're able to sort of like bring in as new customers, and we also have existing customers now start going back and doing more business, and we continue to support these type of endeavors.

The next question comes from Ken Zerbe of Morgan Stanley.

I guess maybe first question for Irene. Can you just help us understand the benefit of the PPP loans this quarter? Because if I look at the math, you have $1.7 billion of loans, but you have 23 -- sorry, $21.3 million of fees or income, which kind of amounts to about a 5% annualized yield, which seems a bit high. Help us understand that, please.

Sure. I'd be delighted to do that for you. So if you look at the $21 million of PPP-related loan income, that is the one part of it is the 1% that we're accruing. And additional, we estimated what we thought the life would be for the PPP loans loan by loan. And based on that, we have accreted part of that fee income during the quarter. So the combination of that is the $21 million.

So I'll break that down for you. The amount that we accreted was about $17.5 million in the second quarter. So we're estimating that the life of the loans will be shorter than the contractual period, which for us is generally 2 years in total for some of the loans. Some of them, just based on the activity and what we're seeing and what we know about the customers, we are assuming that they'll go through the full contractual life of the 2 years plus.

Got it. So in essence, that if you assume a loan has, say, a 6-month life and you get 3% fee on that loan, you're basically taking the entire 3% fee over the 6-month period. Is that the right way to understand that?

That's correct.

Got it. Okay. And if I can just sneak in sort of a second question. Just in terms of provision expense, Irene, you did mention the provision expense should decline, which I think we all generally agree provision expense should decline if there is no further deterioration to your macroeconomic assumptions. But is there anything unique about East West that would lead that provision to decline a little bit less or more? Or -- I'm just trying to get a magnitude of whether it goes from $100 million down to $80 million or $100 million down to $20 million if there's no further deterioration.

Yes. That's a great question. I don't know -- if you look at it portfolio by portfolio, I don't know if there are any kind of unique characteristics, and that's why our -- relative to others with the same macroeconomic environment, we use Moody's the baseline as a backbone of our allowance calculation would be that different from other banks, quite frankly.

I do think, kind of in continuation of the comments that we've made as far as the resiliency of our customers, income-producing commercial real estate, the reviews that we've done, the single-family customers, the amount of equity that they have, those are portfolios I'm very confident that ultimately, the loss content will be reasonable or reasonably low relative to others. But I don't know if, aside from the oil and gas, which we've talked about, we see anything really systemic at this point.

The next question comes from Michael Young of SunTrust.

Maybe just a quick follow-up on that point, Irene, just within the C&I portfolio, I think you've got a little over 2% reserve on the remaining loans ex oil and gas. Can you talk about what areas you are watching more closely in there, whether it be entertainment and what's in that bucket, or tech and life sciences or if there are other things that we should be keeping an eye out for? It does seem like those might be the higher loss given the fall areas.

Yes. Candidly speaking, I think we are looking at all the portfolios, especially with the pandemic. The concerns, the cash flows, the different circumstances are very different than before the pandemic. So we're looking at as far as what's happening with their business, what's the cash flow, strength of the guarantors and the borrowers as well.

From an allowance perspective, specifically, I don't think that aside from oil and gas, if you look at industry by industry, there's anything very unique with how much we reserved. There are certain portfolios, for example, we have an equipment leasing portfolio. It's a longer life. The amount of reserve for that is higher. But aside from that, I wouldn't say that there's anything very unique industry-wide.

Okay. And this one may be a bit of an oddball question, but kind of just bigger picture on what's going on with Hong Kong right now and China and U.S. rhetoric ratcheting up again. Are there any things that we should be thinking about relative to kind of the Hong Kong-specific or China Mainland operations that could flow back through to East West if things were to deteriorate there?

Well, I think on the Hong Kong situation, let me just maybe see we can break it out into a few different scenario. Let's just say the worst-case scenario, the worst-case scenario will be, let's say, that U.S. government order all U.S. banks to retreat back to U.S. and no longer allowed to be doing business or no longer allowed to have offices in Hong Kong or something like that. That I look at as the worst-case scenario.

Well, keep in mind that we have so far, as of today, only 3% of our loans are in Greater China region. So for example, you look at $37 billion of loan outstanding today, only $1.2 billion is in Greater China. That's even including Hong Kong. So you cut that -- half of that in Hong Kong. Now -- and that's China and Hong Kong combined, half of that in Hong Kong. So we like talking about less 1.5% or so of our total loan portfolio.

And if you look at our history for the last 13 years in Hong Kong, the loss rate, delinquency, nonperforming asset and so forth has been extraordinarily low. So as of today, if we look at what's been happening, Hong Kong went through the pandemic for 6 months and we had no losses. So I feel pretty good that if we end up just having to all come back home, we will talk about revenue risk is very minimal. We obviously, just last quarter, grew our loans by 15% annualized. So there's really no reason for us to worry about a 1.5% loan reduction.

So we feel pretty good about -- even if the worst-case scenario, we're not going to have much -- any losses. So we're going to -- and we talk about revenue risk, we can get it covered. But that is an extremely, extremely unlikely scenario because I look at Hong Kong in 1997 when there was the handover of Hong Kong from the British government to China after 99 years of Hong Kong being colonized by England, the fact is everyone in 1997 was concerned about that was the end of Hong Kong. Singapore had picked up a lot of business. Vancouver, Toronto, Sydney to Melbourne all picked up on new business. And everyone think that everyone is going to be gone and no longer -- Hong Kong is no longer going to be viable. I didn't think so. I was there at the handover ceremony, had some discussion with many different business leaders around the world. And while some of them have pessimistic view, there are many others have optimistic view at the end of the day. Since 1997, Hong Kong had done extraordinarily well.

And so from my perspective is that the more likely scenario is that we're going to have -- see some noises within the next 12 to 24 months, and Hong Kong will be different in the standpoint of now there may be not as much business that Hong Kong is currently doing like -- that we'll be doing in the future but then connecting with a greater base of China. The southern provinces of China connecting to Hong Kong is going to create enormous amount of opportunity for Hong Kong. If you look at end financial by dense, a few of these over $100 billion potential IPO, there will be more and more of those going to Hong Kong. So Hong Kong is still going to have a place.

And if I look at our existing customers for the last several months, by the way, most of them actually have a business headquartered in the British Virgin Island and then type of energy anyway. And they were navigating through this challenging time in Hong Kong just fine, and we are continuing to work with private equity funds. And for them to move to Singapore and then other places, it will be very easy.

So I don't think that there will be that big of a challenge from a business point of view. But there's no question that the political noise will continue to be a major distraction because no matter what, if every day that you read the newspaper what you see is the headline news about something terrible happening in Hong Kong and so forth, it does have a perception risk there that we have to recognize.

But what you have seen so far for the last 2 or 3 years, whether in China, on the tariff situation, East West navigated through the last 3 years, which is heavy U.S.-China political bash regarding the tariff. And somehow, we navigate through and have very minimal losses and continue to be able to maintain our business and going forward. And we're going to be nimble, and we're going to be pretty flexible. And whenever there is certain business caused by the political risk that we should no longer engage, we move forward to other business that is appropriate for us to do.

And I wanted to do -- highlight one other thing is that as all these political rhetoric is going on, for the last few years -- in fact, in the last 6 months, it intensified substantially. And I would expect that there will be 3 more -- 3.5 more months to go before it subside. And with these political rhetoric that's going on, U.S. investment in China for the last 6 months actually had increased. The media don't talk about it much. But if you look at the true statistics, foreign direct investment from the United States to China have actually increased. Business folks still see the potential, are still investing in China. In fact, China is still welcoming U.S. business. As you can see what they've done for Tesla or JPMorgan, Mastercard, I mean they continue to welcome U.S. business to China. And those businesses are continuing to taking advantage of those new licenses that we're able to acquire or the new acquisition they can make.

And so it's a very interesting dynamic in terms of the political rhetorics versus what's happening in terms of the day-to-day business. And East West Bank are apolitical. We stay neutral. And we're focusing on taking care of business, our clients. And we know how to manage risk because we understand the space very, very well.

So, so far, so good. So we will continue to do what we need to do in terms of managing the overall risk profile of this U.S.-China relationship and move accordingly in a prudent manner. So I feel pretty comfortable that we're able to find a way to keep doing well. And it's something that I have plenty of discussion with our Board of Directors in regarding with this situation.

Again, I think that since Nixon's normalized relationship with China, U.S. government policy have always been seek common ground and reserving differences. That's been the policy for a few decades. And the last few months have been quite differently, but I don't think that this sort of like very, very hostile type of relationship can sustain. And at some point of time, in my long-term view, it will normalize again and then things will get better.

The next question comes from Chris McGratty of KBW.

Dominic, in your prepared remarks, you spoke of the consistency of your efficiency ratio in the high 30s. Understanding we're in a different world with interest rates, maybe you could talk about your expectations for this metric going forward and maybe speak of it excluding the impact of the PPP program.

Well, efficiency -- I mean I think I said it before, efficiency ratio is just a revenue of income minus expenses. So there's not much to it. I just basically work with our associates and then I tell them that, hey, I mean, don't take any losses but then book as many loans as you can and then bring in all these good low-cost deposits. And so that generates some meaningful net interest income and then get more fee income, core fee income and then control the expenses, and then something good will come out. And then my definition of something good come out is that these high 30s, low 40s kind of numbers. And that's it. That's what we focus on. And I don't really get into that much about we have a target, anything like that. I just -- we just make sure we do the right thing.

Understood. Great. Maybe I could ask one more on the expenses. You guys have, I think, done a great job adjusting to the revenue environment by slowing the expense growth. I guess 2-part question. The lower expenses, the core expenses this quarter, was there any benefit from the PPP program, the originations? And two, how do we think about just investments in this kind of environment, the pace of investments into '21?

Chris, this is Irene. I'll take that. Yes, there was a benefit during the quarter for loan costs that were deferred. Our gross fees are roughly $50 million in the quarter, deferred about $7 million of loan cost fees associated with the origination of the PPP loans.

On a go-forth basis, if you look at the pace of investment, we have actually many very exciting investments and projects underway to help our customers improving our systems, our platforms, the digital onboarding. Those investments started before the pandemic and are underway, just to share -- well underway, rather. We're implementing a new online banking system for Hong Kong, and that would integrate our U.S. online banking and our Hong Kong online banking. We're also implementing a new global FX system. And we also have many smaller projects underway to improve digital onboarding and then processes.

I think with the pandemic, the investments that we have been and continue to make in these areas are perhaps maybe even more important. So -- and to a certain extent, these are things that we're continuing to do, have started before and will continue to do. And in a way, many of these will also help us as far as the efficiency and the productivity of our team and our ability to continue to serve our customers without adding on as much incremental cost.

The next question comes from Lana Chan of BMO Capital Markets.

Just 2 questions. One, is there any update on the tax credit investments and the associated tax rate going forward?

Update, there's no update. If you're asking what the amortization of the tax credit will be, for the full year, we are assuming around $100 million.

Sorry. To clarify, we are assuming $100 million of tax credits with a tax rate amortization in the low 90% against the $100 million.

Got it. And is there any way you can quantify the reserve build this quarter, how much of it was associated with the change in economic forecast versus loan downgrades and new loan growth?

Yes. Great question. First and foremost, I would say the vast majority of it on a kind of -- there are a lot of moving parts with the allowance, but the vast majority of the increase had to do with the more adverse economic scenario. Secondarily, I would say it's a downgrade, particularly for C&I.

The next question comes from Dave Rochester of Compass Point.

On the credit slide on Slide 14, you're showing classified and special mention in C&I ex energy and PPP going down this quarter in terms of the ratio versus last quarter. I was just looking for some color there. Was that the PPP effect shoring up customer balance sheets or something else going on? Just a little color there would be great.

Yes. It's definitely not the PPP. What we had in the quarter-over-quarter, there were some loans that were resolved during the quarter that were classified last quarter.

Got it. And then for my second question, you guys had mentioned pipelines for building in June in commercial, and you mentioned a few industries there. I was just wondering if you could just talk about what's driving that build, if you're taking share in those areas or if you're hearing more confidence or any positive sentiment amongst commercial customers.

And then I guess on the flip side and the rest of the C&I book, is the expectation that you'll have some more paydowns in energy and maybe see an unwind of some of those draws from the first quarter as we go through the back half of this year?

Okay. For the pipeline that we're beginning to see in June -- in fact, we started booking some of these loans now in July. And P/E, private equity, those are just traditional capital call lines and mainly existing customers that have new funds. So much distressed situation going around the world, there are more people now, I mean, just like putting in substantial amount of liquidity and start new funds to capitalize on these opportunities. And we have these very, very strong borrowers that are starting new funds coming to us, and we are able to actually start booking some of these private equity capital call line business. We just happen to be picking up some more, I think, for the last few weeks versus in the second quarter when people need to just time out and size up what's going on.

And on the entertainment side, I think our team just being very diligent while staying at home but dialing the phone nonstop with the studio executives and then getting these deals that we are able to finance. And again, very strong collateral support type of deals and then things that we sort of like without any question, I'd be more than happy to jump into this kind of type of transaction even during the pandemic. So we feel very good about these kind of opportunities.

And the third category that I thought we saw some nice pickup, our cross-border business. Keep in mind that in the first and second quarter, Hong Kong and China have taken a more draconian type of measurement against -- in terms of, I would say, discipline on fighting the pandemic. Both of them have been extraordinarily successful. But with that, I think that, obviously, business been somewhat shut down in a big way. So they weren't having as much business as you -- as we indicated, in the second quarter -- no, second quarter, we actually have $2 million -- a 2% reduction of our Greater China loan portfolio, but they started getting back business as usual, business as normal, both in Hong Kong and China.

And so our teams in Greater China are picking up some more business. We feel that there's more opportunities there. And same thing for the cross-border team in the United States. Frankly, when everybody look at U.S.-China as something that they don't want to get anywhere close to, if someone just look very hard and deep, they can always find some golden opportunity in there. And we're trying to make sure that we do the best we can to capitalize on some of these remaining good opportunity.

So at this point, we see these 3 industry verticals may have some pretty good traction for now. I mean -- but still, we are in July, still early. So we don't know what the next 2 months will be like. We'll see. But at this point, it looks pretty promising.

The next question the next question comes from David Chiaverini of Wedbush Securities.

First question is on credit and the provision. You mentioned about how it could be lower if the macro environment remains stable. I was curious if the stimulus bill being contemplated is delayed to late August or September, would that change your economic forecast?

I don't know if just the stimulus bill being delayed would change the economic forecast. Certainly, if it impacts the expectation, a lot of the drivers for our forecast, some of the -- there are many drivers. But for us, if you look at it, GDP growth, unemployment, and then to a certain extent, for single family, the housing starts numbers. So those are the things that drive it the most. But certainly, I would say that if the bills are delayed and that impacts the expectation around these key metrics, that, that would have an impact but not just by itself.

Okay. And separately, anecdotally, it appears more retail stores are becoming vacant. I was curious, do you know how much of your CRE borrowers no longer have tenants?

Well, we actually went through the CRE retail customers' loan review. As I said, we review over 50% of these CRE loans in a loan-by-loan review basis and getting the most current information. Our relationship manager actually have the most updated information for the customers. Every one of them have maybe a little bit unique situation. We have some that have maybe 30% of the tenants have to -- cannot pay full rent. And we have some that actually have a few of the tenants just say that I'm out. And then there were others that are still paying as agreed, fully occupied. So every one of them are a little bit different. A few of them that may have some more severity in terms of tenant not paying. Somehow, the borrowers have strong financial ability to continue to carry the payment and knowing that eventually, you will be able to find a way to release it to some other new tenants down the road.

So it's just a multiple different scenario. But one thing we do know is that, because we went through this review loan by loan, we know exactly what the situation is and we know what the stress situation is currently. And at this stage, we feel pretty good and comfortable about the portfolio where it stands today. And we feel that we absolutely -- from a CRE point of view, we have more than adequate reserve to cover any potential losses.

I'd also just like to add, a lot of the comments Dominic made were about tenants and their payments, and especially given in light that many of the stores are closed. Specifically, as it relates to occupancy of the buildings, most of -- as we went through these loan reviews, the occupancy pre-pandemic was pretty high on most of the properties. Most of them were fully occupied.

The next question comes from Brock Vandervliet of UBS.

Just an accounting question here. I noticed there was a negative provision in single-family residential in the quarter. Could you kind of give some color around that, please?

Yes. The slight negative provision in single family, it's very modest in many ways. But the result -- the reason for that was the allowance that was required did reduce slightly from the forecast that we used at the end of March to our forecast as of the end of June that we use for our June allowance close. It was really driven by the less severe impact for housing prices with the HPI improving over the prior forecast.

Got it. Got it. Okay. And did I understand correctly that the next major cliff of deferral expiries is August?

Yes. Based on -- so I'll categorize the deferrals. We have the big groups as far as the commercial deferrals and then also the single family. Single family, a little earlier. For the commercial deferrals, it is August and September. Most of those will come up in a wave then.

This does conclude our question-and-answer session. I would like to turn the conference call back over to Dominic for any closing remarks.

So again, thank you all for joining us for the call. And we are looking forward to speaking to all of you again in October. Thank you.

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