UCBH Holdings, Inc. Q3 2008 Earnings Call Transcript

| About: UCBH Holdings (UCBH)

UCBH Holdings, Inc. (UCBH) Q3 2008 Earnings Call October 24, 2008 11:00 AM ET


Doug Sherk- EVC

Thomas S. Wu - President and Chief Executive Officer

Craig S. On – Chief Financial Officer

Doug Mitchell – Senior Vice President, Corporate Development and IR


Andrea Jao – Barclays

Aaron Deer - Sandler O'Neill & Partners

Ken Zerbe – Morgan Stanley

Erika Penala - Merrill Lynch

Brett Rabatin - FTN Midwest Securities Corp.

James Abbott - Friedman, Billings, Ramsey & Co.

Frederick Cannon - Keefe, Bruyette & Woods

Lana Chan - BMO Capital Markets

Joe Morford - RBC Capital Markets

Raymond Chung – Biondo Group

Donald Worthington - Howe Barnes Hoefer & Arnett Inc.


Ladies and gentlemen, thank you for standing by and welcome to the UCBH Holdings Inc. third quarter 2008 Earnings Call. (Operator Instructions) This conference is being recorded today Friday October 24, 2008.

I would now like to turn the conference over to Doug Sherk of EVC. Please go ahead sir

Doug Sherk

Thank you, operator, and good morning to everyone. Thank you for joining us today for the UCBH third quarter 2008 conference call and webcast. Before we begin, the company's release announcing the third quarter 2008 results was distributed yesterday after the market closed. If for some reason, you haven't seen a copy of the release and would like one, please feel free to call our office at 415-896-6820 and we'll get you a copy immediately.

There will be a seven-day replay of this call beginning approximately one hour after we 303-590-3000. Both numbers require the passcode of 11118995, followed by the # sign. Additionally, this call is being broadcast with a slide presentation over the Internet and can be accessed by the company's website at www.ucbh.com.

I would like to remind you that this conference call contains forward-looking statements regarding future events or the future financial performance of the company. Such forward-looking statements involve risks and uncertainties and other factors that may cause the actual results, performance, or achievements of the company to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, general economic and business conditions in the areas in which the company operates, demographic changes, competition, fluctuation in market interest rates, changes in business strategies, changes in credit quality and other risks detailed in the documents the company files from time-to-time with the SEC. We wish to caution you such statements are just predictions and actual results may differ materially. We refer you specifically to the company's latest Form 10-K and 10-Qs, which have been filed with the SEC.

And now I would like to turn the call over to Mr. Tommy Wu, Chairman, President and Chief Executive Officer of UCBH.

Thomas S. Wu

Thank you and good morning to everyone. We appreciate your joining us this morning for a review of our third quarter 2008 results. On the call with me today is Craig On, our Chief Financial Officer, and Doug Mitchell, Senior Vice President, Corporate Development and Investor Relations.

We are very pleased to announce Craig’s appointment as our Chief Financial Officer. He has done an excellent job in the interim CFO position since May of this year. Craig has been in various senior management positions in our Finance Division at UCBH since 2005. He knows our company exceptionally well. He has a strong fiancé background and is well-experienced with financial institutions through his twenty-one years with the Deloitte & Touche.

Over the past several months the company has conducted a national search for a new CFO and spoke with a number of qualified candidates. Following an extensive [inaudible] our Board of Directors concluded that Craig was the best choice. We believe Craig will be instrumental in providing leadership to drive the future growth and enhance the profitability of UCBH.

Our earnings call will begin with an overview of our third quarter financial results. We will then provide a review of our credit metrics and loan portfolio, including a breakdown of our three largest loan portfolios, which are commercial business, commercial real estate, and construction. Finally, we will provide updates on several additional financial and business metrics. We will conclude with our report on current market conditions and our outlook for the fourth quarter of 2008. We encourage you to follow our presentation with the slides provided on our webcast which is available on www.ucsh.com. At the conclusion of our formal remarks we will take your questions.

Now I would like to ask Craig On to begin with a high-level overview of our financial results for the third quarter.

Craig S. On

Thank you for the nice words, and good morning everyone.

I would like to start with comments on some of the key financial metrics that occurred during the third quarter. Reflecting the very challenging economic environment that we have been facing and that we continue to face, the bank incurred a net loss available to common stockholders for the quarter of $3.5 million which equates to a loss of $0.03 per share.

However, as we paid a dividend on our convertible preferred stock in the quarter, our reported net income available to common stockholders includes $3.0 million for the amount of the preferred dividend payment. Excluding the preferred stock dividend, net loss was $493,000, or $0.00 per share.

There were three major contributors to the results in the quarter. The first was a $43.2 million loan loss provision that was higher than we initially anticipated, due primarily to continued weakness in housing in residential construction markets in California.

The second contributor was the $17.8 million other than temporary impairment of our investment in preferred stocks of FNMA and Freddie Mac, which we had previously disclosed in our September 10, 2008, Form 8-K filing.

The third contributor was a $9.0 million income tax benefit which was caused by the significant decrease in our pre-tax income during the third quarter of 2008, resulting in items such as tax-exempt interest income, low-income housing tax credits, our UCB China income which is taxed at a lower rate, and California net interest deduction having a relatively greater impact to the effective income tax rate.

However, top line revenue generation remained strong and our core operating performance was positive. On a per-share basis, excluding the impairment charge on our GSE securities, we earned $0.07 per share, as you can see on the chart.

Our net interest margin decreased 12 basis points from the prior quarter to 3.05%. The decline in the net interest margin is due largely to the Fed Funds rate cuts as well as the impact of interest reversed on our non-accrual loans, which in tandem, lowered the yield of our loan portfolio.

Our deposit costs came down slightly compared to the prior quarter because of the Fed Funds rate cuts, as well as our diligent deposit management efforts.

Our loan loss provision increased to $43.2 million from $32.6 million in the second quarter. The provision was higher than we initially anticipated primarily due to further softening in the residential construction markets in California.

Our construction loan provisioning was impacted by increases in both specific loss reserves as well as by increases in loss factors applied in our general reserving methodology.

Also, $4.2 million of this quarter’s provisioning was associated with in increased commercial lending reserves as we provisioned for one commercial loan totaling $28.0 million.

Our higher provisioning in the quarter resulted in a further build of the allowance for loan losses where the ratio of allowance to loans held in portfolio increased from 1.26% in the second quarter to 1.36% in the third quarter.

Additionally, total reserves to loans held in portfolio, which includes both the allowance for loan losses and the reserve for unfunded commitments and which excludes our cash-secured loans, rose to 1.48% at the end of the third quarter of 2008 versus 1.37% at the end of the second quarter of 2008. Given current market conditions, we anticipate that our allowance levels will continue to build in the fourth quarter of 2008.

Charge-offs for the quarter increased to $31.6 million compared to $26.3 million in the second quarter. The charge-offs were primarily related to our construction portfolio in the distressed markets where conditions continue to show weakness.

Non-performing loans increased by $36.2 million from $196.0 million in the second quarter to $232.2 million in the third quarter, primarily reflecting a $29.3 million increase in non-performing construction loans.

Our net loan to deposit ratio increased to 102.5% compared with 98.2% in the second quarter of 2008. The increase reflects our growth in the loan portfolio as well as a slight decline in total deposits in our Hong Kong branch.

During the third quarter we observed that foreign press coverage of the turmoil in the United States financial markets was notably negative resulting in some overseas clients with large deposit balances diversifying their deposit holdings.

However, the recent coordinated global response to this situation and the 100% guarantee of all deposits by the Hong Kong Monetary Authority, which was announced this month, has stabilized this trend. We anticipate that we will be able to gain back a lot of deposits at our Hong Kong branch and we will also be committed in maintaining the loan to deposit ratio under 100%.

Our capital position remains very strong. Our capital levels remain well above regulatory minimums for well-capitalized banks and we believe that they are at levels that will allow us to continue to pursue our strategies for prudent growth.

In addition, we anticipate our capital ratios will improve in the fourth quarter of 2008, which we will discuss further in a few minutes.

Year-to-date interest income increased by 3% year-over-year in a period in which the Fed cut interest rates by 325 basis points. The increase was due to higher average outstanding loans during the quarter, offset by lower average investment securities, higher average deposit balances, and higher average non-accrual loans during the quarter.

Our year-to-date fee income, including commercial banking, service, and other fee income which in turn is comprised of foreign exchange and translation gains and loan servicing fee income, grew over the prior year by 8.6%.

During the quarter we were able to sell some investment securities and recognized approximately $4.8 million in gains from these sales. However, this was offset by the other than temporary impairment charge that we recognized on our investments in the preferred stocks of FNMA and Freddie Mac.

These securities have been in our available for sale investment securities portfolio and had an original carrying value of $23.5 million at the end of March. Recollect, if you will, that at the end of the second quarter we had recognized a $4.4 million other than temporary impairment charge on four of the Freddie Mac investment securities.

We recognized an additional $17.8 million in other than temporary impairment charges in the third quarter. These securities are currently trading at approximately 5% of their par value and it is unclear at this time if their values will improve or recover.

This write-down of the GSE portfolio represented the only other than temporary impairment charge that we took in the third quarter. We are treating the GSE write-down as a capital loss for this quarter but will recharacterize this to an ordinary loss in the fourth quarter for tax purposes.

Please not that in connection with our third quarter other than temporary impairment analysis, we implemented the updated requirements stipulated by the FASB staff position 157-3 determining the fair value of a financial asset when the market for that asset is not active, which as issued in October.

We are in the process of completing our annual review of goodwill. This analysis will be completed prior to the filing of our Form 10-Q. We are not anticipating any potential impairment of our goodwill as a result of our annual review.

Year-to-date net interest income grew 11.5% year-over-year driven by organic balance sheet growth and the acquisition of UCB China in December 2007.

As previously mentioned, we also recognized a $43.2 million loan loss provision in the quarter primarily due to the decline in pre-tax income as well as due to other items, such as tax-exempt interest income, low-income housing tax credits, and favorable tax rates on UCB China income. We recognized a $9.0 million tax benefit in the quarter.

At this point I would like to turn the call over to Doug Mitchell who will provide a review of some key credit metrics and of the loan portfolio, which will include a breakdown of our three largest loan portfolios.

Doug Mitchell

Gross charge-offs in the third quarter totaled $31.6 million, 20% higher than the second quarter charge-offs. This was consistent with our expectations given our level of provisioning in prior quarters and the continued weakness we’ve observed in certain distressed residential construction markets.

The charge-offs were predominantly related to construction loans which increased to $27.4 million from $21.0 million in the second quarter. Construction loan charge-offs represented 1.41% of the total construction portfolio, up slightly from 1.11% in the second quarter.

Commercial business charge-offs decreased over $1.0 million in the third quarter to $2.0 million from $3.3 million in the second quarter, while charge-offs for commercial real estate loans were low and relatively flat in the quarter.

The annualized net charge-off ratio for the entire portfolio was 1.4% in the third quarter compared with 1.23% in the second quarter. Total non-performing loans increased from 2.27% of loans outstanding in the second quarter to 2.62% in the third quarter of 2008. The increase was driven primarily by higher non-performing construction loans while the decline in commercial real estate non-performers and minor increases in non-performing commercial business and multi-family loans nearly offset one another.

Total delinquencies as a percentage of total loans increased 104 basis points to 2.79% at September 30, 2008, from 1.75% at the end of June 2008. This increase was mostly driven by higher construction and isolated commercial business loan delinquencies.

Construction loan delinquencies increased to $153.0 million at the end of the third quarter, from $93.6 million at the end of the second quarter, bringing the delinquency ratio on construction loans at the end of the third quarter to 8.72% compared with 5.4% at the end of June 2008. We noted that the increase in the current quarter was driven by new delinquent accounts replacing accounts that were past due in the second quarter where the delinquencies from the second quarter cured in the third quarter. Meaning that the second quarter delinquencies were not all migrating to more severe conditions in the third quarter.

Additionally, the 90+ day delinquent loans declined by $14.4 million with one loan being brought current and one being placed on non-accrual. The new non-accrual account in the remaining 90+ day delinquencies represent commercial construction loans identified in the second quarter of 2008 that are supported by strong collateral and for which we believe do not have significant loss content associated with them.

Commercial business delinquencies increased by $30.5 million from $19.5 million at the end of June 2008 to $50.0 million at September 30, 2008, driving the delinquency ratio for this portfolio from 0.84% to 2.0%. The increase in delinquencies was in the 30 to 60 day category and was primarily the result of a single loan totaling $28.0 million.

This loan is backed primarily by inventories and receivables which are being identified and valued by the bank through an appointed receiver and appraiser since we are concerned about potential fraud associated with this loan.

Commercial real estate loan delinquencies also increased nominally to $25.8 million at the end of September 2008 from $18.0 million at the end of June 2008. The increase was also found in the 30-to-89-day categories and the delinquency ratio increased from 0.7% at the end of June 2008 to 0.99% at September 30, 2008.

Delinquency migration was not observed in the quarter as the third quarter delinquencies represent a different set of borrowers than those found in the second quarter delinquencies.

In contrast, the delinquency rates of the consumer and multi-family portfolios improved in the third quarter compared to the second quarter.

Overall, in addition to the continued weakness in residential construction, some softness has appeared in other markets and we are seeing some weakening in overall payment trends. However, given the turnover in our past-due accounts we believe our borrowers are continuing to be able to support their projects and properties. We remain diligent for changes in these patterns.

Interestingly, market data from MDA DataQuick, released in October 2008 showed real estate trends from September 2008 beginning to show that deteriorating housing values in California may have begun to find a clearing price as Northern California home sales rose 45% and Southern California home sales jumped nearly 65%. Depending on region, between 40% and 50% of these sales represented foreclosure resales and were coming from the less expensive inland markets and reflected 30%+ price declines from the 2007 peaks that was pushing the sales to these levels. For example, in Riverside County, in the Inland Empires, sales rose 106% year-over-year on 37% price declines where 69% of these sales were foreclosed homes.

We are encouraged by these home sale figures as inventories are being cleaned up, however, we remain cautious whether this activity will be sustained through the fourth quarter and into 2009 in light of the recent market turmoil.

UCB continues to carefully manage its loan growth in light of the current market conditions. We have previously noted that we see opportunities to expand our presence in key markets and while we continue to make new loans, we have consciously slowed the pace and remain focused on our relationship building.

We have further tightened our underwriting standards and we have raised the rates on new loans we agree to fund.

Loans outstanding grew 10% on an annualized basis to approximately $8.9 billion where 60% of this growth was generated from the Greater China region while much of the rest was driven by further utilization of existing loan commitments rather than new loan growth.

In managing our pipeline, loan commitments in the third quarter were down 19% compared with second quarter commitments. Loan commitments to borrowers in Greater China represented approximately 32% of the total third quarter new commitments. We anticipate that the contribution from China will continue to benefit us as we expand our presence in the region.

Our problem credits were significantly identified back in the first quarter of 2008 and our elevated provisions and non-performers continue to primarily come from these previously identified residential construction loans in the distressed markets.

We have observed continued weakening of the housing markets in the distressed markets and some softening in housing markets contiguous to the distressed markets, however, our efforts to maintain continuous monitoring of our local markets for changes in housing absorption rates, sales prices, and similar metrics, is helping us to stay in front of local market trends.

In addition to our portfolio management efforts, we are also employing targeted independent loan reviews of our construction portfolio to ensure risk ratings, assessments of collateral support, project progress and other items are accurate and reflective of current market conditions.

While we observed an increase in commercial lending delinquencies during the quarter, this was mostly due to a single loan with unique issues. Our commercial portfolio is diversified by geography and industry and performance appears to remain consistent with the nature of commercial lending. We continue to monitor our C&I portfolio very diligently in light of the current economy. Our commercial real estate and multi-family portfolios continue to show strong credit metrics.

At this point I would like to provide an overview of our major loan portfolios, starting with the construction portfolio.

Our construction loan portfolio, totaling $1.94 billion at September 30, 2008, is diversified by both location and loan type. 17% of the portfolio is comprised of loans on properties and what we have defined as distressed areas that include Riverside, the Central Valley, San Bernardino, Sacramento, and Imperial County in Southern California, and the High Desert in Reno, Nevada.

It is noted that the majority of our construction loans, 83% of the portfolio, are in properties outside of these distressed areas, including 34% of loans outside of California altogether.

When considering loan types, the credit issues in the portfolio continue to be concentrated in land and acquisition development and construction loans, which we have experienced continued weakness in valuation.

Our raw land exposure is only 5% of the construction portfolio.

Our commercial business portfolio increased to $2.52 billion in the third quarter. All of our commercial business growth in the quarter has been organic and the portfolio is well-diversified by location and industry.

We do have a significant presence in California and our commercial lending here is primarily related to trade finance activities and continues to perform.

Greater China represented 37% of the portfolio and remains a major source of commercial business loan production. This portfolio has strong collateral support with approximately 85% of the commercial loans in Greater China secured by either first liens on real estate or cash.

Our strategy of targeting the small- and medium-sized enterprises in China is unchanged and we expect Greater China will continue to be a major area of growth.

We do recognize some exposure is to industries that may be more sensitive to the downturn in the economy, including the building supply, home furnishing, and auto-based industries. We continue to monitor these segments and are pleased with the portfolio’s current performance.

Our commercial real estate portfolio totaled $2.64 billion at September 30, 2008. It is diversified both geographically and by collateral type, as well. Unlike our construction portfolio, we have minimal exposure to distressed geographical areas in California and Nevada.

On a geographical basis, 41% of the portfolio is outside California and only 2% is located in distressed areas. Retail and offices remain our largest concentrations, each representing 19% of the portfolio.

Now I would like to turn to a review of our deposit portfolio. Total deposits declined slightly from the end of June 2008 to $8.5 billion at September 30, 2008. However, domestic deposits actually increased by approximately $150.0 million in the quarter. The increase was primarily driven by our domestic time deposit gathering efforts and from several promotions during the third quarter. Our promotions targeted deposits under $100,000 to emphasize core deposit gathering and was very successful during the period.

The decrease in deposits was primarily the result of withdrawals at our Hong Kong branch from customers located in Hong Kong and Taiwan. The withdrawals in Hong Kong were prompted by negative press regarding the conditions in the United States financial system and rumors regarding the safety of one large Hong Kong-based bank that quickly spread to other banks in the area.

In our case, the withdrawals came primarily from banking customers who maintain large deposits and wanted to diversify the risk.

The situation in Hong Kong has stabilized very quickly. Recently the Hong Kong Monetary Authority stated that it would guarantee 100% of all deposits and we are no longer seeing unusual withdrawal activities. We are, in fact, regaining some of the deposits we lost during the second quarter.

Deposits at UCB China with operations in mainland China grew a healthy 23% from the end of June 2008.

Domestically we are also participating in the FDIC’s temporary liquidity guarantee program to offer deposit insurance on non-interest bearing transaction accounts with balances greater than $250,000. This is expected to help future deposit growth.

I would now like to address the company’s capital position and related developments.

The bank maintains strong capital ratios in excess of the regulatory minimums for well-capitalized institutions. Our capital in excess of the Tier 1 capital minimum is $415.0 million and $257.0 million in excess of the total risk-based capital minimum. We feel that this is prudent in the current economic environment.

The bank continues to work with China Minsheng Banking Corporation, Ltd. and the Chinese State Administration for Foreign Exchange, also known as SAFE, to close the second step of the investment in UCBH. This second investment will bring in approximately $30.0 million of additional capital. This transaction will also bring Minsheng’s total investment in the bank to 9.9%. The first phase of approval from SAFE has been obtained and the final phase is being processed. We anticipate to close the step two China Minsheng investment shortly.

Additionally, UCB plans to participate in the Treasury Department’s Capital Purchase Program. While the deadline for submitting applications for participation is not until November 14, 2008, UCB has determined that the bank will benefit from participating in this program.

Our pro forma capital calculations across the range of minimum and maximum capital injections show that the banks’ already strong capital ratios would strengthen dramatically with participation in this program, with Tier 1 capital potentially reaching 12.86% and total risk-based capital reaching 15.24% if we participate at the maximum levels under the program.

I would like to now turn the call back to Tommy Wu for his discussion of our outlook for the remainder of 2008 and our strategy going forward.

Thomas S. Wu

Unprecedented events during the third quarter had a meaningful impact on our earnings. The failure of the GSEs resulted in the largest other than temporary impairment charge and the continued weakness in the housing markets drove provisions and their allowance for loan losses high.

While the third quarter has continued to be a challenge for financial institutions in the country, our fundamentals and core performance remain sound. We continue to generate strong top line core income with year-to-date net interest income showing 11.5% growth over last year.

Loan growth has been measured and prudent. Our focus on generating deposits and building relationships with customers has continued and we were successful in driving growth in domestic deposits during the quarter.

Our capital position is strong and will be further enhanced through the second phase of the Minsheng investment and our participation in the Treasury Department’s Capital Purchase Program.

As a result we are very well positioned in the current credit cycle and will continue to focus on building our franchise for future expansion and profitability growth.

The expansion of our branch network across the United States and in Asia has not only given us access to a broader customer base, but also provides opportunities to diversity our loan portfolio. We will continue to build our branch network in 2009, building customer relationships when and where appropriate in the market place.

Our Greater China platform is unique and is already exceeding expectations in its contribution to our operating results. Our franchise value in Asia continues to grow as our name recognition increases in the region.

We are building new relationships every day and experiencing good and steady loan and deposit growth among existing and new customers. At the same time we evaluate credit risks very carefully and are prudent in our pursuit of good performance and profitability.

As we look to the final quarter of 2008 we remain very cautious as recent market development and volatility have demonstrated the difficulty in forecasting results.

Using the best information we have available to us today, we offer the following outlook on the fourth quarter. We do not expect to see additional other than temporary impairments in our investment portfolio in the fourth quarter.

Loan growth for the year will be in the range of 10% to 15%. Deposit growth for the year will be in the range of 8% to 12%. Net interest margin will go down a little in the fourth quarter due to the expected Fed Fund rate cut. We expect that our non-interest expense run rate will remain steady at approximately $51.0 million.

We therefore anticipate a profitable fourth quarter and a profitable 2008. Additionally, UCB will continue to strengthen its capital position with the closing of the step two of the China Minsheng investment and through our participation in the Treasury Department’s Capital Purchase Program. We believe that our participation in this program is key to our ability to remain competitive in a dramatically changing market environment and to support our strategies for future expansion and acquisition opportunities.

This concludes our formal remarks. Thank you again for participating in this call. I will now ask the operator to open up the lines for any questions you might have.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Andrea Jao – Barclays.

Andrea Jao – Barclays

Craig, I was hoping to get your interest rate assumptions, not just for the remaining quarter of 2008 but also for 2009 and given those assumptions, how should we think about the drivers in the margin into 2009?

Craig S. On

I think we see, based on where we were at for Q3, that we see the margin staying flat. As we indicated in our presentation, we ended up at about 3.05% for Q3 so I believe we will be staying there or maybe down-ticking just a little bit.

Thomas S. Wu

And for 2009 I think the model really depends on how the Fed Funds rate will come in at the end of the year. Assuming another 25 basis point rate cut in the fourth quarter, I think we believe there should not be any more rate cuts for 2009. And our margin will be stable at the beginning and then increase at the end of the year.

Andrea Jao – Barclays

And Tommy, I was hoping to get more detail in terms of conditions in both Greater China and Hong Kong and how this is impacting what you want to do over there.

Thomas S. Wu

Let’s go to Hong Kong. I think Hong Kong, right now the economy is still stable, even though the stock market came down a little bit. But I think the overall economy is still very stable. The retail sales still remain very stable in Hong Kong and I would expect the Hong Kong GDP growth will slow down a little bit in 2009 but I think overall the economy is healthy in the Hong Kong market.

Now as far as Greater China is the GDP growth for the third quarter for the third quarter is about 9% compared to 12% in the past year. But 9% growth is still a very healthy growth for Greater China, particularly a lot of growth is different internally. And also because of the turmoil in the U.S. and also around the world, it does affect the export of China. But having China, the currency, RMB, being very stable right now at $6.83 to US$1.00, I would expect that the export will be stable in next year, unless the global economy melts down, which I don’t think will be the case.

So, as you all know, the business focus for our Greater China operation is in the SME market and SMEs will continue to do well, particularly in the Yangcheng Delta, River Delta region, which is the northern part of China. That’s where we are headquartered and I think that our business momentum will continue to grow steadily in China in 2009 in the SME market.

And also we are seeing a lot of demand on our surface for [inaudible] from our existing customers who are actually doing business in China and the U.S. right now. So we anticipate very steady growth in China in 2009, particularly we are getting better and better in terms of business traction in the SME market.

And recently the Chinese government is encouraging banks to focus on the SME market because the big banks, major banks, domestic banks, are not really capable, infrastructurally, to serve that target market. As you can tell, evidently, it will continue to be evident that our strategy on the SME market will be a strong one because the market is so big and it is still underserved.

That’s why the PBOC, the CBRC, in the mainland China really will encourage banks to focus in this market. They even mentioned about creating a new bank to serve the SME market. You can tell how this market is totally underserved.

So I think we are optimistic about our operation, our growth, in China in 2009 as we see today and of course the good thing about this market is the SME vending in China, the majority of which about 85% is secured by either cash or the first lien of real estate. So in terms of credit risk it’s actually very high quality.


Your next question comes from Aaron Deer – Sandler O’Neill & Partners.

Aaron Deer - Sandler O'Neill & Partners

I just wondered if I could get some more color on this $28.0 million delinquent C&I loan. What industry is that in and can you discuss how many loans you have at that size and on this one in particular is it held by multiple banks and are you the lead bank?

Thomas S. Wu

We are the only bank and it’s in the electronic industry, selling TVs to the domestic U.S. market and also to the Mexico market. We believe there might be a potential for fraud so that’s why we suspended the line and actually we appointed a receiver and an appraiser to evaluate its receivable and also the inventories to evaluate where we are.

We have very little of our commercial C&I in this size category.

Aaron Deer - Sandler O'Neill & Partners

And the substantial growth in the C&I in the quarter, can you give some color on that in terms of where you saw the strongest growth and do you see any risks in growing that so rapidly. It’s a big number this quarter.

Thomas S. Wu

Actually, if you look at the growth rate for this quarter, in the third quarter, it’s actually smaller than our first or second quarter growth. But we feel very comfortable with the growth because a majority of the growth actually comes from the Greater China region.

As I mentioned earlier, the risk in the Greater China region in the C&I sector is very different from what we’re doing here in the domestic U.S. market because almost the majority of those loans are in the SME category and the average loan size is between EUR $0.5 million to EUR $2.5 million. This is very small, well diversified and also well secured by real estate or cash in that area. So we feel very comfortable to continue growing that sector in that market.


Your next question comes from Ken Zerbe – Morgan Stanley.

Ken Zerbe – Morgan Stanley

In terms of the NIM compression that we saw during this quarter, can you quantify how much of that came from the Fed cuts earlier in the year versus the interest accrual reversals, and I guess to take it one step further, looking forward to fourth quarter, if you are expecting flat NIM, should we assume a somewhat similar level of interest accrual reversals?

Thomas S. Wu

If you look at our deposit costs in the third quarter compared to the second quarter we managed to actually lower our total deposit cost in the third quarter. That’s a very big task in a very challenging deposit gathering environment. The yield of the interest income on the loan side actually came down because of the reversal on the interest income accrued on the non-accrual loans, which is equivalent to 18 basis points.

Had we not had to do the reversal on the non-accrual loans, in fact, the margin would have improved compared to the second quarter. So what we anticipate in the fourth quarter will be a flat or maybe 5 basis points to 10 basis points, it really depends on the rate cuts determined by the Fed. Otherwise I think it will be a pretty stable quarter in terms of NIM in the fourth quarter and also the first quarter of next year.

Ken Zerbe – Morgan Stanley

Just in terms of the tax benefit that you get, I understand how you get sort of a stable level of tax credits each quarter, which probably shows up more when your income is lower, but why did it stand out so much this quarter when you also had low pre-tax income in the last couple of quarters as well. What was the difference now versus period previously.

Craig S. On

It’s basically just the federal tax benefit as well as just the benefit from tax-exempt loans and we kind of look at the run rate through the whole year because when we actually go and recalculate where our effective tax rate needs to be, we constantly look at it on an annualized basis. So what’s happening is just the tax benefit on what we call our permanent items in the third quarter had a greater impact and created that larger tax benefit.

We’ve got a very nice benefit coming from our municipal bonds. The benefit from that is just a tad around $4.0 million and then low-income housing tax credits are about $2.0 million so those are the biggest components of what’s driving the tax benefit, both for the quarter and then for the year, too.

Ken Zerbe – Morgan Stanley

But wouldn’t that have had a benefit in the first quarter and second quarter as well?

Craig S. On

We had some but having the net loss really exacerbated the situation, if you will. And again, under the APB 28 standards, you look at it in the period and then calculate it for the year and then true up during the quarter.


Your next question comes from Erika Penala – Merrill Lynch.

Erika Penala - Merrill Lynch

I just wanted to ask about your strategy for working out the non-conforming construction loan. Are you looking to dispose of these problems assets through loan sales? And if so, can you give us a sense of what the demand is like out there in the market for these projects and what the bid/ask spread is like?

Doug Mitchell

We have not changed our approach to how we are working these out. The things that we have said in some of the prior quarters is that we have a very beefed-up special assets group that is focused on the non-performers and they’re working on those every day. Part of that is a combination of both completing projects where appropriate, but also looking for loan sales where they can be made.

The one thing that we did not experience in the third quarter were existing note sales. So it’s hard for us to give an indication on bid/ask spreads when we don’t have transactions to really give a benchmark to.

There was weakening in the markets and I think that was evident in the lack of sales and it will remain to be seen when some of that liquidity comes back.

Thomas S. Wu

Actually it was going to happen, but all of a sudden at the end of the third quarter we saw what we saw in the turmoil in the markets. So it was a little bit delayed. So I think we might see some happen in the fourth quarter but I think, as Doug mentioned, the bid is hard to predict at this point. But we also might have, actually we have a very good piece on one of the problem assets, I think it’s a very high bid of about $0.80 or $0.90 on the dollar, too.

So it really depends on the project, it really depends on the location and things like that. So you can’t just use one metric to determine how do you evaluate the potential sale on all the projects. It really depends on locations and quality and the types of projects.

I was very encouraged, there was one bid that’s actually going to be closing probably sometime this quarter, that will be almost $0.90 on the dollar.

Erika Penala - Merrill Lynch

We’ve heard from some banks that they have gotten informal indications from their regulators that they would qualify for TARP. Have you gotten a similar informal thumbs-up from your regulators? And if not yet, have you gotten feedback from them as to whether or not the composition of a bank’s portfolio will have any weight on the recommendation to the Treasury?

Thomas S. Wu

We were approached by our primary regulator to see whether we would be interested in participation and I said yes. And as you know, right now the regulators are focusing on healthy banks, on the participation in this initial round. So we will be participating.


Your next question comes from Brett Rabatin – FTN Midwest Securities Corp.

Brett Rabatin - FTN Midwest Securities Corp.

On the deposits that you had the inflow/outflow in China, I was curious if you could give us any color on a) can you quantify what that change was with just what was going on in Hong Kong, and b) if you excluded that noise, what would the growth have been in the cored deposits in the mainland U.S.?

Thomas S. Wu

The mainland China operation continues to experience very good growth on deposit during the quarter, about 70% during the quarter. What we experienced in deposit runoff was in the Hong Kong operation.

The Hong Kong operation, as you know, we don’t have a retail operation, we just have a branch office in the office building. So a lot of deposits are actually coming from some larger depositors in Hong Kong and also from Taiwan. And these large depositors actually they are not focusing on the Hong Kong operation, but what we experience is that the media coverage in Hong Kong and Taiwan on U.S. financial institutions and also the conditions of the U.S. market was very negative, after the [inaudible] failure.

So what happened was, because this media coverage scared some of our customers and they wanted to take out some of their deposits. Not all of them. Some of the deposits, at our Hong Kong branch, during the third quarter, that’s why we experienced some runoff in the third quarter.

And the Hong Kong government actually kind of monitored it very carefully. That didn’t just happen to our Hong Kong branch, which is actually licensed under the Hong Kong Monetary Authority. And it happened to all the banks in Hong Kong. And that’s why very quickly they came out to guarantee all deposits with unlimited amounts for all the licensed banks in Hong Kong, including our branch in Hong Kong. So that actually stabilized our deposit situation in Hong Kong very quickly. And in fact, in the fourth quarter, once that announcement was made on October 14, our Hong Kong branch started to actually grow in deposits.

As far as domestic deposits are concerned, and we actually have a net increase of $150.0

Million during the third quarter, despite a very challenging environment in the third quarter, so we are very pleased with that.

Brett Rabatin - FTN Midwest Securities Corp.

I was just hoping to get quantified what the Hong Kong impact was. I don’t know if you have an approximate number of how that impacted the third quarter numbers.

Thomas S. Wu

We lost about close to $300.0 million in the third quarter but then we are gaining it back right now. So that’s why, with the net gain of $150.0 million domestic deposits we saw a little bit of a run off for the third quarter but I think our focus will continue to be on the domestic market in terms of mass market, deposit gathering effort, and we will go back to the existing customer in Hong Kong to gain back some of the deposits.


Your next question comes from James Abbott – Friedman, Billings, Ramsey & Co.

James Abbott - Friedman, Billings, Ramsey & Co.

I had a question on the reserve build. You mentioned in your prepared remarks that you anticipated building the reserve in the fourth quarter. I was wondering if you could give us your sense as to what you mean by that? Are you talking 5 basis points, 10 basis points, 20 basis points? And then also on the net charge-offs, I suspect it’s a big function of construction loans, but what is the carrying value today on a lot of your non-performing construction loans versus the original value? Maybe that will help us get a sense of where charge-offs might go in the fourth quarter.

Doug Mitchell

To start with your first question, regarding the reserves. The one thing that’s really difficult, with all the volatility in the market, is to really be particularly specific on how things are going to happen in the next few quarters. It makes it very challenging for us to give you an indication on timing of quarters and when provisions happen and therefore what the reserves end up being. But what we do anticipate is that we will continue to providing in excess of charge-offs in the coming quarters and that will result in a reserve build in the fourth quarter and potentially into the beginning of 2009.

The reserve levels regarding the loans that are non-performers relative to the charge-offs is maybe the best way to give you some color on your second question. For the loans that we have that are non-performers and where we are applying actual specific reserves, each loan is very unique and very specific so I can give you an average of how the reserves apply to those loans, but it’s going to be hard to really appreciate because some of them may have loan reserve amounts because the collateral is very strong and some may represent weak projects that have much stronger and higher reserve levels, I should say.

But on average I think we’re about 25% to 30% on those specific loans that we have reserves.

James Abbott - Friedman, Billings, Ramsey & Co.

And that is reserved relative to the current carrying value as opposed to the original value of the loan, which has been charged down presumably by now. Am I understanding that correctly?

Doug Mitchell

Yes, that is correct.

James Abbott - Friedman, Billings, Ramsey & Co.

So right now you are assuming another roughly 25% net charge-off out of the existing construction non-performing loan portfolio, or at least that’s where you’re setting yourself up or preparing yourself for the scenario. But how much has the portfolio been charged down life-to-date, if you could? Any idea? Also another 25%, or more?

Doug Mitchell

I don’t have the map in front of me and I can get back to you off line on some of this stuff but the reality is that our charge-offs over the prior quarters were predominantly driven out of our residential construction portfolio, so if I take a look at what our portfolio sizes are and I add up the charge-offs that we’ve incurred, that’s going to give you a good idea of what we have taken to date on the particular portfolio.

Again, I think the charges associated with construction portfolios that we have that are in our portfolio right now that are non-performers, is going to vary, which does make it hard to estimate in the future quarters, but we do see additional pressure on these things and expect that, from our information today, that our reserves levels are appropriate for what we have in non-performers.

Thomas S. Wu

May I also add some color? Starting from the second quarter, we actually used data points in such a way that we look at our construction portfolio on a weekly basis and to compare with recent home sales price, recent appraisal price, and we kind of use that to model our existing portfolio in such a way that we make sure that every single project, we are comfortable with the value. If it actually comes down then we will put the provision to make sure that we have all the projects on hand that are non-performers are appropriately provided in terms of level reserve at any moment in time.

So our methodology right now is pretty current in terms of provisioning. That should give everybody a high level of comfort in terms of our current provisioning level.

James Abbott - Friedman, Billings, Ramsey & Co.

What is the reserve on performing or pass-grade loans? What’s your ratio on that? I’m just trying to isolate how much of the reserve is set aside for non-performing stuff and watch list items versus pass-grade loans?

Doug Mitchell

In aggregate, outside of the non-performers, we have about $32.0 million reserved against the portfolio.

James Abbott - Friedman, Billings, Ramsey & Co.

Tommy, you mentioned you had a bid for $0.90 on the $1.00 for a particular project. Was that $0.90 relative to your current carrying value or $0.90 relative to the original loan amount?

Thomas S. Wu

Original loan amount.


Your next question comes from Frederick Cannon - Keefe, Bruyette & Woods.

Frederick Cannon - Keefe, Bruyette & Woods

I was interested in your comment about the Hong Kong, when they guaranteed all deposits and the turnaround you saw. I was wondering if you have seen anything similar with the U.S. decision to go to $250,000 and guarantee [inaudible] if you have seen an immediate effect from that or not and how do you think deposit pricing will play itself out over the coming weeks.

Thomas S. Wu

Actually the increase to $250,000 is very helpful for community banks. And also we participate in that program so they are guaranteeing all the deposits on interest bearing checking accounts for all the above $250,000. That will also be helpful for community banks.

We are seeing actually quite a bit of decrease on deposit rates in the last two weeks. After Washington Mutual was taken over by JP Morgan Chase. So actually deposit pricing has come down almost 75 basis points in the market right now. So that’s a very positive sign.

And the competitive pressure is not as big as what we experienced in the first part or second part of the first quarter. So in the fourth quarter what we will see is less competitive pressure but I think banks are still focusing on innovating deposits to fund their loan growth so I think that will continue.

The good news is the rate is actually going to come quite significantly in the fourth quarter.


Your next question comes from Lana Chan - BMO Capital Markets.

Lana Chan - BMO Capital Markets

I have a follow-up question to the reserve answer you just gave to James’ question. When I look at the loan loss reserve as a percent of total loans, that’s building pretty nicely. But the reserve to non-performing loan ratio is fairly low relative to the industry averages. And if you are building in 25% to 35% reserves on the residential construction loans, it doesn’t seem like there is a lot of cushion in there for other potential problems. Kind of like the C&I loan that came up, this $28.0 million loan, you reserved $4.0 million for it, but if it’s a fraud credit it could potentially be higher losses than that.

Thomas S. Wu

First of all, we have to look at the loan loss reserve on the non-performing loans in different perspective from different banks because the majority of our non-performing assets are actually secured by first lien on the real estate. So that’s a value there. So we actually provide allowance on reserve on each particular loan. We look at a current market value, and versus the outstanding. And we make a provision on any short force or we make a bigger provision for the portfolio as a whole, depending on the economic environment.

So you really have to look at the portfolio in such a way that, okay, if there is a majority of commercial business loans, then you are talking different numbers. But right now the majority of the problem assets is in the real estate loans so we have the value on the assets. That’s why we feel very comfortable with the coverage ratio.

And also the commercial reserve on the pass-grade, we have almost $40.0 million reserve on the commercial business loans. So we have a very high loan loss factor for C&I loans, that’s what we’ve been doing. And that will continue. And also this quarter, we applied a 5 basis point across the board on our pass-construction portfolio just because of the economy. That’s why we will continue to build the reserve as appropriate, depending on the economy, depending on the trend, and depending of the uniqueness of each loan and of the portfolio.

So that’s why we feel very comfortable with the current ratio.


Your next question comes from Joe Morford - RBC Capital Markets.

Joe Morford - RBC Capital Markets

Again, on this $28.0 million C&I credit, I was kind of unclear in terms of the resolution process and what kind of loss potential there might be on this credit?

Thomas S. Wu

Well, we provided $4.0 million in this quarter for this particular credit. Now just because we don’t know. It will take some time to go through the evaluation process and receiver process because of the potential fraud we have identified. So it will take a little time but for whatever we don’t know we always make some quick provision in the third quarter. If we see something actually negative, then we will provide more in the fourth quarter.

Joe Morford - RBC Capital Markets

And then if you could kind of give us a general update of how the credit trends have been in the New York region in the past quarter.

Thomas S. Wu

Actually the New York region continues to hold up very well. Of course, we see some softening in the market in New York because of massive layoffs on Wall Street. But that doesn’t really affect our target markets because as you know the majority of our projects in New York is really in the ethnic Chinese areas in New York, like Flushing and some areas of Brooklyn. And also in Chinatown. Those economies have not been affected by what’s going on in Main Street and Wall Street.

So we see it pretty stable in terms of the market in New York. We have not seen any negative trend at this point on our portfolio but we will continue to monitor it very closely because of what’s going on on Wall Street every single day.


Your next question comes from Raymond Chung – Biondo Group,

Raymond Chung – Biondo Group

My question is a follow-up to the reserve question as well. I just wanted to get some clarification on that. Basically you are taking everything asset by asset and if you feel the asset is in good shape you are not going to take a reserve on it?

Thomas S. Wu

No. That’s a general step applied to any loan outstanding. So we have a very, I would say, sophisticated loan risk rating system. Every single loan is being rated and graded. So on each type of loan, on each grade, we have a loan loss factor to be applicable to outstanding. So this is something that I think the regulators are very pleased with what we have developed in the loan risk rating system. And that will help us to make a very accurate determination on the level of allowance, from day to day, month to month, and quarter to quarter.

That will continue to help us in determining the loan loss factors and the loan loss reserve.

Raymond Chung – Biondo Group

So if the value of the asset falls, then something needs to be taken care of then, right?

Thomas S. Wu

When any value on the particular loan, on its project, falls, then we make provisions right away.

Raymond Chung – Biondo Group

How does that balance off the fact that should people with these loans go delinquent as well, how do you account for the fact if people are late on their payments? How do you factor that as a percentage?

Thomas S. Wu

I’m not sure I understand your question. Can you repeat your question?

Raymond Chung – Biondo Group

How do you decide how to mark things down when people are 90 days delinquent? How do you decide how much reserve you should account for that?

Doug Mitchell

The process that we go through is we have what I would characterize as a real time risk rating process where we evaluate our credits and grade them on a scale. As we monitor them and track things like in the credit metrics like the delinquencies, that would definitely be a factor that comes into this. Depending on the different loan types, the assessment will be different, whether there’s different hard collateral, like in a real estate loan, or depending if we’re talking about a commercial loan.

So as we monitor delinquencies and get concerned about credit pressures, then we would go through that evaluation, assess the collateral support that is associated with the loans, and then that ultimately determines what sort of reserving we take.

As we go down through a migrating credit from better to worse, it eventually gets to a point where it’s a very specific analysis. We move from a general reserve to a loan-specific analysis where we do all this very detailed analysis.

Craig S. On

We have been and continue to follow the accounting standard under FASB 114, so what Doug has said, in terms of just the process we have, where we funnel everything down based on risk ratings and then to the extent that we get information that might indicate that we have a specific impaired loan, we will put those into the FAS 114 category, which we do very timely. That is a basic underpinning of our methodology.

From just a critical component standpoint, and you may want to, in terms of analyzing that, and maybe Lana, if you’re still on the phone, this is a component you may want to look at, but our FAS 114, the total loans that we had as of September 30, 2008, was about $325.6 million. Total specific valuation allowance on these loans amounted to $27.1 million, or if you wanted to put that in a percentage basis, 8.3%, which I think gets to Tommy’s comment that a lot of our loans are very adequately secured. So that really protects against loss content.

So from an accounting standard and you will see it when we file our 10-Q, you might be able to get a better handle on how that all works. Hopefully that’s helpful.

Raymond Chung – Biondo Group

It is. I think a lot of people are concerned that why not be more conservative, why not reserve more.

Thomas S. Wu

I think, to counter your comment, I think we have been quite conservative in the provisioning, and so far, as you can see the trend, we always actually overprovide against our losses. We will continue to build. But at the same you have to acknowledge the fact that from where we were in terms of the allowance percentage to where we are today, we have built a lot of reserve in the last three or four quarters.

Craig S. On

And please also note that the reserves, particularly the FAS 114s, are after our charge-offs. So our basic philosophy is to charge-off when we feel that we need to do so. So those balances that I cited just a couple of minutes ago are net of charge-offs that we’ve taken.


Your next question is a follow-up from Erika Penala – Merrill Lynch.

Erika Penala – Merrill Lynch

Can I have the loan and deposit balances as of September 30, 2008, for the Greater China arm?

Thomas S. Wu

We don’t that reporting here.


Your next question is a follow-up from Andrea Jao – Barclays.

Andrea Jao – Barclays

Would you already have the tax benefit, the specific number, for [inaudible] benefit next quarter? And then, excluding that, as the contribution of China starts to grow, how should we think about the tax rate going forward?

Craig S. On

I thought I had addressed this in the presentation but I probably need to add a little bit more color. For the GSE other than temporary impairment, please keep in mind that it is an unrealized loss for tax purposes. Because of our tax planning and built-in gains on our perceived ability to utilize the losses, we actually provided benefit in Q3 for the OTTI write-off. That is, we are not deferring recognition of the income tax benefit to Q4. We had the loss, if you will, characterized as a capital loss because we fully anticipate being able to absorb it, but because of the tax situation allowing us to treat this as an ordinary loss, we will, in essence, recharacterize, or shift this to an ordinary loss in Q4. So there really won’t be any bumpiness or lumpiness as we move into Q4.

Does that kind of get after your question?

Andrea Jao – Barclay’s

Now given that, what is the normal tax rate?

Thomas S. Wu

Do you mean for Q4?

Andrea Jao – Barclay’s

If you have an indication that would be great, but also through 2009 because China should make a bigger contribution and their tax rate is lower, no?

Craig S. On

That is correct. Under the APB 28 we look at the lightly taxing of China. Just in terms of what we’re looking for in Q4 really depends on the level of our pre-tax income. To the extent that it is a reasonable number, we will need to provide, but we still have tax benefit that we fully anticipate taking. That’s kind of the run rate on our permanent items. My best guess, because it is really hard to determine an effective rate for the full year of 2008, but I would think, if I had to throw out a range, I think it’s going to be more like single digits but 8% to 12% would be a reasonable effective range, depending on where we come out on pre-tax income.

In terms of what we’re looking at right now, which does include our best guess on growth at UCB China Ltd., we’re looking at an effective tax rate for 2009 of between 25% to 30%.

Andrea Jao – Barclay’s

Another thing, how much is the foreign exchange translation impact this quarter? And correct me if I’m wrong, I thought I heard you say it is included in non-interest income?

Craig S. On

That is correct. You know, we came out like a race horse coming out of the gate at the beginning of the year, but because of the dollar strengthening against the RMB, things have started to slow down. Just to give you some color, the total cumulative translation, FX translation gain, through the nine months is about $3.5 million. It slowed down quite a bit. I would say there was incremental benefit in Q3. The most of the tax benefit came through in the first two quarters of this year.

Andrea Jao – Barclay’s

And this impact is non-interest income. Because if I’m not mistaken, previously it was in expenses.

Craig S. On

That is correct.

Andrea Jao – Barclay’s

And we will get a breakdown in the 10-Q, I guess.

Craig S. On

Yes, you will.


Your next question comes from Donald Worthington - Howe Barnes Hoefer & Arnett Inc.

Donald Worthington - Howe Barnes Hoefer & Arnett Inc.

In terms of your CDs, I’m just looking in terms of the press release, $5.6 billion in total CDs. How much would you, just a general breakdown between retail and wholesale on that?

Thomas S. Wu

I would say the majority of our CDs are retail.

Donald Worthington - Howe Barnes Hoefer & Arnett Inc.

In terms of just access to liquidity, have you set up a borrowing line with the Fed?

Thomas S. Wu

Yes, we have a very big line with the Fed, Federal Home Loan Bank. In terms of liquidity, as of October 20, 2008, the unused liquidity line was about $3.2 billion.


There are no further questions.

Thomas S. Wu

Thank you again for participating in this call. If you have any questions please call Craig On, Doug Mitchell, or myself. We appreciate it.


This concludes today’s conference call.

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