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Executives

Irene Oh – SVP of Corporate Finance

Dominic Ng – Chairman, President and CEO

Tom Tolda – EVP and CFO

Analysts

Joe Morford – RBC Capital Markets

Aaron Deer – Sandler O’Neill

James Abbott – FBR Capital Markets

Lana Chan – BMO Capital Markets

Erika Penala – Bank of America-Merrill Lynch

Juliana Balicka – KBW

Joe Gladue – B. Riley

James Abbott – FBR Capital Markets

East West Bancorp, Inc. (EWBC) Q4 2008 Earnings Call Transcript January 28, 2009 11:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2008 East West Bancorp earnings conference call. My name is Eric; I’ll be your coordinator for today. Now, at this time, all participants are in a listen-only mode. We’ll facilitate the question-and-answer session at the end of the presentation.

(Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn your presentation over to Ms. Irene Oh, Senior Vice President. Please proceed.

Irene Oh

Good morning, everyone, and thank you for joining us to review the financial details of East West Bancorp for the fourth quarter of 2008. In a moment, Dominic Ng, our Chairman, President, and Chief Executive Officer, will provide highlights for the quarter; then Tom Tolda, our Executive Vice President and Chief Financial Officer, will review the financials. We will then open the call to questions.

First, I would like to caution participants that during the course of the conference call today, management may make projections or other forward-looking statements regarding events or future financial performance of the company within the meaning of the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995. We wish to caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties. For a more detailed description of factors that affect the company's operating results, we refer to you our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2007.

Today's call is also being recorded and will be available in replay format at www.eastwestbank.com and www.streetevents.com. I will now turn the call over to Dominic.

Dominic Ng

Thank you, Irene. Good morning and thank you for joining us on today’s call.

Yesterday afternoon, we announced financial results for the fourth quarter of 2008 and reported net income of $2.4 million. Earnings for the quarter were again negatively impacted by a heightened provision for loan losses of $43 million, additional other than temporary impairments, in short OTTI, of $9.7 million, and a decrease in overall net interest income resulting from the recent unprecedent decreases in interest rates. We expect 2009 will be another challenging year and have positioned East West well to meet the difficult operating environment in the industry.

In our 36 years history, East West has weathered all kinds of economic storms and has repeatedly emerged a stronger, more focused institution, ready to seek new opportunities. Our sound fundamentals, conservative management philosophy, and focus on core operating strengths remained unchanged. The current economic cycle would eventually give way to growth and expansion and we are well positioned to capture new market share and continue delivering long-term shareholder value. Tom will discuss the results of our fourth quarter earnings in greater depth later in the call.

First, I would like to provide an overview of the objectives that we achieved during the full year 2008 and for the fourth quarter. Additionally, I would like to share with you the actions we have taken to strengthen our balance sheet and improve profitability and the steps we are taking to lead East West through this challenging economic cycle.

Throughout 2008, East West focused on one mission, which was to protect the interest of our shareholders and customers for the long term. We achieved this goal by taking decisive actions to strengthen capital, liquidity, and reserves. We did not lose sight of our disciplined focus on doing what was right for the organization, our shareholders, and our customers.

The short-term uncertainty amidst the volatility in the financial markets did not eclipse our long-term vision. We dealt with problem loans head on and significantly decreased exposures to our most troubled assets through early identification and review of our loan portfolio. We launch and promote deposit program that provides our customers with 100% assurance of safety during this time of instability and uncertainty. Additionally, in the second half of 2008, East West meaningfully lowered cost, decreasing non-interest expense each and every quarter. As a result, East West has meaningfully strengthened the balance sheet, increased operating efficiency, and is well-positioned for 2009.

On the liquidity front, our total borrowing capacity in cash as of December 31, 2008, increased to a record of $3.3 billion, 27% of total assets and 41% of total deposits. This is a $2.2 billion or 196% increase from total borrowing capacity and cash levels a year ago. Our available borrowing capacity comes from diverse resources including Federal Reserve, repurchase agreements, and Fed fund facilities with various financial institutions and the Federal Home Loan Bank.

Historically, East West Bank has been very well-capitalized and continues to be well-capitalized with year-end total risk-based capital of 15.83% or over $600 million above the well-capitalized threshold. Through the convertible preferred stock option in April 2008, we’ve raised $200 million in capital. We raised $306.5 million capital again in December through the preferred stock investment we received from the US Treasury’s Capital Purchase Program. So, at December 31, 2008, all our repertory capital levels were substantially above well-capitalized minimum levels. Our tangible equity to tangible assets ratio is 9.88%, up from 6.95% at the start of the year.

Now, I would like to briefly discuss each of our loan portfolios and what actions we have taken and are continuing to take to minimize problem credits. In early 2008, we were the first amongst our peers to order 100% new appraisals for all of our land, residential construction, and commercial construction loans. Of course, in early 2008, the unprecedent challenges that will face the entire financial community later in the year were not yet known. However, we fully understood that the proactive, early identification and resolution of problem assets was the best way to help us navigate through a challenging economic environment. We believe this early identification of problem loans and potential future problem loans has enabled East West to get a head start over all our peers and will enable us to resolve our problem assets sooner and with substantially less risk and ultimate losses.

Year-to-date, we lowered total commitments on land and construction loans by $1 billion. We decreased land loan exposure by $105 million and construction loan commitments by $908 million. Overall, we have significantly lowered our exposure to land and residential construction loans, our most risk asset class. I would also like to point out that we are not only rationing down our land and residential construction loan balances at a fast clip.

Throughout the year, we have strategized and worked with our borrowers to develop individual plans to improve loan structures and our collateral position. We have shored up a significant number of loans by obtaining additional collaterals such as cash, deed of trust on residential and commercial real estates, and other investment securities. Additionally, we have obtained cash down payment or pay downs on numerous loans to achieve better loan-to-value that meet our current underwriting guidelines. For many borrowers who were struggling and cashrupt, we work side by side with them to improve the liquidity and their ability to withstand this economic downturn.

We will remain committed to this proactive strategy for management problem loans throughout 2009. We continue to be disciplined in our loan review process, which includes weekly meetings with all senior management and lenders. We believe that our diligent and effective asset resolution is a direct reason why problem loans have not accelerated at a more rapid pace in this troubling credit environment. At this point, we have not experienced significant contagion [ph] of credit deterioration in other asset categories.

Given the economic situation, we believe that delinquencies and ultimate losses are likely to increase for other asset classes beyond land and construction and are carefully monitoring all portfolios. Recently, there have been many forecasts and speculation on what may happen to the income-producing commercial real estate market. While we have experienced a small uptick in the delinquency in our CRE portfolio, we have not seen any significant stress factor such as material charge-offs or non-performing assets. In fact, in the fourth quarter, commercial real estate charge-offs were only $750,000 out of the $3.5 billion portfolio. Throughout 2008, we carefully monitored this portfolio and will continue to do so this year.

For the residential real estate portfolio comprised of single family and multi-family loans, delinquent and non-performing loans have increased during the quarter as the downturn in the economy continued. As of December 31, 2008, total non-performing single family and multi-family loans worth $32 million, an increase from $20 million at September 30, 2008 and $21 million at June 30, 2008.

We continue to proactively contact, help and work with customers in order to mitigate losses. At the same time, we remain committed to our customers and are diligently working with them to modify and structure loans to allow them to stay in their homes during this period of heightened unemployment and economic downturn. As many of you have heard me say in the past, I believe that C&I loans may prove to be problematic for many banks as the recessionary economy continues. We started an active 100% review of our C&I and trade finance loans in late 2007.

Last year, we continued to pare down C&I and trade finance loans, reducing exposure to borrowers and industries we believe would have more difficulty withstanding a longer downturn in the economy as we prepare for a more severe recession in 2009. This active reduction in exposure to borrowers that we believe will see future problems is the predominant reason for the decrease in both balance and commitment with C&I and trade finance loans.

Year-to-date, the total balance of C&I and trade finance loans have decreased $252 million. The relatively low level of delinquency and non-performing C&I and trade finance loans is a direct result of this intensive scrutiny. In fact, total delinquency in C&I loans have increased only $1.3 million from the second quarter and trade financial loan delinquency are essentially non-existent at $439,000. Charge-off on C&I and trade finance loans were elevated in 2008 as we aggressively wrote down loans we believed to be impaired.

Unfortunately, further deterioration of the economy in the fourth quarter made the disposal of problem assets more challenging than ever before. During the quarter, we sold 32 REO assets and problem loans with a carrying of $48.9 million. While this is a decline in the sale volume compared to the third quarter where we sold a total of $86.4 million, we believe our disciplined approach enabled us to find viable solution in an increasingly unstable market. In fact, seasonal factors such as holidays like Christmas and Thanksgiving, and the announcement of the TARP program also contributed to the slowdown in the fourth quarter.

Starting this year, we will continue to diligently work through the loan portfolio. Along with our aggressive efforts to reduce loan delinquencies and problem assets, we are continuing to build and maintain reserve levels that we believe appropriately reflect the potential risk in our portfolio and the overall credit environment. We started prudently building the allowance for loan losses one year ago, at the very start of the economic downturn. Quarter after quarter, we continued to appropriately increase the allowance for loan losses which totaled 2.16% as of year end. We have maintained this elevated reserve level while consistently charged off loans throughout 2008. Net charge-off for the fourth quarter totaled $41.5 million compared to $39.7 million last quarter.

Now, I would like to spend a few moments and discuss what we have done on the deposit front in 2008. Quarter-to-date, core deposits increased to $3.4 billion, a $191 million or 6% increase. Time deposit increased to $4.7 billion, a $414 million or 10% increase quarter-to-date. Year-to-date total deposit increased to $8.1 billion, $863 million or 12% increase from last year.

Starting in the third quarter of 2008, with the ongoing instability in the global banking industry, we focus on products that would best meet the needs of our customers. We actively promote two deposit programs that provide customers with enhanced multi-million dollar FDIC insurance on both money market accounts and time deposits. Although East West is very strong financially with strong capital and liquidity levels, we believed providing and promoting these programs to our customers was appropriate during this time of great depositor and investor uncertainty. We wanted to ensure that our customers obtained 100% assurance and protection for the deposits. Additionally, these measures we have taken to look out for the best interest of our customers has served us well, as the strong relationship we have with our customers have been further strengthened.

By the way, these deposit programs are categorized as broker deposits under the call report [ph] repertory reporting guidelines. However, I wanted to clarify that these are not broker deposits and are true long-term East West bank customer deposit with ties to the bank that are stronger and stickier than ever. With elevated capital levels, strong liquidity and healthy loan loss reserve, we are well positioned to prudently expand our lending capabilities to our credit worthy customers. In fact, we have increased loan origination in the fourth quarter in a careful manner. Our new loans origination in the fourth quarter totaled $326.8 million, 38% or $89.6 million increase from new loan origination in the third quarter. This year, we plan to continue to provide loans to credit worthy customers and small business owners who are in need and are critical to bringing back economic vitality to the communities that we serve.

On a final note, I would like to discuss our current expectations for 2009. We currently project loan growth in 2009 of 11% and deposit growth of 5%. Given the current forward rate curve, we expect that the net interest margin for 2009 will be approximately 3.2%. We anticipate that full-year 2009 non-interest expense will decline moderately from 2008 as we continue to carefully monitor all expenditures. Additionally, we currently expect that the provision for loan losses for the first quarter of 2009 will approximate $40 million.

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

Tom Tolda

Thanks very much, Dominic, and good morning, everyone.

I would like to start with the summary of our financial results to begin with the more significant changes to the balance sheet this year. Throughout 2008, you heard us say that we were focused on ensuring strong capital, strong liquidity and strong loan loss reserves. In large part, we were successful in this.

In April, we were among the first banks to raise capital with our convertible preferred issue raising $200 million. We followed this in December with the addition of $306.5 million in TARP capital. These actions brought our total risk-based capital ratio to 15.83% and we grew our tangible capital ratio to 9.88%.

To put it in another perspective from year-end December 2007, we grew stockholders' equity 32% to $1.6 billion. At the same time we were building capital, we were also reducing our total borrowings. We reduced borrowings $653 million or 20%. Our allowance for loan losses increased to $178 million or 2.16 of total loans.

In terms of the deposits, we hold our own deposit growth despite a very competitive market environment. Deposits increased $863 million or 12% year-over-year. Our stated goal at the start of 2008 to deleverage the balance sheet as measured by our loan-to-deposit ratio was accomplished as we’ve reduced this from the 122% at December 31, 2007 to 101% by end of the year 2008. Given the deleverage activity and additional liquidity brought on through loan payoffs, higher deposits, added capital, our overall investment securities portfolio and cash equivalents grew $1.1 billion to $3.3 billion. This portfolio is well diversified among the highest-rated investment grade securities that include MBS, agency bonds, corporate bonds, money market mutual funds, and other smaller concentrations of securities with relatively shorter term and high credit quality.

As we closed out 2008, we believe the balance sheet has been significantly fortified with borrowing capacity and cash substantially increased to $3.3 billion, $2.2 billion greater than a year ago. This capacity provides added support to deal with a higher level of market uncertainty than ever before.

Turning to the P&L, no doubt earnings were hard to come by in 2008 and it looks like we had a lot of company in this regard. We were quick to deal with the emerging credit risk in our portfolio and substantially increased loan loss reserves in first and second quarter of 2008. From the fourth quarter earnings announcements, it looks like others are now either recognizing their issues or starting to catch up. Provision for loan losses in 2008 cost $226 million full year. Distressed capital markets brought us a heavy dose of other than temporary impairment on securities starting with the write-down of $47 million in Fannie and Freddie preferred stock in the third quarter, followed by impairment of our pooled trust preferred securities that cost $17.8 million full year. As if these weren’t enough, margins were squeezed as the Fed decreased rates an unprecedented 400 basis points during the course of 2008. As a result of the above, East West Bank reported a net loss for the year of $49.7 million.

Let me turn to the fourth quarter for a moment. During the quarter, East West Bank earned $2.4 million net income after absorbing $43 million provision for loan loss and $9.7 million of OTTI. The EPS impacted of $43 million provision was $0.68 per share for the fourth quarter. The impairment loss we incurred in our pooled trust preferred securities remains a function of inactive market and it has exposed the overall negative market conditions for banks which have continued to adversely impact the fair value of these pooled trust preferred securities. All of the pooled trust preferred securities we own continue to have adequate collateral support to generate sufficient cash flows to make all payments. We continue to monitor the credit ratings on these securities, the amount of deferrals and defaults within these pools; we perform our own credit assessments of the banks included in these pools and the time we anticipate to recover all of the cash flows generated from these securities.

Net interest income for the quarter was $76.9 million, reflecting a net interest margin of 2.72% versus 3.10% in the third quarter. We expected a spread decrease from third quarter, yet the Fed went deeper than we expected with their 175-basis-point decrease in Fed funds for the quarter. 31% of our loan portfolio immediately reprised downward after the Fed fund changes while deposit reprising lags. We anticipate coring back our net interest margins in 2009. Some of this will come from new loan origination, some from renewal of existing loans, some from shortening up a bit on our deposits, and some will come from higher yields on the liquidity we have built up. During the quarter, we reduced borrowings primarily from FHLB by $184 million. The pay down of these higher cost borrowings in fourth quarter and more planned in 2009 should also help to improve the net interest margins as we go forward.

As expected, non-interest expenses for the fourth quarter decreased to $44.2 million, reflecting operating efficiency of 47.5% in the quarter. Generally speaking, this should still be among the better ratios in our industry. We will be continuing to focus on cost management in 2009 as we anticipate that there will be additional credit cycle cost including legal, consulting and real estate-owned expenses that will be incurred as the downturn in the economy continues. Opportunities are still present with regard to some of our infrastructure, improved vendor management and net attrition. Fourth quarter non-interest expenses decreased $4.3 million from third quarter, $11.5 million from second quarter and $8.7 million from the first quarter. This reduction in expenditures has come largely through attrition, reduction of incentives, and other compensation-related expenses.

As stated in the earnings and dividend announcement released yesterday, the Board of Directors declared a dividend of $0.02 per share for the first quarter of 2009, down from the $0.10 we were paying previously. We fully understand that the dividend is an important part of the total return to shareholders and investors. Despite our very strong capital levels, we felt that in this period of economic uncertainty, we felt that it was both a responsible and prudent decision to reduce the payout and preserve capital at this time.

In sum, and as Dominic mentioned, we head into 2009 with the winds still at our face. Risk management is still at the forefront of what we are doing. In 2009, we will continue to focus on credit, loan and deposit pricing, growing our deposit base, and expense management.

I will now turn it back to Dominic.

Dominic Ng

Thank you, Tom. Now, I would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Joe Morford with RBC Capital Markets. Please proceed.

Joe Morford – RBC Capital Markets

Thanks. Good morning, everyone.

Dominic Ng

Good morning.

Joe Morford – RBC Capital Markets

I guess – a couple of questions. First, with the sales you made of residential construction land, NPLs and REO this quarter, what kind of bids did you see versus original loan amount, and how did they compare versus where you’d written them down to?

Dominic Ng

They all vary. We compare to the carrying value rather than the original loan amount simply because we have provide, either charge-off or provide reserve, specific reserve to these loans and that’s the amount that we look at. I think they vary from a pretty wide range, but in average, Irene, you have any kind of average number at this point? 10% to 15%, is it, Tom, or –?

Tom Tolda

Probably, that’s correct.

Dominic Ng

Okay.

Tom Tolda

Roughly 15% to 20% and, of course, it does vary.

Dominic Ng

Yes. Some of them, we actually have par, some of them below, significantly below; and then it all depends on specific assets. What we have, the situation that a borrower that may be in a bankruptcy, they’re a little bit more challenging, then we’re more willing to sort of let it go for a little bit bigger discount because we do not want to take on to that task. Then there are others who seem to be a little bit simpler, we get a pretty good price.

Joe Morford – RBC Capital Markets

Right. Okay. That’s helpful. I guess, the other question was just did interest reversals contribute much to the decrease in the margin this quarter? And in getting to the 320 average you’re projecting for 2009, what kind of progression do you expect throughout the year of this 270 base?

Tom Tolda

Yes, Joe, the interest reversals cost us about 1.5 million if I recall correctly for the quarter. And then, going forward, I think a combination of the loan production, some shortening up on the deposits, higher yields from some of the liquidity that we’ve built up, that we’ve kept in a very liquid form and are now placing into higher-yielding securities, all should contribute to the margin improvement next year. We’re certainly not anticipating any further reduction, so all of that should work out for us.

Dominic Ng

Yes, because the loans – I mean, we do not see any more further reprising down.

Tom Tolda

Right.

Dominic Ng

Simply because it’s – for those that we adjust, we adjust it. And they are now Fed funded at 25 basis points, there really isn’t much to go down anymore. But the deposit side, we have, I mean, pretty significant opportunities because we did not go in and drop deposit even for many of our money market and other sort of like adjustable type of deposit accounts. We did not go in – intentionally, we did not go in and immediately do a big drop, and we want to do it gradually. And so, in that standpoint, one is to not to shock our deposit customers much in this environment, but on the other hand, gradually when we start lowering the interest rate for deposits which we assume that in the market anyway, we feel that there is going to be significant potential for us to pick up margin. And obviously on the loans, when we renew loans in today’s market environment, we are able to charge better pricing than we were a year ago. So all of that would add together to see a much more promising margin going forward.

Joe Morford – RBC Capital Markets

It sounds like with all those different factors, you shall start to see that increase beginning here in the first quarter?

Dominic Ng

Yes.

Joe Morford – RBC Capital Markets

Okay, great. Thanks you so much.

Operator

Your next question comes from the line of Aaron Deer with Sandler O’Neill. Please proceed.

Aaron Deer – Sandler O’Neill

Hi. Good morning, everyone.

Dominic Ng

Good morning.

Aaron Deer – Sandler O’Neill

I just got a couple of questions on the growth outlook. I guess, first, the 11% loan growth that seems just I guess pretty big expectations given the environment. What are your thoughts there in terms of what kind of production you are looking to do and what would be the timing of that there?

Dominic Ng

Mainly, they are single family, multi-family and commercial real estates. I would think that that will be the primary area. And also, we may look at affordable – these tax credit affordable housing deals. And the reason that we feel that we have some good opportunities there in these categories is I think that we had a little bit taste of that in the fourth quarter for jumbo, single family mortgages, the non-conforming at low loan to value which is the one that East West has been doing for years. The market really are very different in the last few months, and I would expect it to even continue to the next few months than it was, let say, a year or two ago. There is just not a whole lot of competition there, so we think that we can increase some volume there. And for multi-family, we also see some opportunities because big competitors like WaMu that way back like two years, three years ago, just ate our lunch – basically, we could not compete anywhere close to them in terms of terms and pricing – are not active in the market.

When we look at those factors, we think that there are opportunities for us to make some loans there. But more importantly – I think more important I want to emphasize that the primary factor that we can actually see this type of 10%, 11% growth is the prepayment has dropped dramatically in the last like six to nine months that we have seen, and I would expect that in the next 12 months prepayment would continue to be quite slow. Customers are just not actively out there looking to trade up single family homes; are looking to buy more apartment loans to do these 1031 exchange. We just do not see that much activities going on. I mean, the bad news is that that means that we do not have the kind of origination like we are happy for but the good news is that when loans are not paying up, if they are current, it actually makes the loan balance growth quite easy.

So as we pointed out in the fourth quarter, we only originated $326 million on loans, but in fact, it does help us to retain the balance at what we are. Because we have substantial pay down in land, construction, C&I loans, and trade finance loans that we sort of like continue to work them down to reduce exposure but we end up retaining the balance okay in the fourth quarter in terms of the loans simply because all the other asset categories are not reducing balance in the same rapid pace like it was back in 2005, 2006 and so forth, and we anticipate 2009 will be very, very similar and in fact, it maybe even slower in terms of pay down. And so, therefore, we feel comfortable at this stage that that growth projection is very doable.

Now, on the other hand, if five, six months from now markets change or the government stimulus package can provide certain guarantee results and all banks coming back up and they all start making loans again, it may change the factor. But in today’s environment, in a rough guess, we feel very confident this is very doable. But come next quarter, we will see what the world changes to and then we will give you the new update.

Aaron Deer – Sandler O’Neill

Okay. And then on the deposit side, your outlook there is considerably less. Can we at least expect to maybe see some improvement in the deposit mix? Have you set any goals for core deposits versus just continuing to see the CD balances grow?

Dominic Ng

I think that if you look at last year, our intention was to get our customers into these 100% FDIC insurance deposit. Frankly, at the beginning when we started this campaign, the only product that is available are CDs, it’s a seeders [ph] program CDs. And with that in mind, we actually help – guide most of our core customers that have significant money market account or put their money in an account and savings account and move their deposits into CDs. But the purpose of doing that is that the volatility of the market is so unpredictable and every two or three months something changes and then there are people who worry about – now, today’s money sender banks problem, like nine months ago was the savings and loans problem, so things just keep changing for investment banking problems.

We just don't want our customers every few months have to worry about that. We also do not want to have our deposits should be in a volatile situation. So, by putting all these customers that have deposits substantially higher than the $250,000, or way back then, it was really only $100,000 limit, we thought that keeping them in a very much peace of mind would allow us to not have as much volatility. So that is why you see that deposit shift to CDs. It’s an intentional move by East West because maybe from an investor standpoint, it may not look as good but this is a different time, it required different strategy. I look at it as save deposits that comfortably park their money at East West. Whatever category we call them, it is much better than depositors, it may be in a different category that look nice optically, but if customer worry about, do I need to move money and put it under my mattress and other kind of stuff, we do not want to have that to be any concern to East West going forward in 2009.

Now, so that being done, the campaign of getting low cost core deposit such as business checking account from small business owners and also continue to get more retail deposit in the checking account, savings account, it is just a given. I mean, we will continue to aggressively work on getting those accounts. However, also keep in mind is that while we feel that loan that we have at this stage, a little bit more growth than deposit is because it is much easier to get very creditworthy good loans with good pricing and actually very safe loans in the real estate side in today’s environment with a new appraisal, with a new market value for this real estate, with new borrowers with very strong liquidity, all of that will ensure us to get various strong safe loans with good pricing.

From a deposit end, it’s the other way around. Everybody in the world now wants to get deposits. Banks, big banks that used to have loan-to-deposit ratio at 150%, 160% are now feeling that maybe they need to get more deposits. Investment banks are coming into the market trying to get more deposits. And the FDIC assisted-type of banks are still out here aggressively getting more deposits. So in that kind of deposit environment, as much as East West is putting deposit as the number one priority.

In fact, if you look at our goal for this year, deposit is still the number one priority. We feel that the market maybe a little bit more challenging, and we do not want to put ourselves in a position to go out there, and when our competitors offer, let’s say, 2.9%, 2.8% and we go out and try to match it. And so, because we feel that with a 5% growth, if they have good core deposits, it’s still going to be a very nice organic movement, and without huge liquidity right now, we’re in a great position.

And therefore, there’s really no reason to go out there and trying to stretch to go to like 15% deposit growth, and then end up getting a bunch of deposits that are really non-core or maybe a bunch of deposits that have rates that are so high that ultimately would damage our margin and our overall safety and standards [ph], and that’s the approach that we’re taking.

Aaron Deer – Sandler O'Neill

Okay, that’s helpful. Thank you, guys.

Operator

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

James Abbott – FBR Capital Markets

Yes, hi.

Dominic Ng

Good morning.

James Abbott – FBR Capital Markets

At first, I thought I would ask a quick question on the reserve to net charge off ratio. And in the fourth quarter, it came close to or was that a one-time coverage, and just to reconcile that with your outlook on the first quarter’s provision level of $40 million, is that – do you anticipate $40 million of charge offs in the first quarter or do you anticipate building the reserve? And how do you look at the reserve to net charge off ratio?

Dominic Ng

I think what we do is that we have a relatively complex model. Actually, it’s a very good model. I think that outside, our auditor and regulators really like it. That model really dictate the numbers, so it’s really nothing that we can – there’s nothing we can comment on to see how allowances versus charge-off allowances versus provision and versus NPL and any of that. The model really covers everything in the standpoint of economic factors, classification of assets, charge off, historical charge-off, also our updater appraisals, specific reserve, general reserve due to economic environment, general reserve due to the type of loan category, reserve versus classification of substandard doubtful, and also indexation of market decline.

Obviously, we can offer – we cannot order new appraisal on a weekly basis, so what we do is that when the appraisal was completed recently, we just continued to have market indexation by zip code and by looking at what the decline at the market is, and we also look at the disposition when we start taking these problem loans into REO. And also, when we are selling these problem loans, when we’re doing this disposition, it is also a great indication of what the market value in general is going with this type of asset type or not. All of that will be taken in consideration, plug it into the model, and whatever the model spit out, we’ll take. And so, the numbers basically is pretty much – there’s a lot of thought put into it to make sure that it’s reasonable and we would (inaudible) to make sure that we adjust it timely to meet what the market condition is. However, it’s pretty much whatever comes out, comes out.

James Abbott – FBR Capital Markets

Okay. And so, in the $40 million provision outlook, is that mostly based on charge-off assessment within your portfolio or –?

Dominic Ng

No. I think right now is our rough guess and then saying that, well, at this moment, because obviously, without the NPA, without a lot of information as of March 31, 2009 to pluck into the model, to come up with what the provision is required, clearly this is a rough guess. Now, this is a gut call, so Tom and I and our Chief Credit Officer and a few other senior management together, when we start looking at a projection and say, “what do you think that would happen come first quarter?” To be a little bit more conservative and things like that. What we looked at is that this market is not going to get better. This market is only going to get worse in the first quarter. No matter what kind of great news are coming from even Washington DC, the reality is in the first quarter, we think that the market is going to get worse.

So, relatively speaking, although we are providing fully adequate reserve to cover all the problems that we have today, we just expect that there’s going to be either more problems that may potentially pop up or the existing reserve that we have covered, the existing problem credits may end up seeing further deterioration on the value of these assets that require us to put more provisions. And given all of that, we just say that, “You know what? I think we should expect similar level of provision just like the fourth quarter,” and that’s what we can do. I mean, it’s not, quite frankly, very scientific, but it’s a lot of experience among ourselves looking at this book on a daily basis and come to a conclusion that, well a rough guess, it’ll be somewhat in line like the fourth quarter.

James Abbott – FBR Capital Markets

Okay. Well, I guess, the way I was looking at it is that the number of non-performing loans or the dollar amount is substantially higher going into the first quarter, which it is for everyone. You’re not unique there, and so – and then the severity, the last given default ratios appear to be higher in the fourth quarter, and so that’s why I was trying to reconcile how the provision in the first quarter was going to be similar to the fourth quarter. Maybe it’s based on not a lot of loan sales in the first quarter versus a large amount of loan sales in the fourth quarter. I don’t know.

Tom Tolda

I was going to say, James, that just when we look at the delinquency quarter to quarter, we have a very modest tick-up in the overall delinquencies. Just from a roll rate perspective, it would certainly suggest that from provisioning standpoint, it would look much like fourth quarter of 2008, so I think that weighs in. I think the build up in the NPL, obviously when we are moving loans there, we are marking down to the appraised value at that point, so we’re not anticipating a lot more bleeding from those assets in the first quarter. So, all of that gives us a reasonable comfort with the estimate that we’ve put out there. We’re very sure, but we believe that that’s going to be the ballpark in which the provisions will settle in at.

Dominic Ng

Yes. I think that – let me emphasize what Tom just highlighted is that we maybe a little bit different than some of the other banks who are catching up now and are being surprised with more NPA. The fact is these NPA that popped up now, it was the same old loans that we identified as a problem back in June of 2008. If we mark them down to the appraised value, they just didn’t go bad at that time. We knew they were bad, they didn’t go bad, so now essentially we are hoping they wouldn't go bad. We are hoping that we were conservative that they wouldn’t go bad, but obviously every one of us know the economy got substantially worse for the last six months. So, some of these that look bad didn’t think that they would go bad, turn out they’re bad, but we already had the specific reserves set for these type of assets.

Now, so what we do, we are talking about the incremental losses that we take. It’s a little bit easier to take the incremental losses than a one-time catch-up for things that you’re not aware because this is what happened in the second quarter, where after the four appraisals all been done, we did the one-time catch-up and that resulted in over $80 million of provision. So, we – as long as there’s not any more new surprises that haunt us, we think that it should be okay. But again, this is – let me just emphasize again. This is just our gut check as of January 15, when we finalize the numbers in the middle – second week of January, so that’s a quick gut check. And come March 31, we’ll pluck in all the numbers and whatever comes out, comes out, and it will be what we know best at that point. But at this point, I would say that we feel comfortable with this provision.

James Abbott – FBR Capital Markets

Okay, that’s helpful. Thank you. I have others, but I’ll let – I’ll stop here at this point. Thank you.

Dominic Ng

Thank you.

Operator

Your next question comes from the line of Lana Chan with BMO Capital Markets. Please proceed.

Lana Chan – BMO Capital Markets

Hi, my first question on credit quality. There was some increase in NPAs on the commercial and commercial construction side, and I was wondering if you could give us more color on what drove the increase there? Was it some larger credits, some smaller credits, and what kind of industry and property types they were?

Irene Oh

Lana, sure. I’ll start with the increase that we have in the commercial real estate.

Lana Chan – BMO Capital Markets

Okay.

Dominic Ng

No, commercial construction.

Irene Oh

Commercial construction. Commercial construction, there were a few loans, a little bit larger. It was really primarily three loans; two located in the northern California area, one located in Inland Empire. There is really only one loan of those three where we feel that there may be some loss content. The other two, we have updated appraisals on all of them. Updated appraisals show that our loan-to-value even in this current economy is fine and that there’s no loss content for the commercial construction loans.

Lana Chan – BMO Capital Markets

Are they office properties or retail?

Irene Oh

Excuse me?

Lana Chan – BMO Capital Markets

Are they office properties or retail, what kind of properties are they?

Irene Oh

They are two hotels and then one is office.

Lana Chan – BMO Capital Markets

Okay.

Irene Oh

And then on the commercial business side, there is a combination of a lot of loans; a couple of larger ones and then smaller loans that make up the balance of this.

Lana Chan – BMO Capital Markets

Okay. And any industry specifically there?

Irene Oh

Not really particularly. It’s really more what’s happening in the overall economy that’s affecting those loans.

Lana Chan – BMO Capital Markets

Okay. And could you talk about – mention better loan pricing today versus a year ago, particularly in the commercial real estate and multi-family, could you quantify that for us?

Dominic Ng

In terms of pricing, it’s relative to the fed fund rate and also the prime rate. We actually have pricing around, let’s say, 6% or 7% two years ago. We can still charge 6% or 7% today. However, obviously, prime rate then and prime rate today is dramatically different. So, in that standpoint, I think that the pricing is relatively attractive.

Lana Chan – BMO Capital Markets

Okay. And then just my last minor question is, was there an MSR impairment charge this quarter in the income?

Tom Tolda

Yes, Lana. There was a $950,000 charge in the quarter primarily related to the multi-family.

Lana Chan – BMO Capital Markets

Okay. Thank you.

Operator

Your next question comes from the line of Erika Penala with Bank of America-Merrill Lynch. Please proceed.

Erika Penala – Bank of America-Merrill Lynch

Hi, Dominic, Tom, and Irene.

Dominic Ng

Good morning.

Tom Tolda

Good morning.

Erika Penala – Bank of America-Merrill Lynch

My first question is on the margin. I just want to make sure I fully understand the dynamics that have been explained in the call. So, on the asset side, you’re expecting to get a boost in yield as the short-term investments that you put on in the fourth quarter are redeployed to higher-yielding instruments, and also loan renewals and loan originations are coming at higher rates. I got that correct?

Dominic Ng

That’s correct [ph].

Erika Penala – Bank of America-Merrill Lynch

Okay. And then, but on the liability side, I’m a little bit confused because – so, if deposit growth is short of loan growth, it looks like your alternative funding cost is higher than your deposit cost currently. And though, you mentioned you had room to cut deposit costs, Dominic also mentioned that everyone in the world is still focused on trying to delever their balance sheet. So, I guess, what are you seeing in terms of the dynamics from the funding side that gives you confidence that the margin will expand in that wide of a pace?

Dominic Ng

Yes. First, I think that deposit, as you also mentioned that as I highlighted earlier is that, clearly, what the re-pricing on the CDs, when you see the amount of CDs that we have, each of the CDs start re-pricing, they’re re-pricing down substantially. That’s one, okay? So, that’s still the absolute maturity of our liability. Then, when you look at, if we need to supplement with borrowings, that’s even better because the new – I mean, not only we, as Tom mentioned at the call earlier that he paid down over $600 million of borrowings, those borrowings from federal bank have 4% and then 5%. But if we need to, let’s say, supplement loan growth with some level of borrowings with over two point some odd billion dollars of secure line from the Federal Home Bank and the Federal Reserve, the borrowing cost today is less than I guess 40, 50 basis points. So, I mean, actually, we can choose up the margin dramatically if we actually ignore deposit growth, but we don’t think this is a viable solution in the long run anyway because we are in the business of growing core customers.

For the core business in the long run, everyday when we’re bringing in another customer in the door and then trying to work with them to provide more East West loan or deposit or fee product to them, in the long run is the better franchise value anyway. So, therefore, we continue to go in that direction. So, for us to go out now to pay, let’s say 1.8%, 1.9%, or even 2% for a deposit customer, CD customer, if we look at the alternative to use, to just tap into the secure borrowings, over $2 billion of them, we can actually change their margin dynamic dramatically because the borrowing cost is so low. So, it’s a very different dynamic than major money-centered bank or maybe investment bank because those institution actually already tapped out these secure borrowing from the fed and the Federal Home Bank, and they are borrowing from the commercial paper and in a much higher rate. We don’t have any of that stuff. We have secure borrowing from the fed and from the Federal Home Bank that we have not tapped one penny at this point and those are substantially lower in pricing.

Erika Penala – Bank of America-Merrill Lynch

Okay.

Tom Tolda

Lana, I would just add to that that I mentioned that we would try to shorten up on the funding, and Dominic hit the point with the maturing CDs and so forth. We certainly are encouraging core deposits and therefore money market accounts. We are being competitive on our money market account pricing, which is certainly less than those 12 months CDs and so forth. So, all of these things combined, we feel pretty good about lowering the cost of our funding.

Erika Penala – Bank of America-Merrill Lynch

Okay. That’s clear. In terms of the loan sales that occurred in the quarter, could you give us a sense of what the underlying properties were, in terms of both geographic location and whether or not they were completed projects, fully completed projects, or were you able to sell land loans in partially completed projects as well?

Dominic Ng

All kinds. Unfinished condos, land loans in the remote area, single family homes; you name it, we sold it. So, we sold a lot more in the third quarter than the fourth quarter and we intend to try to sell more this quarter.

Erika Penala – Bank of America-Merrill Lynch

Okay. And just one or two last questions, I hope they’re quick. On term commercial real estate, Dominic, you mentioned that you’re not seeing any stress factors from a loss perspective. But have you spoken to your – kept in touch with your borrowers lately in terms of what they’re saying about rent rule trends, expectations on rent rules trends into 2009?

Dominic Ng

Yes, we did. In fact, our account officers visit borrowers and then visit the sites and trying to see what’s going on, and there are some small percentage of these borrowers experiencing some challenges. That is that – they have a few tenants that went under and which resulting them having vacancies, and that is expected because, in today’s environment, we would expect that there may be even more of that happening. One of the advantage that we have in the commercial real estate loans is that we’re – first of all, the great environment resulting in them not having as high of an interest payment that they had. And then also, I think our average debt coverage ratio – Irene, was that over 2 now, in terms of –

Irene Oh

Lower rate environment.

Dominic Ng

Yes, over 2 now. So, in the standpoint of these borrowers that they are feeling the pain, it’s not painful enough for them to walk away from their properties. And so, that’s why we see a little bit of uptick on the commercial real estate delinquency and so forth. But the reality is that, for a $3.4 billion, $3.5 billion portfolio and we only have that very small percentage of delinquency, I think that at this stage right now, we are in a very good shape. Now, I would like to caution just because we are in a great shape does not mean that we actually are in denial of the economic situation.

I think that, comes the end of this year, maybe by October, November, if the market continued to deteriorate in this kind of manner going forward, there is got to be some of these borrowers who are going to have enough pain to stop making payment. So it is something that we anticipate maybe coming and that is why we are taking all these precautionary procedures to strengthen our capital, substantially lower dividends, shore up liquidity and all that. And plus getting these earning assets in a way that we can generate substantial core earnings to offset against these additional potential provision that may be coming.

Erika Penala – Bank of America-Merrill Lynch

Okay. And just a quick question on the expense side, the guidance for lower expense levels in 2009, are you assuming that some of the potential infrastructure rationalization that you referred to will offset increased FDIC insurance premiums?

Tom Tolda

Yes, Erika, and I apologize, I was referring to you as Lana before.

Erika Penala – Bank of America-Merrill Lynch

It’s okay.

Tom Tolda

Erika, we have good momentum on this and while the FDIC premium certainly is increasing in 2009, we do feel that with the efforts that we have underway, we can largely offset those.

Erika Penala – Bank of America-Merrill Lynch

Okay. Thank you for taking my call.

Dominic Ng

Thank you.

Operator

Next question comes from the line of Juliana Balicka with KBW. Please proceed.

Juliana Balicka – KBW

Good morning. I just have a couple of very quick questions, please. What are the remaining construction commitments in terms of residential and commercial construction? And also, could you give me a little bit more color on the new originations that scored a $327 million in terms of geography and any other characteristics that you may have at your disposal right now?

Tom Tolda

Yes, Juliana, I can answer that question for you. On the residential construction, our total commitment outstanding at year-end was $1 billion, $1.10 billion to be exact, and then on the commercial construction, $593 million of total commitment.

Juliana Balicka – KBW

Great, thank you. And do you have any more color on the new originations?

Dominic Ng

New originations?

Juliana Balicka – KBW

In your press release, you referenced $327 million of newly originated loans in the quarter?

Dominic Ng

I mean in terms of from construction or from –?

Juliana Balicka – KBW

It’s on the first page. Let me grab the press release.

Irene Oh

Juliana, for the new originations in the fourth quarter as far as geography, primarily Southern California region, San Diego Valley, greater LA region is the area, and the loans were single family, multi-family, commercial real estate.

Dominic Ng

Yes, mainly.

Juliana Balicka – KBW

Right. But you don’t have a specific breakdown by loan category?

Tom Tolda

We don't, at this point, Juliana, but we can get back to you after with that.

Juliana Balicka – KBW

Okay, great. Thank you very much. That’s all I have.

Tom Tolda

Sure.

Operator

Your next question comes from line of Joe Gladue with B. Riley. Please proceed.

Joe Gladue – B. Riley

Hi. Pardon me if I missed this, but do you have the amounts of 30 to 89 days delinquencies and how did that shift from last quarter?

Dominic Ng

It’s in the press release.

Irene Oh

Yes, the last page of the press release there.

Joe Gladue – B. Riley

I’m sorry.

Irene Oh

No, that’s okay. So 30 to 59 days delinquencies is $75 million, 60 to 89 were about $70 million as of the end of the year. And that compared to 30 to 59 day delinquencies as of the end of September of $112 million and 60 to 89 of $54 million, Joe.

Joe Gladue – B. Riley

Okay. Well, thank you. That was it.

Dominic Ng

Thank you.

Operator

And you have a follow up question from the line of James Abbott with FBR Capital Markets. Please proceed.

James Abbott – FBR Capital Markets

Yes, I have one follow up to see. The reserve on the currently delinquent loan to non-performing assets, I was wondering if you have that number. So in other words, if we strip out the reserves that are specifically assigned to those particular loans, what is the reserve on the remaining which I suppose would cover some of the watchlist and the past grade loans.

Dominic Ng

The reserve for – say it again?

James Abbott – FBR Capital Markets

The reserve that is allocated to all of the delinquent loans, so 30 days past due all the way up to non-accrual.

Dominic Ng

I don't think that the formula works this way, so I apologize, Jim. We do not strip it out. It’s because the formula really does not work in that kind of direction. And so, we would not be able to answer the question this way because it’s –

Tom Tolda

We have not cut it that way.

Dominic Ng

Yes.

Irene Oh

James, just to clarify, I do not have the number in front of me, but the reserve, I think what you are talking about maybe is that the reserve for impaired loans is set aside differently than performing loans. But it is not necessarily a breakdown as far as if it is 30 days delinquent, et cetera. But we could talk offline. Let me – I do not have it in front of me but I can provide you that.

James Abbott – FBR Capital Markets

Yes, that would be another way to ask the questions, what is the reserve for non-impaired loans or past grade loans? So, yes, if you can get back to me that would be helpful.

Dominic Ng

Okay.

James Abbott – FBR Capital Markets

Okay, thanks.

Dominic Ng

Thank you.

Operator

(Operator instructions)

We are showing no more questions. Now, I would like to turn the call over to management for closing remarks.

Dominic Ng

Thank you. Again, I would like to thank everyone for joining the call today and for your continued interest in East West. And we all look forward to talking to you again in the next quarter. Thank you and goodbye.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: East West Bancorp, Inc. Q4 2008 Earnings Call Transcript
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