Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

East West Bancorp, Inc. (NASDAQ:EWBC)

Q3 2009 Earnings Call

October 22, 2009 10:00 a.m. ET

Executives

Irene Oh - SVP

Dominic Ng - Chairman, President and CEO

Tom Tolda - EVP and CFO

Analysts

Ken Zerbe - Morgan Stanley

Joe Morford - RBC Capital Markets

David Rochester - FBR Capital Markets

Aaron Deer - Sandler O'Neill & Partners

Lana Chan - BMO Capital Markets

Julianna Balicka - KBW

Jeannette Daroosh - JMP Securities

Joe Gladue - B. Riley & Company

Jennifer Demba - SunTrust

Operator

Hello and welcome to the East West Bancorp’s third quarter 2009 earnings conference call. All participants will be in a listen-only mode for this event. (Operator Instructions). After today’s presentation there will be an opportunity to ask question. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Irene Oh, Ms. Oh the floor is your ma’am.

Irene Oh

Thank you. Good morning everyone and thank you for joining us to review the financial results of East West Bancorp for the third quarter of 2009. 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 number of risks and uncertainties.

For a more detailed description of factors that affect the company’s operating results we refer you to our filings with the Securities & Exchange Commission including our annual report on Form 10K for the year ended December 31, 2008. 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 reported a net loss of $68.5 million, and the loss was driven by the $159 million of provision for loan losses and a $24 million write down on our trust preferred securities.

During the quarter, we made great strides in our efforts to reduce risks in our loan portfolio. We believe we are well on our way to getting our credit issues behind us in 2009, and returning to profitability in 2010.

Now, the overall operating environment continues to remain difficult with a weak economy and unemployment rate still high. The latest figures show that unemployment in the California is still at 12.2% for September [albeit] as a slight decline from August. However for East West because of our aggressive actions throughout 2008 and 2009 to reduce credit risk and improve our capital position. We actually seen many positive signs that the majority of our credit issues are behind us.

Our strategy of managing through this credit cycle was to be aggressive from the onset taking charge off as necessary and disposing of problem loans. In many instances, we have separated the charge offs by resolving problem loans quickly and aggressively to remove additional risk today and to reduce any of the additional deterrence for future profitability.

We believe that our approach of quickly resolving problem loans today as opposed to waiting for the market to improve and slowly work out these problems has proven to be a success.

Our strategy for reducing credit risks includes various actions. These actions include selling loans that are actually performing and current which we believe to have inherent risks. The $180 million in loans sold during the quarter includes sales of such performing current loans. Also of the $204 million in non-accrued loans as of September 30, $66 million or 32% are actually under 90 day delinquent. But in fact of the $66 million, $26 million or 40% are not even delinquent, and are actually current and paying as agreed.

We are committed to proactively recognizing problem credits, our dedicated focus remains on taking action to get our credit issues behind us in 2009. One of those primary reasons we believe that our credit issues peaked in the third quarter is that we were able to dramatically reduce our exposure to land and construction loans.

Over the last 21 months since the start of 2008, we have reduced exposure to land and construction by 2 billion. Quarter-over-quarter, we have reduced exposure to land and construction loans by 25% or $355 million. We sold $206 million as loans and REO during the quarter at about a 29% discount to carrying value largely in land and construction loans.

Loan delinquency remains low with 30 to 89 days delinquent loans comprised only 1% of total loans. And total non-performing assets are also low at about 1.84% of total assets. I believe that of the banks that have issued third quarter earnings so far our credit metrics are now set. Many of our peers have low exposure to problem asset classes at the onset of the downturn today. The same peers have higher exposure to come asset class, higher delinquencies and higher nonaccrual loans that need (Inaudible).

One interesting fact is that after our acquisition of Desert Community Bank in May 2007 our construction exposures at that time were highest among our Chinese American peers. Now we are lowest in our construction exposure and also lowest in delinquency and Naps and nonaccrual. So we feel pretty confident at this stage right now, our credit exposure is substantially better shape than our peers.

Additionally, allowances for loan losses coverage remains high at 2.74% of total loan. As of September 30, 2009 the allowance for loan losses is over 100% of both delinquency and nonaccrual. Based on [these sales] we have seen in early parts of the fourth quarter we expect that land and construction loan balance will continue to increase in the fourth quarter of 2009.

Other areas of our loan portfolio are holding up well and land and construction loans are the only areas of our portfolio that are showing weaknesses. With the significant reduction in exposure to these loan categories we’ll be able to move from our current asset resolution centric focus to a more normalized banking environment, where we can focus on both building new customer relationship and expanding existing ones.

East West would have opportunities to increase market share in the near future. Going into 2010, many other community banks would still have high levels of non-performing assets combined with reduced capital levels. These problems will pose difficulties for them to grow the balance sheet, additionally they will have to increase their focus of problem loans and assets resolution. As a result, we will have less competition for new business and customers. This situation poses an opportunity for East West to both grow organically and through potential acquisitions that lead to competitors. Other matrix that provide us with added confidence about a future of strong core earnings and profitability. Gross net interest margins and also control expenses. Core operating earnings totaled $63 million for the third quarter up $7 million or 12% from second quarter and up over $14 million or 28% from first quarter. We stated in our earning release that we expect margin will continue to grow in the fourth quarter to 3.35 to 3.4%. For the quarter, we are also encouraged by our improved efficiency of 40% down substantially from 55% from the second quarter.

In the earnings release, we added some new tables that provide additional information about the quality of our loan portfolio. On the third page of the earnings release in the credit quality section, we have added a table that summarizes the composition of our loan portfolio and what the delinquencies and nonaccrual loan percentage of each loan category.

This table clearly shows that the problems in our loan portfolio are largely isolated to the land and construction loans. Nonaccrual loans range from under 1% to about 2% for all loan categories excluding land and construction loans. Additionally, total delinquency for all other loan categories also remained low, ranging from under 1% to about 2% for all loan categories.

Specifically, income producing commercial real estate loans continues to perform well. As of September 30, 2009, total delinquencies in income producing commercial real estate loans were only 1.2% of total loans and nonaccrual loans were only 0.9%. Further, in our press release we provide additional information on our income producing commercial real estate portfolio which comprise 43% of our loan portfolio. It is important to understand the specifics of our income producing commercial real estate portfolio and why we believe these loans will prove to be resilient and perform better than other commercial real estate loans that you see in the market.

To begin with, our income producing commercial real estate portfolio is comprised of seasoned, smaller loans with an average loan size of $1.3 million, average original loan to value of 54% with full personal guarantee from almost all borrowers. Not only is the average original LTV very low at 54%, 81% of our commercial real estate loans have an original loan to value of 65% on that, at only 3% cap original loan to value of 75% or more.

East West commercial real estate loans are well seasoned and were underwritten with longer terms compared to many other banks and financial institutions. Only 5.5% of these loans are coming duly in 2009 and another 6.4% only, will come during 2010. Generally speaking, we expect that it will be challenging to obtain financing for commercial real estate in the next year and banks are not actively lending and also, real estate valuation remains low.

However, the refinanced risk is low for our commercial real estate loans as we have single digit maturities for each of the next few years. Additionally, due to the original longer term of our commercial real estate loans, these loans are coming due shortly are well seasoned. Further, our commercial real estate loans are amortizing loans where the borrowers have continued to make principal payment throughout the loan term.

And as of September 30, 2009, 85% of our income producing commercial real estate portfolio is variable rate and our borrowers have benefited from reduced debt service during this low interest rate environment. The credit quality of the income producing CRE loans we originate recently in 2009, also remains fair high. We do not deviate from our high underwriting standards and maintain our guidelines for loan to value, high debt coverage ratio despite recent decrease in real estate valuation.

As of September 30, 2009, we have 210 of 508 million commercial real estate loans originated in the years of 2008-2009 with a weighted average loan to value of 52%. Even at today’s much depressed real estate price, only 13% of these commercial real estate loans originated in 2008 or 2009 had loan to value of 65% or greater. We feel confident that these strong characteristics will allow our income producing commercial real estate portfolio to continue to perform well and better than our other CRE portfolios throughout this economic down cycle.

In summary, we are not positive about the overall economy, but we are positive about East West. East West is in a strong position to capitalize on opportunities ahead with strong levels of capital, strong reserves and substantial reduction in problem loans, low levels of delinquency and nonaccrual loans and a prudent ability to quickly and efficiently resolve problem credits.

With that, I would now turn the call over to Tom to review our third quarter results.

Tom Tolda

Thanks very much, Dominic and good morning everyone. In third quarter, we recorded a net loss of $68.5 million where results were negatively impacted by loan loss provision of a $159.2 million coupled with a $24.2 million non cash charge but other than temporary impairment on our pooled trust preferred securities.

As Dominic mentioned, we have been diligently derisking our balance sheet by reducing our credit risk exposures across all our loan portfolios and aggressively getting after problem credits, resolving them and taking appropriate charge-offs when short falls in values become evident.

In third quarter, we recorded a $151.2 million in net charge-offs which largely drove a heightened provision for loan loss. In second quarter in a row, loan delinquencies declined. Should this indicator continue through fourth quarter, all the more reason why we feel more assured that the worst is over.

Turning to the balance sheet for a moment, throughout this economic cycle, we have taken deliberate steps to harden the balance sheet, increase liquidity and reserves and build capital. That focus continues today. In third quarter, we purposely held total assets in check and shrunk the balance sheet modestly by $234 million quarter-to-quarter. With core deposits up 9% with $358 million from the second quarter and over $1 billion since December 2008, we took the opportunity to decrease wholesale funding. This allowed us to both gently view of the balance sheet and help improve our net interest margin.

Throughout 2009, we demonstrated good success in growing core deposits, lessening reliance on high cost CTE while lowering the cost of deposits. These important actions are occurring as the focus on our sales efforts were renewed with emphasis placed on attracting new customers and expanding existing customer relationships by offering deposit, products and services that offer higher value.

This focus expands all the customer segments we target that is retail, small business and mill markets. In third quarter, we added 6863 new, net new checking and money market accounts which represented 10% increase in sales versus the number of new checking and money market accounts acquired last quarter. Year-to-date net new checking and money market accounts growth exceeded 20,000 accounts, which at the same time, the average balance of these deposits accounts grew to 25,000 per accounts of 17%.

As our efforts to grow strong core deposits continue, we are pleased to know that all our core deposits that is DDA, checking, money market and savings accounts grew quarter to date, core deposits balances all grew at the this quarter by $358 million and increased by $1 billion or 30% since year end 2008.

At this juncture, we anticipate core deposit will continue to grow and wholesale deposits were less than similar to what we’ve observed at this quarter. These reason follows deposit as of September 30, 2009, came in $10 million higher than second quarter while our loan to deposit ratio came in at 97.1% better than the 98.5% in the second quarter. For the third, consecutive quarter, net interest margin increased reaching 3.20% in the third quarter of 22 basis points from 2.98 in second quarter and up 46%, of 46 basis points from the 2.74% margin in first quarter 2009. During this same time that interest income grew to $95.9 million in third quarter up 9% from the $88.3 million in second quarter and up a full 20% from the $79.7 million in first quarter. The core deposits increasing overall cost of funds decreased 24 basis points to 1.88% than 2.12% in the second quarter of `09, the decrease in the cost of funds was primarily due to lower cost of deposit and with further help by the pay down of long term at HOB advances, which we’ve been doing for most of the year.

During the third quarter we pay down $250 million in maturing that HOB term advances, the courage in interest rate to 5.14% and expect to continue this strategy by paying down 200 million as 4.43% in fourth quarter of 2009. In 2009, we anticipate having paid down these borrowings by a total of $630 million or 47% by year end. In liability management action combined with steady yields on interest earning assets will provide the further margin expansion in the quarters ahead, we are confident of this heading into fourth quarter as the net interest margin for the month of September with 3.32% with 12 basis points higher than the quarter to date margin of 320. Non-interest expenses in the third quarter totaled $46.1 million, a decrease of $11.8 million or 20% from the second quarter of 2009. Our efficiency ratio in third quarter was 40% down from 55% last quarter, this decreasing cost was largely due to lower real estate owned expenses that declined from $8.7 million in the second quarter to $767,000 in the third quarter, during the third quarter, we recognized that net gain on sale of REOs with $920,000. We took a additional right downs in REOs for $560,000 and incurred $1.1 million of REO maintenance expenses.

Further heading to the decrease in non-interest expenses was a decrease in FBIC premium of $3.5 million from the prior quarter which included a special assessment, if we exclude the impact of REOs expenses and the FDIC assessment, non-interest expanse has decreased $422,000 in the third quarter compared to prior. We continue to focus on increasing operating efficiencies through out the organizations.

On a final note, I would recap the actions we have taken to increase capital during this quarter. Specifically Tangible common equity, quarter to date we increased tangible common equity by $219 million, $80 million to a successful common stock offering which closed in July, $28 million to private placement of common stock and $111 million to the conversion of convertible preferred stocks to common stocks. Our capital levels continue to be solid and will be further strengthened as we return to profitability in 2010. Our Tier 1 risk-based capital ratio is now 13.08% substantially higher than the well capitalized regulatory requirement of 6%, while our tangible common equity to risk weighted asset ratio is a solid 8%.

With that I will turn call over to Dominic.

Dominic Ng

Thank you tom, again I would like to thank everyone for joining the call today, and for your continued interest in East West, I would now open the call for questions.

Question-and-Answer Session

Operator

We will now begin the question and answer session, (Operator Instructions). The first question we have comes from Ken Zerbe of Morgan Stanley.

Ken Zerbe - Morgan Stanley

First question I had was in terms of the decline in the land and construction loans, could you just tell how much of that decline was driven specifically loan to sales as well as moving say some of the construction loans into a permanents loan types, and asset because the mortgage balance has gone up a lot, just trying to figure out how that’s being reduced? Thanks.

Dominic Ng

Zerbe in terms of the reduction of the construction loans actually it’s a combination of mainly from loan sales and also pay down form borrowers when they find other, when this condo units are being sold, they found other buyers, retail buyers coming and starts buying these condo units and that’s not paying down, if you recall in my last conference call of a quarter or two ago. I have talked about that more and more of these projects are coming to finish line as we expected that in the third and the fourth quarter, there will be substantially more pay down simply because of the construction loans is getting completed and moving on.

Now, we did not do that much residential financing for the single family units, such as the condos, the reason is that out pricing is not as attractive as (Inaudible) Wells Fargo and so forth so its hard for us to compete for that, that single family residential mortgage growth are mainly either through our own retail banking origination and also some purchases, we have done one bulk purchases in the third quarter, so for that reason I don’t think that there is much mature impact at all form the some of like, our single family residential mortgage growth really doesn’t have much to do with the construction pay down simply because we do not have asset attractive of a product in terms of long-term fixed rate, low interest rate type of mortgages for these condo buyers.

Now on the commercial construction area also as of the last three months I don’t recall that we have any construction loans that are taking now as a permanent mortgage in our commercial real estate category, so mainly these projects pay down when projects finish and taking out by some other vendors.

Ken Zerbe - Morgan Stanley

Okay that’s perfect, and then the other thing I have was, when you mention that your credit issues are going to be behind you by year end, are you trying to personally make the statement that you are going to post a profitable quarter in first quarter 2010?

Dominic Ng

Ken I think what we’re saying is that the provisioning level will taper off from the peak that we’re at today and that we returned to profitability in 2010. First quarter may be a little bit premature but overall, we expect the profitability to come back in 2010, probably closer to that mid-year mark.

Operator

The next question we have comes from Joe Morford of RBC Capital Markets.

Joe Morford - RBC Capital Markets

I guess may be Tom, if you could just talk a bit more about what gives you the confidence to say the credit issues have peaked, you know is the delinquency trends or the inflows to classifieds and why you see provisions and charge-offs going down from here, and should NPAs go down as well or will the decrease in construction and land issues be offset by increased commercial real estate problems where you just don’t see a lot of lost contents.

Tom Tolda

Yeah, First of all, if you look at our lost content mainly driven by the land and construction loans, we went from over $3 billion exposure and now down to $1 billion and as we speak, everyday the construction and land portfolio continues to reduce in size. So by the end of this year, clearly our construction and land portfolio will be substantially reduced to a very, very manageable level. Plus the fact that, all the write down that needs to be taken would have always been taken place.

Then the question will be on the other loan categories. Now, everyone was concerned about commercial real estate income producing property, which is the next wave, but in a way the next wave started already. If you look at most of these banks in the country, many of them already experienced high delinquency in commercial real estate loans including retail, hotel, office buildings, etcetera, etcetera. If you look at our current portfolio, it still stands pretty good in terms of having only 1.2% delinquency and 0.9% nonaccrual.

So, we feel pretty good about well, I am not saying 2010 as the economy is going to come back. To me, I think it's going to get worse, but the fact is, even as our commercial real estate loans having a little bit more pressure going into 2010, we wouldn’t have the kind of massive losses that we had experienced in the construction and land portfolio. And we feel that the loss content probably would be substantially lower, and in fact, if you look at the charge-off that we have taken, we have actually sold many loans and resolved many problem credits that have not even been delinquent.

A good example is when we talk about the troubled debt restructure, and some of you include that in our NPA which I think is probably as a very distorting figure. Let me explain to you why. With a $110 million of troubled debt restructure loans over $100 million of them are the A/B notes. Most of these A/B notes, in fact have never once been delinquent. We look at the real estate value of these notes and we see that, because the real estate values have dropped so much, that we want to head and charge-off a proportion, we call it B notes and we charge them off so that we can create the A note that have a very decent coverage ratio, a decent loan to value and these loans were performing before the loan to value dropped. These loans are performing after the loan to value dropped and these loans are still performing after we charge-off the B notes.

Everyone of these notes are performing ever since that we created these A/B notes and comes January 1, everyone of these notes is going to be at least over $100 million of them, that all are going to be turned into our TDR..

So, those are all the different factors and characteristics that we see right now that by striking some of these loans today, given their performance, by causing loans to be nonaccrued when they are still current or within 60 days delinquency and so forth.

And all of that combined, I think helps us to, what I call accelerate the problem to that solution. So, come 2010, I do feel that the economy is not going to get much better. However, our portfolio would be substantially derisked. And mainly when these construction and land loans come to a very small manageable levels, it will make it much easier for us to get through the next two years, and more importantly, having good core profitability that we keep growing these core earnings would help us to get to profitability much easier.

And that’s the reason why we feel that we think that at this moment, our charge-off and provision for loan losses have come to peak and I am not saying that in fourth quarter we would not also have a pretty sizeable charge-offs and provisions. We plan to do exactly just that. However, the likely issues that we are able to do as much like what we have done in the third quarter is not very high, simply because there are only so many loans left for us to keep doing what we have done in the last two quarters.

Joe Morford - RBC Capital Markets

Okay that’s helpful, and one separate question was on the acquisition front, are you just interested in Chinese, American banks and what about going outside California? Have you reconsidered your positioned there at all?

Dominic Ng

At these moment, I wouldn’t think that we need to think about outside of California and we have made acquisition outside of the Chinese-American community and we actually had a pretty good success in prime bank that we acquired in 2001 and we do retain all the customers and grew deposit by three or four fold.

The Desert Community Bank acquisition was much more challenging well, but we have to keep in mind it was made in late 2007. They came with a big construction and land book and on top of that, it’s in the high desert area that currently with an employment rate closed to 20%, and so obliviously, that was challenging. However, we look at the Desert Community Bank deposit base; we actually were able to retain the deposit very, very nicely despite the very, very challenging economy.

Well now we pretty much guarantee the problem loans behind us, in most of the problems, I wouldn’t say all of that, we still have some customers settling in the high desert area, but if we had a much better shake than we were obviously in early 2008. So, we were able to do pretty well in the non Chinese-American community acquisition.

Now, that’s been said, the likelihood that we're doing that type of acquisition in 2010 or the next 12 months, I would say is somewhat remote. The reason is that, I think there will opportunity just within the Asian community. There will be a lot more opportunities in the next 12 months in California within Asian community. So therefore, there is really no reason for us to get beyond that. Now, two the three years from now, whether we'll even considered looking beyond that I think that there’s always a likelihood.

Operator

The next question we have comes from David Rochester with FBR Capital Markets.

David Rochester - FBR Capital Markets

First, just real quick on the construction and land exposure, you mentioned we'll see that decline in the fourth quarter. Should we expect to see another, maybe 200 or 300 million reduction in the bucket?

Dominic Ng

Possible, yeah. I think at this moment right now the pace that we are going in right now I think that most likely would above another 200 to 300 million.

David Rochester - FBR Capital Markets

Where do you anticipate that eventually leveling off over the next few quarters.

Dominic Ng

It should be. I mean that’s about it. I think that once we get to that level I think that in 2010, if I can encourage our staff to be brave enough to go back on and start making some construction loans because, I mean one of the issues here is that there is no better loan to [make] it today than construction loan because nobody is doing it you can call any terms that you want, you can be as prudent as you ever wanted to be in terms of loan to value and then the required liquidity that the personal guarantee requirement, all sort of things that you can ask for is available because nobody is doing it.

Obviously we won’t jumping into it because we recognize that we have a pretty large substantial construction loan book to start with and I really didn’t wanted to have our staff to get confused in terms of when we said that our primary focus is to pair down the toxic asset and we are going to do it as fast as we can and we are going to be as focused as we wanted to be and this is the number one priority. It will be quite confusing if we immediately at the same time start getting them to say that oh, by the way just go ahead and book these constructions on (Inaudible) and I think that may be a little bit confusing for our staff in terms of focus.

But once we get down to that you know $300 million level out of I mean loan broke up $8.4 billion, $8.5 billion suddenly particularly recognizing these loans going to be very high quality full and full in the future and also we are getting a little bit closer to economic recovery. All of that would be a reason for us to potentially thinking about getting into the business again, but with obviously substantial better caution and knowledge about what to do, make sure that we are not making the same mistake like we used to. And so I think that I don’t expect it to go down to zero. Let’s put it that way.

David Rochester - FBR Capital Markets

Got you, makes sense.

Dominic Ng

I also wanted to highlight that in the land loans you would not expect that kind of dramatic drop like the construction loans for the following reason: The construction loan we allow many of them to keep building up and while we at the last I mean 17 months or so we've been aggressively paring them down, cutting down the unfunded commitments and selling some of the loans and also funding some of some these project etcetera. But most of the projects were allowed to continue to finish up and third quarter is one of the I think at the end of second quarter and the beginning of third quarter and now I think going into the fourth quarter also many of these projects have completed and they are in the process of selling, if there are condos projects there in the process of 71 condo unit at time and impairing down these loans. And so what you see is that constructional build up to the maximum outstanding balance, and then they just drop off very rapidly loan-by-loan.

In the land category, it doesn’t work that way. In the land, no matter how we are trying to get rid of this. So we have actually made a lot of replacement of old borrowers and new borrowers. New borrowers have like substantial liquidity who bought these land loans at a substantial discount. However, there is nobody out in the world making land loans right now. So, when we actually sold some of these land loans we have or may be we did short pay and etcetera, etcetera. We usually still have to provide financing.

So, therefore while we were able to reduce the land loan by either charge-offs and additional pay down and principal reduction through work out etcetera, etcetera the fact is we always, always need to provide some level of financing. So, therefore and you wouldn’t see a suddenly drop off like the construction when they project finish it and then you know they were able to lets say through an auction and then suddenly a $10 million or $12 million projects in about two months time suddenly comes to zero.

If we can go and see that land loans. Now on the other hand the land loan also has much smaller balances in general. We don’t have these like $12 million $15 million construction balances [sympathy] goes to constructional when you get to finish line it usually tend to be much higher balance. Land loans just kind of sit there and middling down by principal pay down one month at a time. So, usually the balance is much smaller so our approach also has been well for some of the land loans, if we wait a little bit, we sometime wait till before closing then we sell it.

On construction loan, we have a lot more note sales that before will come to foreclosure. For land loan we kind of like tend to wait till before closure comes in and then we sell them. And now by doing this way what we have done is that which is actively and aggressively target down to the most likely selling price instead of just the appraisal value because one of the interesting thing we have seen is that this quarter we actually have a net gain on sale of REO instead of another big lay down, and because what we do is that we try to write down to the level that we feel that most likely we can sell.

So I think that that is kind of like the summary, you would have seen that again a much bigger reduction in the construction side, feel a very healthy reduction in the land balances but would not be as huge as the construction.

David Rochester - FBR Capital Markets

Okay, Thanks for that and on the CRE portfolio you talked about debt service coverage ratio is being supported matter of fact that a large part of that portfolio is variable rate, can you talk about updated debt service coverage ratio on that portfolio I know they used to be maybe around two times which is one of the stronger levels in the industry?

Irene Oh

Well, obviously know what’s happening with real estate in the economy though are this way where borrowers are having more difficulty and their NOIs are decreasing. So we find just kind of with the updated financial that we get from our borrows net-net, because so many of them do have their variable rate loans and net-net debt service covers it substantially different.

David Rochester - FBR Capital Markets

Okay great and finally can you talk about the status of your discussions with the auditors on [DTA], it sounds like those conversations have been going pretty well recently?

Dominic Ng

Yeah Dave, we at the start of the year, we anticipated the [credibility] credit situations so for we would be taking some losses this year, I think the aggressiveness that, the aggressive approach that we’ve taken aside from getting the credit problem behind us is also helping us to return to profitability sooner, so we have gone about documenting our assumptions on our return to profitability, we feel very confident that we can do that, as we approach the new year and at these point in time there’s no reason to believe that the likelihood of the realization of that the DTA, in not unlikely. So at this point in time we have no [sunset] and allowance needs to be put against that in fact profitability is near at hand

David Rochester - FBR Capital Markets

Okay great thanks a lot guys.

Operator

The next question we have comes from Aaron Deer of Sandler O'Neill & Partners

Aaron Deer - Sandler O'Neill & Partners

Hi, good morning Dominic, good morning Tom. Can you give a little bit more color on your thoughts with respect to capital I am curious to know if you guys would have been a intention of doing any additional comment equity raise or converting some of the additional prefer share is still outstanding and what are your thoughts on repaying TARP and timing of that?

Dominic Ng

I think in terms of repaying TARP our desire is that we want to make sure that we get these credit issues behind us in 2009 and in 2010 when we thought looking at getting this momentum of profitability quarter -by-quarters and then I think that will be the time that is appropriate for us to look in to paying our TARP. And clearly at that point I would imagine that it would be very appropriate for us to raise additional capital to pay TARP.

Now in the mean time I would say that our capital ratio is adequate if we anticipate that there will be more opportunities for acquisitions that will be coming in the next quarter or two then obviously we will be also looking potentially getting ourselves geared up, so I mean what I’m looking at is that from a capital raising standpoint is more or less like its not a need for our current balance sheet but then if we raise some additional capital assuming that the market is still positive then it may not be a bad idea to raise some just to gear up ample capital for future acquisition and in case that the acquisition may not be available then we always can save those money for top payment eventually anyways, so I think we are going to be very flexible in that regard.

Aaron Deer - Sandler O'Neill & Partners

Okay, and then I believe you guys are in the midst of over maybe completed your regulatory exam I am wondering has the, have you guys had your exit interview done is that done?

Dominic Ng

Not yet.

Tom Tolda

Not yet.

Aaron Deer - Sandler O'Neill & Partners

Okay and then just a technical thing. The deposit insurance premium backing out the special charge in the prior quarter seems like that was up a bit, is there anything behind that might have driven that?

Tom Tolda

We had a special assessment in the last quarter earned and with the increased deposits and so forth and so our higher deposit insurance. But that was about it.

Aaron Deer - Sandler O'Neill & Partners

A higher rate or just a higher overall dollar amount?

Tom Tolda

We did see a slightly higher rate that’s true.

Aaron Deer - Sandler O'Neill & Partners

Okay. All right. Thank you very much.

Operator

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

Lana Chan - BMO Capital Markets

Hi good morning.

Irene Oh

Good morning.

Lana Chan - BMO Capital Markets

I was wondering if you could give us a number of the new inflows into nonaccrual loans this quarter I think it was about $211 million last quarter, would you happen to have that yet for this quarter.

Tom Tolda

We were a little bit higher than that Lana but that’s pretty close, close to last year.

Lana Chan - BMO Capital Markets

Last quarter?

Tom Tolda

Last quarter I am sorry.

Lana Chan - BMO Capital Markets

And do you have any color about where the inflows are coming from is it still primarily from the residential construction side or are you seeing more of an increase on the commercial real estate side?

Dominic Ng

Actually both residential and commercial construction and also land loans. So I mean it has been pretty I would say that overall if you look at land and construction loan as still the dominant force of going to nonaccrual, creating charge offs and causing us for additional provisions.

Lana Chan - BMO Capital Markets

Okay and then I guess as we go through your I guess land and construction portfolio now I have been through a couple of innovation in terms of reassessment. I mean how much further do you think that there is in terms of new recognition of problems in that portfolio as you are looking at further the stress points.

Dominic Ng

Actually it’s not that much of a new recognition of problems. I mean we identify them pretty much in 2008, the challenge is that actually a lot of them seem kind of resolved in 2008 when we first identified these problems and we nearly worked with dollars that they may be appropriate, substantial principal pay down or some of them set up a P&I payment and also set up payment reserve and so forth.

But this land value despite the fact that back then we have reduced the values substantially but 9, 12, 13 months later they come down even more and on top of that when it comes down to truly if we want to get rid of them, the buyers are expecting discounts on today’s ridiculously low appraisal value. So, I mean we are just trying to face to the truth is that if we do want to get rid of these, I mean we can always write down to net current appraisal value and then feel good about it. But the fact is if we can just see that I think they are doing better [analysis] in there and that’s why we are going in and start taking these slide down.

And so I think that most of the problem has been identified in the past but the severity of these problems have increased and caused us to continue or have to lay them down than further and as a combination, we no longer took the 2008 approach. I mean if you look at it that its kind of ironic I think that we are more aggressive than most of our peer banks but I wish I was substantially more aggressive in 2008 because back in 2008 we were aggressive to take the write down by doing a 100% updated, full appraisal review, look at every single one of these loans from a loan review standpoint and then charging down and provides the fake reserves for the purpose of making sure that we got all these problems covered.

But what we didn’t do in July and August, September of 2008 was [ignobly] got rid of these loans. We just fought those loans, we take all the write downs and everything is going to be fine and then we’re just going to see how things go and what a turn out was come 2009 as long as you leave them alone they continue to create problem. So, and I think early 2009 we saw, getting a little bit more aggressive and accelerate the aggressiveness of resolving these problems once and for all. So, the remaining balances that we have right now frankly though quite a few of those have been repositioned something like I got new buyers coming in and now taken over these loans.

So, we can’t say that these are the same characteristics adjust and reduce exposure actually this whole is in addition to reduce exposure also the characteristics are quite different too. But that being said we still think that there are still enduring risk in there and we will continue in the fourth quarter to look at whether its C&I loans or commercial real estate loans, whether we can strike before they even go back.

That is a good example as that, we have actually sold one CRE loan that are actually payment degree trend, we took a big loss on it because we assume that if we let it lingering on in 2010 sometimes in the second half of 2010 that CRE loans may turn out to be just like these construction loans that we experienced from 2008 to 2009, so we are (Inaudible) despite of strategic reduction and our third quarter we have done more of these strategic reductions than second quarter and fourth quarter if we didn’t have as much land in constructions clear problem asset to write down that was a go and try to find a few of the other categories and make sure we’ll be listed and so that’s the combination that we are looking at in the fourth quarter so hopefully we can kind of like it most of these credit issue behind us.

Lana Chan - BMO Capital Markets

Okay Dominic. Thank you for the answer, I appreciate it.

Dominic Ng

Thank you

Operator

The next question we have comes from Julianna Balicka of KBW

Julianna Balicka - KBW

(Inaudible)

Irene Oh

Julianna, we cannot hear you.

Dominic Ng

Are you on a speaker phone or something?

Julianna Balicka - KBW

No (inaudible) maybe I will just call back after the call is over.

Dominic Ng

No you’re okay now, now your okay. Go ahead..

Julianna Balicka - KBW

(Inaudible) update you showed some of the current performing loans at a discount what kind of discount were you seeing on the performing and as in excluding loans versus the discounts that you saw on the sales of the more problem loans

Dominic Ng

It varies, I mean every one of them that the (Inaudible) because we did not go in as you said so, just like other assets, we did some slow book sales on a single family and then on starting single family, but because of most of these construction land and commercial real estate loans that we sold are selling them all one by one it goes from all the way from selling them at par all the way to I mean a large discount so everyone of them are different. Irene if you can look at the numbers made and then give Julianna a bit more details.

Irene Oh

We’ll do that Juliana.

Julianna Balicka - KBW

And then (Inaudible) complete last year at this time we were doing the very solid portfolio being rolled up into the appraisal sector. So all these to be appraisals are not cutting up to a one-year mark do you have a plan on leaving them or how you looking at that going forward?

Dominic Ng

We really don’t need to go with this full one time re-appraisal because what happened is that on these construction and land loans they have very short maturities. So pretty much so first of all many of them have already been resolved and also it’s pretty much the remaining whatever that comes to maturity because it’s not like that we will sit there and then wait another year or two because they all have become due anyway. So we constantly had to into July of last year, we constantly got new appraisals for these construction and land loans.

So I think right now we are in pretty good shape as far as getting more up-to-date information now obviously not 100% of them on a snapshot as of today but I can tell you that we've got all the more spread value but I think we have a vast majority of them are pretty current. Secondly, these appraisal value to me is not going to be crucial anymore because either they are going to be found and what we've found is a lot of our construction loans that we expect them to decline and they turn out to be fine. Now they’ve finished projects finished and they stop selling and they stop reducing our balance one by one.

So whatever their appraisal value is, whatever they feel getting out just right. And then there are others even the appraised value looks pretty good but when they start having difficulties and they cannot move forward and we decided that we cannot continue to fund interest reserves and we don’t want to have it sit in nonaccrual we end up starting to note, we end up picking losses that are higher than the appraised value anyway.

So at this stage right now I think that we feel pretty good about while we have this exposure kind of contained and all the updated value that we appraised value we get in, we continue to go through our methodology to know write, and basically provide you with statistical write down and et cetera. But then when it comes to sell, then we would look at what exactly the kind of losses that we were willing to take and then we get over with. And the main thing about it is that we’ve done so much right now I mean I think that after fourth quarter we probably are not going to be doing much of regional sales going into 2010.

Julianna Balicka - KBW

Okay Dominic. See you in the next quarter call.

Dominic Ng

Thank you

Operator

The next question we have comes from Jeannette Daroosh of JMP Securities.

Jeannette Daroosh - JMP Securities

Good morning and thank you for taking my call. Most of my questions have been asked so let me just go for just a couple of smaller items. Given the position that you have taken to clear out all of your problem assets as quickly as possible I was wondering the REO expense that we saw on the quarter, is that an anomaly or should we think about the expense being that low also for the fourth quarter?

Tom Tolda

Jeanette I think its hard to make a call on that specific time the transactions that we had in the fourth quarter at this point we certainly benefited from some gain on sales. We wouldn’t be surprised if that would repeat but at the same time you don’t know once you have a deal closed and really hard to call on that.

Jeannette Daroosh - JMP Securities

Okay. Would you say that perhaps the better performance in the third quarter was that investors were coming back of at the sidelines and that perhaps there is a trend that one if it’s looking see from this or…?

Dominic Ng

I think there is always buyers out there but it’s always going to be a like, they are always buyers as long as dealing is still cheap. And as long as the price look ridiculous, there are always people who wants buy. So, buyers are always there. Now, if it looks like there are more buyers I think so. But on the other hand one of my fears that I am pretty sure and make sure there are even more buyers but then I think there should have been a lot more inventories because most community banks have not even recognized these losses, have not even taken them to market.

But 2010 most of them have to, there is no way around it. When I am looking out, many of our peer banks have these 4%, 5% or even 8% to 9% MPA. It’s just not sustainable, at some point of time they are going to have to start resolving these problem assets and when that happens then market will be flooded with a lot more inventory. I think there will be a healthy demand from a buyer standpoint but also that may be a healthy inventory available. So what we are trying to do is to get it a little bit ahead of the curve. Now from the REO expenses standpoint if you look at it is that three quarters in a row now our REOs balances have continued to decrease. It’s down 38, 28 and its coming down.

So, I think in the fourth quarter we will try to do the best we can to may be having even less. But it’s at the very, very small level. So, I don’t think there should be a substantial risk. Now, come 2010 and may be a little bit different strategy. Once we decided that we will get our exposure down to a level that we are very, very comfortable, we may not be going with these what I call accelerated type of loan sale.

So, I am not going to go in 2010 and start looking at performing loan recognizing there may be only one more year of hard time that I'm not going to go in and look at all these performing loans and start selling them at like may be 10% - 20% discount.

The reason I really want to do that is do that if I do not think that our overall non-exposure is going to get much worse and also the likelihood of a recovery coming in the horizon maybe in 2011, and then it doesn’t make sense for us to start selling these loans too quickly with a big discount.

However, what I may do is that, once we feel that the NPA is doing acceptable levels total risk exposure in acceptable levels, we may just sit on some of these, I shouldn’t say we sit on it. So, through a quite normal disposition cycle, that is that there maybe a higher likelihood we let these loans to go to foreclosure and after foreclosure, we hire a confident, let us say, broker to help us to dispose these, let us say in the market in a normal pace.

Now, if we start doing that in that direction, obviously our yield may grow. NPA may grow slightly also because, if everybody out here are sitting on 4% to 5% next year, it doesn’t make sense for us to trying to [ration] it down to 1%. We made as far as we feel comfortable that our overall credit exposure is not high, our most toxic category like land and construction continue to fare down and is now performing in a more decent manner. Then I think that letting this NPA go up a little bit is okay and letting the problem loans to go through the normal cycle of this position, like coming down to REO and then we settle it, is okay.

So, I wanted to share then our view is that there is no magic or specific so direction that East West has to follow. Just because we’ve been aggressive for the last three or four quarters doesn’t mean that we have to be doing exactly the same way going forward. Its all common sense dictate. So when it comes to 2010, and we start making profits, things are going pretty good exposure, our credit exposure in terms of problem credit exposure are down, then we may just come riding along and at that point, all your expenses may go up a little bit.

Jeannette Daroosh - JMP Securities

Okay. That’s very helpful. Now of the sales that you did do in the third quarter, I think you said $206 million is what you sold? Did you finance any of those or were they all outright sales for cash?

Tom Tolda

Combinations. Actually there were more cash fired in the third quarter than the second quarter. However, some of that we feel have to do with financing, specifically on the land loans we obviously have to do financing for these buyers who would be able, many of these buyers who bought these land and to just sit on as well in the next four to five years, because they bought it cheap enough and so what they do is they set up payment returns and then they make sure that the loan to value is appropriate and then they come in and get a loan from us.

Jeannette Daroosh - JMP Securities

Okay and then separately on a different topic your [pool] trust preferred securities I think in the second quarter you had taken a approximate $101 million impairment charge and most of that was through the OCI I think you have taken a $37 million credit charge through the P&L in the second quarter and now another $24 million in the third quarter. Given the current economic environment how should we think about the balance of I think its about $39 million in the OCI account, is it likely that this will also eventually be run through the P&L?

Tom Tolda

Well I think if there’s any good news on the securities one is that we from a capital standpoint we now have the securities written down to about $0.04 on the dollar so from a capital perspective I think we’ve insulated ourselves from the issue. From a credit deterioration perspective this one is a hard thing to call, would not be surprised if we see more deferral defaults. On the other hand, we do have a lot of banks that are recapitalizing so that is working sort of accounted to that. So it would be we’ll see how this plays through, but we certainly have hit it hard this year and we’ll see like I say what happens in the fourth quarter it’s difficult to forecast this one.

Jeannette Daroosh - JMP Securities

Okay. All right, thank you so much for your time and your answers.

Operator

And the next question we have comes from Joe Gladue of B. Riley & Company.

Joe Gladue - B. Riley & Company

Hi. I think most of my questions have been answered, but just wondering if you could give us some idea of how much the non-performing land and development loans have been marked down from their original values?

Tom Tolda

How much the land and construction loans have been marked down from original values?

Joe Gladue - B. Riley & Company

The non performers?

Dominic Ng

The original value, we don’t have that because every quarter we keep marking them down and down since early 2008. So, at this stage right now we wouldn’t have that number right of at the top of my head. I think that we can look into that numbers and they may be provide to you later on.

Joe Gladue - B. Riley & Company

Okay. That would be fine. Thank you.

Operator

(Operator Instructions). The next question we have comes from Jennifer Demba of SunTrust.

Jennifer Demba - SunTrust

Thank you. Good morning. Just wondering as we looked out towards a more normal environment, where do you think your margin can get back to?

Tom Tolda

Yeah, Jennifer. I think interesting question I think we certainly have great momentum right now and getting the margin and up. As we hit next year I am sure we’ll be will around that 350 or more level, I think a lot comes back to also our ability to bring back some new assets or originate some new loans that would be further momentum, coupled with the decrease in any reduction and nonaccrual loans that is the interest reversal on nonaccrual loans to the extent that decline that would give us additional lift on the net interest margin, so I think its reasonable to think that we can get close to the 4% may be by the end of next year if all things works out.

Jennifer Demba - SunTrust

How much of a drag are the nonaccrual loans right now on the margin?

Tom Tolda

Probably somewhere around 12.

Jennifer Demba - SunTrust

Thank you very much.

Operator

(Operator Instructions). We show no further question at this time, I will like to turn the conference back over to management for any closing remarks.

Dominic Ng

Thank you, well if there is no other questions, I look forward to speaking with you all of you on our come January 2010. Thank you.

Operator

Thank you sir, the conference is now concluded, we thank you for attending today’s presentation, you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: East West Bancorp, Inc Q3 2009 Earnings Conference Call

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts