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East West Bancorp (NASDAQ:EWBC)

Q2 2011 Earnings Call

July 21, 2011 11:30 am ET

Executives

Irene Oh - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Chief Financial Officer of the Bank and Executive Vice President of the Bank

Julia Gouw - Vice Chairman, President, Chief Operating Officer, Member of Executive Committee, Vice Chairman of East West Bank, President of East West Bank and Chief Operating Officer of East West Bank

Dominic Ng - Chairman of the Board, Chief Executive Officer, Member of Executive Committee, Chairman of East West Bank and Chief Executive Officer of East West Bank

Kelly Adams - Vice President, Corporate Communications

Analysts

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

Ken Zerbe - Morgan Stanley

Ram Shankar - FBR Capital Markets & Co.

Christopher Nolan - CRT Capital Group LLC

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Aaron Deer - Sandler O'Neill + Partners, L.P.

Joe Morford - RBC Capital Markets, LLC

Jonathan Elmi - Macquarie Research

Brett Rabatin - Sterne Agee & Leach Inc.

Gary Tenner - D.A. Davidson & Co.

Lana Chan - BMO Capital Markets U.S.

Matthew Keating - Barclays Capital

Operator

Good morning, and welcome to the East West Bancorp Second Quarter 2011 Earnings Conference Call and webcast.. [Operator Instructions] Please note, that today's event is being recorded. At this time, I would like to turn the conference call over to Kelly Adams, First Vice President, please go ahead.

Kelly Adams

Good morning, and thank you for joining us to review the financial results of East West Bancorp for the second quarter of 2011. Here to review the results are Dominic Ng, Chairman and CEO; Julia Gouw, President and Chief Operating Officer; and Irene Oh, Executive Vice President and Chief Financial Officer. We will then open the call to questions.

First, we would like to caution you that during the course of the call, management may make projections, or other forward-looking statements regarding events or future financial performance of the company within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties.

For a more detailed description of factors that affect the company’s operating results, please refer to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2010.

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

Dominic Ng

Thank you, Kelly. Good morning. Thank you, all for joining us. Yesterday afternoon, we were pleased to report financial results for the second quarter of 2011. East West reported strong earnings of $60.5 million, or $0.39 per diluted share for the second quarter. This is the fifth consecutive quarter we have increased net income, and we are pleased with the progress we have made in growing a strong balance sheet and increasing revenue. I'm going to quickly touch on just a few highlights for the quarter, and ask Julia and Irene, to discuss our results in more detail later on.

Year-over-year, East West increased earnings by 67%, or $24.2 million, and increased earnings per share by 86% or $0.15. From the first quarter of 2011, East West increased earnings by 8% or $4.5 million, and increased earnings per share by 5% or $0.02. This earnings growth was fueled by an increase in average earning assets to $19.4 billion for the second quarter, which is an increase of $1.9 billion, or 11% from the year-ago period.

Although we are only at the midpoint for 2011, East West has already made significant progress in achieving our 2011 goals, and making strides towards our long term strategic goals, including growing our commercial loan portfolio and fee-based revenue sources.

During the second quarter, total loans receivable increased $300.2 million, or 2% to $14 billion, and total fees and other operating income increased $3.1 million, or 17% to $22.1 million.

In addition to our progress in these key areas, credit quality matrix continued to improve with each passing quarter. Charge-offs declined 8% during the second quarter, and nonperforming assets declined to $181 million, or to only 0.83% of total assets at June 30, 2011.

Overall, our ability to grow market share combined with reduced credit costs and a strong expense control will result in strong earnings. This earnings trend and growth will position our franchise to provide superior value to shareholders in 2011 and beyond.

I will now turn the call over to Julia, to speak in more detail of our key successes during the second quarter of 2011.

Julia Gouw

Thank you very much, Dominic, and good morning to everyone. As discussed in previous calls, East West has focused on making investments in our infrastructure to increase revenue, diversify our business and improve efficiency. We have directly realized benefits from these investments as seen most clearly in our commercial and refinanced loan growth during the first half of 2011. I would like to spend a little time discussing this in detail, and providing some insights into where we are seeing the most growth and opportunity.

During the second quarter, total non-covered loans increased $543 million to $9.7 billion at June 30, 2011. The primary driver of this increase was an increase in commercial and trade finance loans of $500 million, or 23%.

As we mentioned in our earnings release yesterday, approximately 1/2 of this commercial and trade finance loan growth stems from our commercial lending platform in the U.S., while the other 1/2 was from our Hong Kong and China lending platform.

The loan growth from Hong Kong and China was a result of our cross-border renminbi trade settlement finance business. Over 80% of this cross-border RMB loans are 100% secured by a combination of cash and often by LCs, issued by large financial institutions.

This growth in the cross-border RMB business also led to an increase in deposits in Hong Kong and China of about $370 million increase quarter-over-quarter. In addition, we also noted growth of $84.9 million, or 7% of our non-covered single-family loan portfolio and growth of $69 million, or 2% in our non-covered commercial real estate portfolio.

Customer demand remains high for single-family loans in our niche markets. The loans we originated in the second quarter was generally small with very low loan-to-value ratios. The average loan balance of these loans is $350,000, and average loan-to-value is about 55%.

On the commercial real estate front, loan balances increased $69 million, or 2% quarter-to-date. The growth in commercial real estate loans during the second quarter, was largely due to expanding relationships with existing customers and new loans to new commercial customers.

Our growth in non-covered commercial and trade finance and single-family loans, was offset by decreases in the non-covered land, construction and consumer loan portfolios. As of June 30, 2011, our construction and land loans equal only 3% of total loans.

Further, during the quarter, we sold $212 million of government guaranteed student loans at a gain of approximately $5.9 million. In addition, as expected, the covered loan portfolio continued to decline, decreasing $243 million, or 5% from March 31, 2011.

In general, with our strengthened lending platform in place, we are confident that the select portfolios we are focusing on will continue to grow in future quarters. With the growth in commercial and trade finance loans, we have also experienced improvements in core noninterest income from fee-based revenues.

We reported total noninterest income of $12.5 million during the quarter, as compared to noninterest income of $11.1 million during the first quarter of 2011. Noninterest income was impacted by a net decrease in the FDIC indemnification asset and receivable of $18.8 million.

In addition, during the quarter, the company recorded $5.9 million gain on the sale of student loans, a net gain of $1.1 million on investment securities sold, and gains on sales of 2 bank promises, totaling $2.2 million. Aside from this activity, our core fees and other operating income increased in the second quarter to $22.1 million, up $3.1 million, or 17% from the first quarter of 2011, and up $5.8 million or 35% from the second quarter of 2010.

As we continue to look for opportunities to diversify our income sources and interest fee-based income, we expect to continue to see improvements in core fees and other operating income. Although we continue to make investments to support future growth opportunities, we also remain disciplined over expense controls.

Excluding prepayment penalties of $4.4 million on the Federal Home Loan Bank prepayments and netting out amounts that are reimbursable by the FDIC, second quarter noninterest expense totaled $99.6 million. The increase in the noninterest expense from the first quarter of 2011 was primarily related to an increase in credit cycle costs, as well as compensation costs.

As have discussed before, under loss share agreements with the FDIC, 80% of eligible expenses on covered assets are reimbursable from the FDIC. In the second quarter, we incurred $17 million in expenses on covered loans, and other real estate owned, for which we expect the 80% of $13.6 million will be reimbursed by the FDIC.

Of the $13.6 million of the expense reimbursable by FDIC, $11.6 million is related to net write-downs and expenses on other real estate owned, and $2 million is related to legal and other loan related expenses. Although we have experienced increased credit cycle costs and compensation expenses, as compared to the first quarter, as compared to prior year, total operating costs have declined as evidenced by the $7.7 million, or 6% decrease in total noninterest expense in the second quarter of 2011 as compared to the prior-year period.

We expect that noninterest expense will continue to remain low, and forecast that will be approximately $97 million to $100 million for the remaining quarters of 2011, net of amounts that are reimbursable by the FDIC.

Before I turn the call over to Irene, I would like to talk briefly about the status of our operations in Greater China. As you may recall from our previous discussions, when we first acquired the UCB China banking operations from the FDIC on November 6, 2009, we quickly recognized the need to make operational changes.

We immediately put into action plan in place to recapitalize and strengthen the balance sheet of the China subsidiary. We are pleased to report that our China operations are now stable. We increased capital level, charged off problem loans, reduced nonperforming assets and improved the loan-to-deposit ratio. At this point, we do not have any regulatory constraints, exit all regulatory requirements and are able to look for opportunities to grow in a careful, prudent way.

At the end of June 30, 2011, nonaccrual loans totaled only $1.5 million, or less than 1% of total loans outstanding. Total loan in China was approximately $165 million as of June 30, 2011, and total deposits were $380 million, or loan-to-deposit ratio of less than 50%.

Now with a stronger balance sheet and infrastructure in place, we are focused on utilizing our presence in greater China to provide more services and products to our cross-border customers.

With that, I would like to turn over the call to Irene, to discuss our second quarter 2011 financial results in more depth.

Irene Oh

Thank you very much, Julia, and good morning to everyone. I'm going to provide a little bit more insight into our financial results for the quarter, especially as it relates to our net interest margin and credit quality.

We reported net income for the second quarter at $60.5 million, or $0.39 per diluted share. Compared to the prior quarter, earnings per share improved $0.02, or 5%, and compared to the prior year, earnings per share improved $0.18, or 86%. This increase in profitability from the prior quarter is a result of an increase in earning assets and an increase in noninterest income.

Average earning assets increased to $19.4 billion for the quarter ended June 30, 2011, compared to $18.7 billion for the quarter ended March 31, 2011. The total increase in average earning assets was primarily due to an increase in average loans and investments.

The core net interest margin, excluding the net impact to interest income of $32.4 million, resulting from covered loan activity, remained stable at 4.03% for the quarter, as compared to adjusted net interest margin of 3.94% for the first quarter of 2011, and adjusted net interest margin of 3.95% for the second quarter of 2010. The improvement in our net interest margin from the prior quarter and prior year is primarily related to an increase in the yield on investment securities and covered loans and a stable yield on non-covered loans.

As a low interest rate environment continues to extend, we are safe with challenges in increasing the net interest margin. And as competition for commercial loans, both commercial and trade finance loans and commercial real estate loans remains stiff, yield pressures continue.

East West continues to look for opportunities to minimize our cost of funds, and maximize our yield to redeployment of excess liquidity into higher interest earning assets, while also ensuring prudent interest rate risk management.

In the second quarter of 2011, East West prepaid $260.7 million of Federal Home Loan Bank advances, at an average effective cost of 1.6%. We also improved the yield on our investment securities portfolio by 22 basis points to 2.90% by repositioning the portfolio.

Despite these challenges and as a result of the actions that management has taken, we feel that we will be able to make a solid net interest margin of about 4% for the remainder of 2011.

Moving on to credit quality. All asset quality metrics improved during the second quarter of 2011. For the seventh consecutive quarter, net charge-offs have declined. Further, nonperforming assets, excluding covered assets, decreased by $7.1 million or 4% from the prior quarter to $181.2 million, or only 83 basis points of total assets at quarter end. The decrease in the nonperforming assets was primarily due to an $8 million, or 5% decrease in nonaccrual loans during the second quarter of 2011.

I'm pleased to report that movements into nonaccrual loans has also decreased sizably for the past 3 quarters, and totaled about $60 million in the second quarter of 2011.

In future quarters, we expect the inflow to continue to decline, while we are also actively managing our REO sales, resulting in a decline in nonperforming assets level.

Additionally, other credit metrics have also improved. Compared to March 31, 2011, we saw improvements in both tax light assets and delinquent loans. All data points indicate that credit is improving, and should be a diminishing issue each passing quarter.

The provision for loan losses was $26.5 million for the second quarter of 2011, virtually unchanged from the prior quarter, and a decrease of 52% as compared to the second quarter of 2010. Although our allowance for loan losses remains very strong at 2.29% of non-covered loans, our allowance and provision have declined for several quarters, as a result of credit quality improvement which was partially offset by increases in the allowance on commercial and trade finance loans as these portfolios have continued to grow.

As in the past, in our earnings release, we provided updated guidance for the full year of 2011. We currently estimate that fully diluted earnings per share will range from $1.52 to $1.54 for the full year of 2011. This updated EPS guidance for the remainder of 2011 is based on the following assumptions: A stable balance sheet; a stable interest rate environment and an adjusted net interest margin of approximately 4%; provision for loan losses of approximately $45 million for the remainder of the year; total noninterest expense of about $97 million to $100 million each quarter, net of amounts to be reimbursed by the FDIC; and an effective tax rate of approximately 37%.

Finally, as stated in the earnings announcement released yesterday, East West Board of Directors has declared third quarter dividends on the common stock and Series A Preferred Stock. The common stock cash dividend of $0.05 is payable on or about August 24, 2011 to shareholders of record on August 10, 2011. This dividend on the Series A Preferred Stock of $20 per share is payable on August 1, 2011, to shareholders of record on July 15, 2011.

I will now like to turn the call back to Dominic.

Dominic Ng

Thank you, Irene. Thank you, everyone for joining the call this morning. And I will now open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ken Zerbe from Morgan Stanley.

Ken Zerbe - Morgan Stanley

I guess first of all, regarding the commercial loan growth, how do we get comfort, given that the rapid, rapid pace that you've been able to grow C&I loans, that they're being put on with very good risk underwriting. That we're not going to see -- and I'm not implying this, but we're not going to see a blowup in a year, or 2 years, or 3 years because of the growth was too much for you to properly manage.

Dominic Ng

Well, first of all, I think that if we looked at the C&I loan growth. Close to 50% of those loans are in the greater China region, and as we pointed out earlier, more than 80% of them are actually secured by cash and Standby LC from very large financial institutions. So these are basically, 100% all-guarantee loans. So on one hand, we look at the loan growth may be big, but then on the other hand, these are not loans that would have any risk at all. Then you have the rest of the loans that we look at. Keep in mind also, is that we have a situation here that, in general, a lot of our competitors that have done business -- well, sort of compete with us in the past, are under either MOU and cease-and-desist orders. Even as of today, they are still going through that kind of pain. And we've got all of that -- well, we never -- actually, thank goodness, I've been here 20 years, we never once been in any kind of, like, regulatory orders. So in this situation, I think that we have a much better opportunity to capture or capitalize on these good C&I opportunities, that frankly, if you've seen in very, very strong economic environment, I think we will have a hard time to take these clients to come to us. Because we have a very interesting dynamic here. East West went from $10 billion to $20 billion after the United Commercial Bank and also, the Washington First International Bank acquisitions. So from a size point of view, we are much bigger. And in addition to that, we have much broader reach in terms of our branch network now. So not only just in the state of California, we have substantial more branches that the customers see, are looking more and more like sometimes Starbucks in Chinatown. When people walk around, say, every corner they turn is East West Bank. So it's much easier for us to attract customers. These clients, now, they recognize our strength. On a balance sheet, they recognize that we are doing well. And all of that, sort of, like, fuel the additional opportunity for us to get additional C&I loans. One other thing that I want to add, the reason you see that payroll costs are going up is because -- well, just keep in mind, we were able to create substantial amount of deficiency with these mergers, because there are a lot of overlap that we're able to really reduce the headcount dramatically through this people and system integration. But on the side, we are out there hiring quite a few of commercial lenders. So all of that combined, every commercial lenders come in, produce additional C&I loans. So I think that's just a trend that is going right now, that we have, sort of like the right timing to grow in the business. And frankly, I think that if the economy turns dramatically positive, we would expect that any other banks also come back sooner, we would expect that we would not have as easy of a time, and gradually or naturally, that we would not have as high of a C&I growth. And so it's a combination of this opportunity in the greater China that cross-borders trade settlement that allow us to make cash collateralized, or maybe, Standby LC-type of loans, that's normally, frankly, 2 years ago even if we had the license, we wouldn't be able to do it, because the regulation in China would not allow us to do that. And on top of that, with this sort of like uncompetitive environment in the banking world in our regions' amount of competitors. I think those combinations help us to be where we are today.

Ken Zerbe - Morgan Stanley

All right, that is very helpful. Just one other question regarding net interest margin. Obviously, you have the 4% guidance for the full year, and I'm kind of assuming that the first half is roughly 4%. So the second half should be 4%. But what factors would actually lead to a disappointment in them? Like, what would drive them below the 4% that you're looking for? Because I assume that you are taking into account, the reinvestment cash flows on securities, given where loan yields are, I guess, where does the surprise comes from, if there were to be one?

Julia Gouw

Ken, this is Julia. I think that the likelihood that we would have, like a net interest margin in the near future to go down significantly below the 4%, is probably very low. So we believe that for the next 2 quarters, margin around 4% is very, very achievable. However, the very low interest rate environment, if it's prolonged into full year in 2012, we'll see some possibility of slight compression because the asset yields will continue to be very depressed. And there's no way to reduce the deposit rates below what it is right now. But in the near future, we feel very comfortable that margin around 4% is very doable.

Dominic Ng

Also competition, if competition gets even more intense going forward, from banks who we're chasing. We are one of the few that actually have a very, well, I would say, that have an easier time to grow loan balance. But a lot of banks are struggling to grow loan balance. And for those banks who are struggling to grow loan balances, they may decide to go with a different strategy of really, cutting down the pricing. We, obviously, do not want to have our good, existing clients to go to another bank, simply because the other bank offer like a 50 to 100 basis point lower in pricings. So every now and then, we need to match. So if that actually intensified in the next 6 months, there is a likelihood that would go down slightly. But dramatically, highly unlikely.

Operator

Our next question comes from Joe Morford from RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC

This is the first time we've really heard you talk about growing in Hong Kong and China since you bought UCB, and I guess, can you just expand on your comments about the current strategy for those markets? How are you going to go about growing the business over there? Is it just going to be in this cross-border RMB business, or are you willing to start doing more of the general middle market, or SME lending over there as well?

Dominic Ng

No. I think our strategies are very consistent. Day 1, when we took over both -- well, we have our branch in Hong Kong, actually, before we acquired Washington International Bank. But the day 1, that we took over Hong Kong, United Commercial Bank and also, China, we never changed our direction. East West have always pride ourselves the financial bridge between East and West, and that's been our sort of vision and mission for the last 20 years, and that really hasn't changed at all. And it will not change going forward in the future, that is that. In Hong Kong and in China, we're going to focus on cross-border trade. We're going to focus on helping Chinese enterprises, Chinese entrepreneurs to invest in the United States. We're going to help U.S. companies to explore opportunities and doing business in China. We will also help high net worth Chinese individual customers, and there are many, many more recently coming to U.S. and settle down in various neighborhoods where we have our branches. And that's pretty much what we do, and that's going to be the focus of what we will be doing also in the future. And the idea about, let's say, expanding in China or in Hong Kong to focus on the retail or commercial banking business that has no strategic connection with United States, will be something that we will continue to avoid. We just don't think that we can add value if we do not use our U.S. and California franchise as a leverage. Whatever you go and to do banking business that you have no strategic value, have no value proposition, there is going to be a high likelihood that you end up taking worse quality credits that the other banks don't want. So we do not want to get ourselves stuck in that position. So that's the kind of direction that we're going to be going forward to. So my sense is that, U.S., I'm sorry, China and Hong Kong, are not going to be growing in the same kind of magnitude like U.S. So a good example will be, we're now $22 billions, and the China loan balance is only about less than $170 million. And in Hong Kong, it's only 400-some-odd millions. So altogether, it's a very, very small balance sheet. You see the growth for the last quarter simply because it is so ridiculously small. Any growth looks kind of big. But I look at it as that -- I just don't foresee that China, suddenly, will go from $170 million to like $1.5 billion, in a year or 2, or that kind of stuff. It's just not going to be -- it is just most likely not possible because we are going to be very focused. We are not looking at the China market as, while it's 1.3 billion population there, and then we're just having a great time chasing every one of them, that is not the strategy.

Joe Morford - RBC Capital Markets, LLC

Okay, that's very helpful. I guess the other question I had was, just curious how you were able to keep the yield on non-covered loans stable in the quarter given that competitive environment you talked about, and the fact that about 1/3 of the growth this quarter came from the cash secured trade finance loans, which I suspect has finished for a business.

Julia Gouw

Well, as you know, the inflow and outflow and the increase, as much as it looks big, but that, as you know, as a percentage of the portfolio, is not that high. So I think that, that's why you don't see major changes, that the yield is pretty stable.

Dominic Ng

Yes, to put it into perspective, it's $300 million net growth in our loans, out of $14 billion of loans. And on top of that, we have a $22 billion asset balance sheet. So altogether, I think that relatively speaking from a growth perspective, it looks high, but then from the overall balance sheet perspective, it's actually relatively small. So by and large, all the margin is primarily affected by the rest of the portfolio that's been with the book for a while.

Operator

Our next question comes from Lana Chan from BMO Capital Markets.

Lana Chan - BMO Capital Markets U.S.

A couple of questions. One, on the increase in the securities yield, you talked about repositioning the portfolio in this quarter. Could you be more specific about what you actually did in the portfolio?

Irene Oh

Lana, it's Irene. Yes, some of the things that we're doing with the securities portfolio, which we started in the first quarter as well, is we want to make sure that we're having prudent interest rate risk management. However, we know that our investment securities portfolio, generally speaking, compared to many peer banks, is lower, the yield is lower, because a lot of our securities are very short-term in nature. So we have a little bit more of a barbell strategy, where there are a small number of securities we're bulling out a little bit longer. Where the vast majority, the impact of the portfolio, is the shorter term, lower rate, but that has helped. Maybe this slight change has helped increase the yield a little bit in our portfolio.

Lana Chan - BMO Capital Markets U.S.

Okay. What's the average duration now?

Irene Oh

It's still pretty short. I would say, about 2 years, 2.5 years, yes. So if you look at the yield itself at 2.9%, it's really not -- you would see it lower than a lot of other banks who probably take on more interests rate risks in their portfolio.

Lana Chan - BMO Capital Markets U.S.

Okay. Also, could you remind us, what other opportunities there are for sort of lowering your overall funding costs? Other opportunities to prepay some of the borrowings?

Irene Oh

Yes. We always have the opportunity to prepay the Federal Home Loan Bank, but the impact would not be a lot. And we'll continue to look at our cost of funds, the deposit rate. But I do not expect that any changes will be dramatic. However, we'll continue to find ways to maximize our funding opportunities and lower the cost of funds.

Dominic Ng

It will be gradual. I think that quarter by quarter, I think that we should expect some slight decreases in the cost of deposits.

Irene Oh

Lana, we have about $0.5 billion of FHLB advances, currently with effective rate of 2.25. So more of a higher cost once we've already prepaid.

Lana Chan - BMO Capital Markets U.S.

Okay. And just one last question. You actually showed some commercial real estate growth this quarter for the first time in quite a while. Could you talk about what opportunities you're seeing there and what's growing?

Irene Oh

Yes. Most of them are either existing relationship, we are not going to just to do a transactional commercial real estate. Some of our current clients had opportunity to get good assets, commercial real estate, we'll be willing to finance that. In addition, some of them are coming from new commercial loan customers, who, in addition to the business, they have an owner-occupied warehouse, or sometimes, additional investments, and we will do that. What we are not going to do is somebody just coming in, along with one-off transactions, buying a real estate, or just want to refinance 1 property.

Lana Chan - BMO Capital Markets U.S.

And are you seeing better yields on the commercial real estate now than before with low competition?

Dominic Ng

It depends, because particular for these commercial C&I clients, and these real estate is a package deal. So whenever we take on a C&I client, we want the entire relationship. So we take that line of credit, and then we have to take the warehouse and then the office building where they're located, whatnot. And then obviously, the demand deposit account and the money market accounts, et cetera, et cetera. So when we do that, because of the package deal, most of these clients have pretty good rate for these real estate loans, so we have to offer just as good of a competitive rate to get them over. Now on the other hand, if it's an existing client buying an additional piece of property because they got it for such a great deal, like one of these FDIC, sort of great bargain, they obviously are not nickel and dime with us, because -- I mean, just to be in the transaction, they already make so much money. And so for us to charge a little bit more, they are very comfortable with it. And also, there's not like a lot of banks out there doing these kind of deals anyway. So for these good existing clients, some of them are willing to pay a little bit higher rate. So it's a combination of these 2, to get where we are.

Operator

Our next question comes from Gary Tenner from D. A. Davidson.

Gary Tenner - D.A. Davidson & Co.

Just a question on the commercial loan growth that you had this quarter, beyond the trade finance. How much of that is new versus existing customers?

Irene Oh

Combination. But I would say, majority are new customers for the C&I, yes.

Gary Tenner - D.A. Davidson & Co.

Okay. And also, how much would you estimate had been SNC or purchased loans?

Irene Oh

Can you repeat the question again?

Gary Tenner - D.A. Davidson & Co.

How much of the loan growth is brought in syndicated loans?

Irene Oh

Oh, very small. Out of that $500 million total of increase, which is $250 million in the U.S., $250 million in Hong Kong and China. Only $30 million is increased from the syndicated loans. So it's a pretty small part of the increase.

Gary Tenner - D.A. Davidson & Co.

Okay, great. And the comment on the cross-border production and the outlook for the Chinese portfolio, you've kind of said, well, it's not going to go up on to $1.5 billion overnight, can you kind of give us your expectation of where that portfolio might get to, say, by the end of 2012?

Dominic Ng

It all depends on the opportunities that come along, because, obviously, we have a lot more of these cross-border deals to do. We actually do get -- I mean surprisingly, I mean, we do get some spread, not -- that's obviously not 4%, but we do get, like usually a couple of percent spread. And you know what? If there are more of these opportunities, we would take some more of these and also, if strategically important for us, we'll do some more. But as of now, we see the Chinese government provides quota to each bank about how much you can do just to control the foreign exchange, we pretty much tapped out. And now, this is the interesting thing though, when we're done with our quota, we go ask to see what we can get more. I have no idea what they're going to give us. They may just say that, everybody stop, no more. Or they may come back and say that we want you to do more. This is all come from the government policy, so it's hard for us to predict. So my sense right now is that, conservatively, we may not be doing a whole lot more.

Gary Tenner - D.A. Davidson & Co.

And is that quota sort of a maximum portfolio level? Or is that an annual quota of new loans you could make? How does that work?

Dominic Ng

It's actually, what they do is that they look at your balance sheet to see how big you are, in terms of how much loans you have and, obviously, they look at your capital, how much you have -- I mean, and then they will make an allocation. Now, I mean, in terms of exactly the detail, this is so new. I'm sure that the Chinese government who are in control of their foreign currency at this moment, they are sort of like coming up with new policy as it goes. So we just get, I mean, like, we get whatever we can get. And that's what this is all about.

Gary Tenner - D.A. Davidson & Co.

So it's conceivable though, that you may not be able to put any more of those loans on the books the rest of the year, let's say?

Dominic Ng

No. We may not be able to do anymore cross-border guarantee loans that are specifically granted by the Chinese government from the foreign exchange agency. However, there are always going to be some loans that we can do. For example, we have quite a few, our U.S. customers, who are currently doing business in China. These are customers we know very well. We know exactly what their financial conditions. Do they have credit exposure with us in the United States? We are very comfortable if they are in China, that need to do some business and they need us to provide some level of financing, we're very comfortable to finance these kinds of customers. Vice versa, there may be a company from China, that we are currently doing business in the United States with their sort of like, subsidiary operations in the United States. Their parent company, to provide more support to the subsidiary company in the United States, may choose to sort of like develop some additional banking relationship to support our branch in Shanghai. And for that reason, we may want to get into provide some sort of credit support, just as a token credit support, to sort of like open up the opportunity to have more commercial deposit from these types of Chinese company that's already been doing business in the United States. So those kinds of combinations are the type of activities that may potential open up to allow us to do more business there. But there is a different dynamic here, is that everything that we do in China is more strategic, not necessarily that we either are going to be counting on them to say, well, without this loan growth, we will not make our earnings. So without the loan growth, we will not sort of like have the balance sheet that we want. That kind of responsibility is shouldered by our U.S. counterpart. So like the domestic U.S. branches and operation need to get the engine going. China, is primary focused on strategic advantage, strategic leverage. The strategic leverage is that, because we have these Chinese companies, that's why we have so many U.S. domestic C&I borrowers who are interested to do business with us, because we are very unique brand that none of the other banks in U.S. can compete with us in this category. And that's why, the Chinese, the China and the Hong Kong operation are very critical to our strategic existence, but we do not need them to go out and crank up loans and deposits.

Operator

Our next question comes from Julianna Balicka from Keefe, Bruyette, & Woods.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

I have a couple of follow-up questions, if I may. Just kind of to go back to this, that the growth topic that you were just addressing on that $250 million that came from the cross-border activity, versus the $250 million that came from your U.S.-based operations. So that $250 million that's from the U.S.-based operations, that's kind of a level from which we should be kind of thinking about forward future growth for the rest of the year, correct?

Irene Oh

We think that probably $150 million a quarter is doable. We may not be able to sustain the $250 million. In the first quarter, we did about $200 million, and the second quarter $250 million. But I would say, probably, $150 million per quarter, for the remaining of the year, is a doable target.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

That makes sense. And then on the $250 million that you attributed to the cross-border loans that Dominic was just discussing, since there is a cap there from the China side, when you are referencing the companies who are U.S.-based with China operations and those are an additional source of growth, would that be part of that $250 million cross-border? Or would that be part of the $250 million domestic?

Irene Oh

No. It will be the $250 million in Hong Kong and China. However, they may not be cross-border. It's just we are very comfortable with the parent company in the U.S. so we give them the credit in China to their subsidiary or operation in China, but we are relying on the global company's financial strength. They're so up loans over there. So when we report that, it would be the loans in China.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

So then considerably, there's going to be growth from the both sides of the $250 million that you have from this quarter, right? The $150 million in the U.S. and then some moreover $250 million on the cross-border, yes?

Irene Oh

Correct, yes.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

Okay, very good. and then the question I have on the follow-up was in terms of loan yields, can you tell us what kind of loan yields you are seeing on C&I, just straight up regular small business C&I in the U.S., trade finance in the U.S. C&I, and maybe, something else you're seeing in the China or Hong Kong loans, can you just give us a little bit more granularity there, please?

Irene Oh

Yes. Right now, for the C&I loans, we're seeing about 350 on the average, some higher, some lower.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

But these are US-based, or China-based, or?

Irene Oh

U.S., right.

Dominic Ng

In Hong Kong, it's lower. In China, it's higher.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

And then, is there a difference in yields between just straight trade finance, C&I versus regular C&I, that you're seeing or anything like that?

Irene Oh

No. It's more case-by-case. So there's not really a clear cutback. One is higher than others.

Operator

Our next question comes from Brett Rabatin from Sterne Agee.

Brett Rabatin - Sterne Agee & Leach Inc.

I wanted to ask on credit quality, generally speaking, as the construction book continues to diminish, should it be reasonable to expect that the charge-offs next year continue to decline? Or can you give us some color on loss content as you see it, as we go into the second half?

Irene Oh

Brett, it's Irene. Yes, definitely, our expectation for 2012 would be that provision charge-offs continue to go down. As you mentioned, construction, land, it's less than 3% of our book right now. So as those balances, as we chip away at those, there will be less provision and charge-offs in 2012.

Brett Rabatin - Sterne Agee & Leach Inc.

Okay, and then the other question I wanted to ask is, you're giving guidance to a flattish balance sheet, assuming that would be the case next year as well, capital continues to accumulate. I know I've asked you about share buybacks and increased dividends in the future. Can you give us some color on how you plan on managing capital next year or even in the second half as well?

Dominic Ng

First of all, I think that, we, at East West, always do things one step of the time. And when it comes to this capital management, maybe sometimes a little bit slower than the others. Our plan is that, we probably, we most likely will increase dividends. Looking at most likely, maybe, right at the beginning of next year. That's what I would say, that we will be very highly likely to get our dividends to double up to where we are today. Secondly, after we increased dividends, double to where we are today, that we look at the balance sheet, and then now, if we continue to have this $500 million a pop, kind of like quarter growth, and then getting very good loans, and then the economy allow us to keep growing, well, that we may not do much with the sort of capital management. Or if for some good reasons, another great acquisition opportunity comes along, we obviously, we'll use the capital deployed for acquisition. However, assuming in this kind of trend today, we have nice organic growth, and there's really no reason for us to get distract and go in and buy a distressed real estate shop, and then if that's the trend that we're going, we have nice organic C&I growth, and everything is going as good as it is today, then I think there is high likelihood we have excess capital even after we double our dividends. And at that point, I think, it will be appropriate for us to look into a stock buyback. So all of that, I think, that we're going to try to have it looked at in 2012.

Brett Rabatin - Sterne Agee & Leach Inc.

Okay, that's great color, Dominic. And then just one last one on the loan portfolio team. Can you talk about the additions you've made to the staff the past year and then perhaps, if you feel that the loan lending team is fully productive at this point. Or if you think that they still have capacity to continue to ramp up, I mean, you won't have to make new hires before or won't have to make new hires as loan growth continues to show on the balance sheet?

Dominic Ng

Well, our hiring practice is really, I will say, more strategic and opportunistic. Strategic and opportunistic is that, we're trying to identify specific industries that are relevant to East West, particularly, industries that maybe, a company from China are interested to participate in the United States, to co-invest in the United States and vice versa. So for that reason, anytime we find great commercial bankers that have these type of industry expertise, or special technical skills, we'll bring them on. As of today, I will say that because of quite a few new hires that we've been sort of bringing on since 2010, obviously, the one that came in less than a year, always have excess capacity to grow their portfolio. And they will need to take their time to gradually build up their portfolio. But in the meantime, while these existing new hires sort of like ramping up in terms of their capacity, we will continue to look for these strategic hires that is out there, and also opportunistic hire. Every now and then, there is one bank, that for whatever reason, whether they are, I think there's not that much that we can find, quite frankly, from distressed banks. I would say that most of the new hires that we brought in are from very strong banks. But every now and then, these really strong banks would like to do a restructure of organization, movement and so forth. And that will cause distress to some of these commercial bankers. And so it gives us the opportunity to bring them back to East West instead of where they were. And so these type of opportunistic hires is something that we continue to explore. And I think that going forward in 2012, we will still be looking at these kind of opportunities.

Operator

Our next question comes from Christopher Nolan from CRT Capital.

Christopher Nolan - CRT Capital Group LLC

How should we look at the reserve ratio going forward? It should be a function of nonperforming loans volumes or some other metric?

Julia Gouw

Yes. The allowance is always a combination of the portfolio mix, the nonperforming assets. But we believe that if the nonperforming assets continue to decline, once they stabilized in the long term, some allowance around 2% seems like a reasonable ratio that we can expect.

Christopher Nolan - CRT Capital Group LLC

Okay. And turning to China for a second, the restriction on the lending cap that Dominic was mentioning earlier, that the Chinese government imposes, that for include Hong Kong loans, or just for Mainland China loans, or is that sort of...

Dominic Ng

Just only applied to -- well, actually yes and no. It applies to our subsidiary bank in China. However, Hong Kong in the last quarter, benefit from this cross-border renminbi trade settlement financing. Because a loan made in Hong Kong, a deposit placed in China, that type of arrangement, were taken place last quarter. So I would expect that if there is no more quota, Hong Kong will be affected slightly because of that. Hong Kong will lose that one additional product they can sell. But if it open up again, then I think that Hong Kong will continue to be have the opportunity to explore this type of financing opportunity.

Christopher Nolan - CRT Capital Group LLC

So if there's no -- if the cap does not increase, you could see some incremental growth from Hong Kong, correct?

Dominic Ng

Yes.

Christopher Nolan - CRT Capital Group LLC

Great. I guess a final question, how much does Hong Kong account for in that $250 million increase of loans from China?

Julia Gouw

China increased about $60 million, $50 million but the rest actually is booked in Hong Kong. $50 million in China...

Dominic Ng

Hong Kong has major growth in loans. China has the bigger growth in deposits.

Christopher Nolan - CRT Capital Group LLC

Got it. So we could see, continued -- potentially, continued growth in China just from Hong Kong growing?

Dominic Ng

Well, no. Again, it depends on this cross-border allocation. And also well, that's just one product. There's always other lending opportunities that we can look at like vendor financing. There are a lot of opportunities that we can look at. But Hong Kong does not have good pricing. The competition in Hong Kong, when it comes to loan yields, is really intense. So as much as I think that there are great -- there are plenty of opportunities for us to make loans in Hong Kong. I just don't like the yield there. So I think that, I don't expect Hong Kong would have any kind of meaningful growth, actually, going forward in the next 2 quarters, simply because that the loan yield has been coming down quite a bit. On the other hand, China, the loan yield has been phenomenally good. But we need to make sure we find the right type of lending vehicle for us to do the right thing in China.

Operator

Our next question comes from Aaron Deer from Sandler O'Neill and Partners.

Aaron Deer - Sandler O'Neill + Partners, L.P.

Just a quick question on one of the guidance components, with respect to looking for flattish balance sheet for the remainder of the year. Given the strong loan growth that you've been seeing, I'm wondering if that's just an offset from some of the run-off in the UCB portfolio or if you're looking to see a loan mix or rather an earning asset mix put more of the liquidity in the balance sheet to work. Why wouldn't we be looking to maybe see a little bit more overall total asset growth between now and the end of the year?

Irene Oh

That's correct, Aaron. We are expecting that there will continue to be growth as Julia mentioned, at least about or approximately $150 million on the C&I front on the non-covered loans, but it would be offset by decreases in the covered portfolio. This quarter, a little over $200 million, pretty much the same last quarter as well. So that portfolio will naturally continue to decline. So net-net, we feel that a flattish balance sheet is a more appropriate kind of estimate for us.

Aaron Deer - Sandler O'Neill + Partners, L.P.

Okay. And within the securities book, are you putting more of your excess funding to work there? And if so, what are you buying? And what kind of durations are you taking on those?

Julia Gouw

No. We talked earlier that, we want to keep the investment securities short. Going back to -- we have very good margins to where it is right now. We are very profitable. So it doesn't make sense for us, at this point of time, to take on more interest and risk, and that's why our yield on the investment securities is lower than majority of our peer banks, because we want to keep it short, and we just have to wait it out until the interest rates go up to take on some duration on the portfolio.

Operator

[Operator Instructions] And our next question comes from Matthew Keating from Barclays.

Matthew Keating - Barclays Capital

Turning back to credit briefly, after taking down for most of last year, nonaccrual residential mortgage loans have increased for the past 3 straight quarters. I was just wondering if you could comment on trends here, with this book growing about 7% in 2Q. And it also represents now about 14% of your non-covered loans. I was wondering if you have any targets on how large of your overall book this could ultimately represent?

Julia Gouw

Even though, it increased slightly if you look at the portfolio that we have, it's still a very small percentage that is nonperforming.

Dominic Ng

So I think the question is on how big of a Residential Mortgage? So let me just make sure, is that your question on how big of Residential Mortgage you're expecting us to grow?

Matthew Keating - Barclays Capital

Yes. I'm just wondering what your targets might be for that, that portion of your book.

Dominic Ng

Well, this is another, a relatively opportunistic. This is now more on the Retail Banking side. I tell you, for the last several months, the major banks who have been doing Residential Mortgage have really scaled back. Well, I don't know if scale back or the paperwork have become so ridiculously tedious, that most of our retail customers that normally would go to the large banks before the conventional mortgage loan have now turned over to East West and asked us to provide financing for their, either refi or new purchase for their Residential Mortgage. Now as Julia talked about earlier, that the new loan origination, the new residential loan origination, that we originated in the last 3 months is around 55% loan-to-value. So it's a very different kind of mix like the typical loans that you heard about in these congressional hearings.

Matthew Keating - Barclays Capital

Got you. And just one last question, perhaps, Irene you could help with this. I was just wondering if you could comment on the level of regular purchase accounting accretion in the quarter outside of the impact from the covered loan dispositions and such.

Irene Oh

It's about $15 million a quarter, Matthew.

Operator

Our next question comes from Jonathan Elmi from Macquarie Capital.

Jonathan Elmi - Macquarie Research

Just quickly, on the expense guidance. If I look at the second quarter expense level and then take out the FDIC reimbursement of $13.6 million, it still looks like you guys are above the high-end of the quarterly guidance for the back half of '11, if I'm thinking about that right. So what's going to drive those expense levels down in the next quarter? I just wanted some clarification there.

Julia Gouw

Well, some of the expenses, we have to pay the 20% of the FDIC reimbursable expenses and some of the legal expenses. There's a likelihood that is slightly lower, but we feel that $97 million to $100 million per quarter the next 2 quarters is a global range for expenses.

Irene Oh

The core expenses are very stable, Jonathan. It's really these unknown credit costs, which can kind of creep up in the quarter. So that's why we get that range.

Jonathan Elmi - Macquarie Research

Okay, that's fair. And then just last question, if we can just go back to the margins, for a second. When I look at the non-covered loan yields, obviously, there was a bit of a pressure there in the first quarter of '11. And I guess, I just want to try to understand what the primary drivers of that first quarter compression were, and why they didn't recur in the second quarter? Any help there would definitely be appreciated.

Irene Oh

We had talked about this in the call last quarter as well. But what particularly happened in the decrease in the yield on the non-covered loans in the first quarter was because there just happened to be many loans where the floors came off at that period, or that were repricing downward. So right now, we feel it will be a little bit more stable for the remainder of the year.

Operator

Our next question comes from Ram Shankar from FBR.

Ram Shankar - FBR Capital Markets & Co.

Just on the RMB loans, what are the average terms of these, I mean how long are these loans?

Dominic Ng

Average?

Ram Shankar - FBR Capital Markets & Co.

Yes, the life of the loan, I guess.

Dominic Ng

It'll be a little bit over a year, because most of them are one-year loan -- the majority of them are one-year loan. There are a few of them that I mean, like a 3-, 5-year terms and so forth. I mean I would say that, if you average them all out, will probably, maybe less than 1.5 year.

Ram Shankar - FBR Capital Markets & Co.

Okay. And just on the trade finance side, is there a typical seasonality pattern involved in this. I mean, do you expect more line withdrawals next quarter ahead of the holiday season, is that typical in that type of business?

Julia Gouw

I'd say, it depends on the customers if their business in growing, they will borrow more. It's not necessarily the timing of it.

Dominic Ng

Yes. Not that much. Because again, not a lot of our trade deals are not just -- I mean, years ago, everybody just sell toys and garments. So they're all going after the Christmas season. I mean, in today's world, the trade is all over the map, different type of products. There are imports. There are exports. So I really don't see that the seasonality should make any difference at all.

Ram Shankar - FBR Capital Markets & Co.

Okay. And a couple of numbers from Irene, will the accretable yield balance at June 30, Irene?

Julia Gouw

$170 million is the accretable discount that will come into income.

Irene Oh

The net accretable discount.

Ram Shankar - FBR Capital Markets & Co.

Okay. And then, what was the duration investment book the last quarter, could remind us that?

Julia Gouw

I would say, it's all about the same. Between 2, 2.5 years.

Operator

Our next question come from Jennifer Demba from Suntrust Robinson Humphrey.

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Julia, I think you mentioned in your commentary, that you expect nice growth in your core fee income line items over the foreseeable future. Can you just give us a little color on that? And are we talking about sort of a low double-digit growth, or just kind of give us some more color that.

Julia Gouw

It will not be dramatic because fee income is quite difficult to get. But a combination, because we have a lot more customers from the activities, from the deposits, from FX transactions that they do. But it will not be in the -- a total revenue basis is not going to be very significant, but like compared to the core fees of about $22 million a quarter, maybe we'll see like $1 million increase. So that's around what we're thinking.

Operator

And we have a follow-up question from Julianna Balicka from Keefe, Bruyette & Woods.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

I have a question on your C&I loan growth. To what degree, or is there a visible presence of tech-oriented loans vertical, a lot of cross-border activity, for example, semiconductor, fabs, et cetera. Could you comment a little bit on the impact of tech and the Northern California in there?

Dominic Ng

Not much in this quarter. We are expanding our tech group. But I would expect that the growth will be hopefully coming in, in the third and the fourth quarter. But in terms of in the first and second quarter, I think that we do have some very minor loans that are from the tech industry, but it's relatively minor at this stage. But I mean, this is definitely a strategically important area that we expect to have more growth going forward in 2012.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc.

And could you give us some idea of how large you expect it, I mean how many people you hired? Just give us a little more color there?

Dominic Ng

Well, we currently have a group of tech lenders in the Silicon Valley, but I think that we are in the process of hiring more. I would say that I will be able to give you a much better idea comes the end of the third quarter. Then I'll be able to give you a better idea about how many people we have, then I'll be able to get you a better idea how much longer that we're going to be doing, 2012 and so forth.

Operator

You have additional follow-up question from Ram Shankar from FBR.

Ram Shankar - FBR Capital Markets & Co.

Just on the UCB loan margin, you narrowed it down from 20% to 14% in 4Q, and just based on the pace of prepayment activity that you've seen and then just overall better credit, is there a chance that you can maybe lower that mark down? I mean, are you guys monitoring that?

Julia Gouw

Yes. So on a quarterly basis, we look at what the credit performance has been, and will continue to be. We'll project that in the future. So I would say at this point, it's not outside the realm of possibility that we might lower that credit mark, but we'd have to do a full analysis. And we would continue to do that on a quarterly basis periodically.

Operator

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

Dominic Ng

Well, thank you all for joining us in today's call, and I look forward to speaking to you in the next quarter. Thank you.

Operator

The conference has now concluded. We thank you for attending today's presentation. You may now disconnect your telephone lines.

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