Nara Bancorp, Inc. Q2 2008 Earnings Call Transcript

Jul.26.08 | About: BBCN Bancorp, (BBCN)

Nara Bancorp, Inc. (NARA) Q2 2008 Earnings Call Transcript July 23, 2008 12:30 PM ET

Executives

Tony Rossi – Financial Relations Board

Min Kim – President & CEO

Al Kang – CFO

Bonnie Lee – Chief Credit Officer

Analysts

Brett Rabatin – FTN Midwest

Aaron Deer – Sandler O'Neill

Erika Penala – Merrill Lynch

Joe Gladue – B. Riley & Co.

James Abbott – FBR Capital Markets

Leona Slongka [ph] – KBW

Chris Stulpin – D.A. Davidson

Dan Boston [ph] – Lazard's Advisors [ph]

Don Worthington – Howe Barnes Hoefer & Arnett

Operator

Welcome to the Nara Bancorp Q2 2008 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) This conference is being recorded today, Tuesday, July 23, 2008. I would now like to turn the conference over to Tony Rossi of Financial Relations Board. Please go ahead sir.

Tony Rossi

Thank you operator. Good morning everyone and thank you for joining us for the Nara Bancorp second quarter 2008 earnings call. Joining us this morning from management are Ms. Min Kim, Chief Executive Officer; Mr. Alvin Kang, Chief Financial Officer; and Ms. Bonnie Lee, Chief Credit Officer.

Before we begin, I’d like to make a brief statement regarding forward looking remarks. The call today may contain forward looking projections regarding future events and future financial performance of the company. We wish to caution you that such statements are just predictions and actual results may differ materially as a result of risks and uncertainties that pertain to the company's business. We refer you to the documents the company files periodically with the SEC, specifically the company’s most recent 10-Q and annual report on Form 10-K as well as the safe harbor statement in the press release issued yesterday. These documents contain important risk factors that could cause actual results to differ materially from forward looking statements. Nara Bancorp assumes no obligation to revise any forward-looking projections that may be made on today’s call.

With that, I’d like to turn the call over to Ms. Min Kim. Ms. Kim?

Min Kim

Thank you, Tony. Good morning and thank you for joining us today. I am going to provide a brief overview of the second quarter of 2008 and then I will turn the call over to Al Kang, our Chief Financial Officer, who will review our financial results.

Following Al’s remarks, I will conclude with a discussion of our outlook for the remainder of 2008.

We earned $0.07 per share in the second quarter compared to $0.33 cents in the same quarter last year. The decline in earnings is attributable to four factors. First, we had a 75 basis point decline in our net interest margin compared to last year. Second, we have lower SBA loan production and a lower gain on sale of those loans as a result of tighter underwriting criteria we have instituted in our SBA lending business. Third, we incurred a $1.7 million charge resulting from the write- down of an asset-backed security that was recently downgraded by one of the rating agencies. And fourth, and most significantly, our provision for loan losses increased by $8.3 million. The increase in provision for loan losses reflects the impact of the slowing economy on our loan portfolio. We have noticed a deterioration in our retail business loans over the past two quarters and now we are starting to see some stress in the commercial real estate portfolio.

We have two CRE loans and one commercial business loan totaling $6.8 million moving to non-performing status this quarter. One was a retail strip mall, the second was a single tenant property, and the third loan was a line of credit to an apparel manufacturer. We have conservatively provided reserves on these loans as we pursue foreclosure workout.

We believe we are being very aggressive in managing the loan portfolio through this credit cycle. We have allocated more resources for visiting and reviewing the business operations for significant credit. This will allow us to identify problem credits as early as possible and establish communications with the borrowers at the first sign of deterioration. And finally, in keeping with our long standing policy, we are being aggressive in charging off loans and maintaining appropriate reserve levels.

Entering this year, we knew that the operating environment will not be conducive for generating earnings growth, so we've determined that our highest priority should be maintaining the strength of our balance sheet and preserving our capital. In this regard, our allowance supporter loan has increased during the year and our capital ratio continues to be significantly above the regulatory definition of well capitalized.

At this point, I am going to turn the call over to Al who will review additional financial results for the second quarter. Al?

Al Kang

Thank you, Min. Before I begin, I would like to note that information that led to some additional provisioning and the write-down of asset-backed security was only received in the last few days and had a significant impact on our reported earnings for the quarter.

I will begin my discussion with some color on the net interest margin. We again saw some compression in our net interest margin, although not to the degree that we experienced during the first quarter. On a GAAP basis, our net increase margin was 3.97% in the second quarter of 2008 compared to $4.15% last quarter, a decline of 18 basis points.

With interest rates declining further in the second quarter, we continue to see a decrease in the yield on our loan portfolio. However, we were not able to reduce deposit costs at the same rate due to the inherent deposit rate and the highly competitive deposit pricing in the marketplace.

During the second quarter, the yield on our loan portfolio declined by 66 basis points from 7.85% to 7.19%, while our cost of total deposits only declined by 53 basis points from 3.43% to 2.90%. The decline in the yield on our loan portfolio is attributable to adjustable rate loan re-pricing lower with these reductions in interest rates. The yield on our adjustable rate loan portfolio declined from 6.63% at March 31, 2008 to 6.02% at June 30.

On the other hand, the yield on our fixed rate portfolio only declined 2 basis points during the second quarter to 7.67% reserved as a buffer against declining interest rates. However, the percentage of fixed rate loans declined during this quarter as we have been emphasizing adjustable rate loan in anticipation of a potential rise in interest rates. Fixed rate loans now represent 51% of our total loan portfolio compared to 55% at March 31, 2008.

The decline in our net interest margin offset the effects of our growth in earning assets which resulted in net interest income before provision for loan losses remaining essentially flat with the second quarter of 2007.

Our non-interest income was $5.0 million in the second quarter which was a decline of 18% from the same period last year. The decline was primarily due to a decrease in SBA loans sold and a reduction in the average sales premium. As Min indicated, we have tightened our underwriting criteria in the SBA lending business, which has reduced our loan originations and therefore our volume of loans sold as well.

Our SBA loan originations were $12.9 million during the second quarter, down from $57.3 million in the same period last year. We sold $12 million of SBA loans during the second quarter of 2008 compared to $33.4 million in the same period last year. The average sales premium on these loans declined by 228 basis points from the prior year We do not expect a meaningful improvement in SBA loan production or the average sales premium in the foreseeable future.

Within our non-interest income categories, our service fees on deposit accounts were $1.7 million, an increase of 2% from the second quarter of 2007. The increase is primarily attributable to a new deposit fee structure that was put in place over the past year.

During the quarter, we continued to reposition the investment securities portfolio as part of our interest rate risk management strategy. We recognized a gain of $393,000 from the sale of $21.9 million of available for sale fixed rate securities. These proceeds were re-invested into adjustable rate securities.

Other income and fees increased by 19% from the second quarter of 2007 to $2.3 million. The increase was primarily due to a valuation gain of $824,000 on interest rate loss. Our non-interest expense increased 18% over the prior year. The increase was partly driven by higher salaries and benefits expense, as well as higher advertising and marketing expense related to several deposit promotions launched during the second quarter of 2008. These increases were offset by a reduction in professional fees, primarily due to lower legal fees.

Our non-interest expense in the second quarter of 2008 included an other-than-temporary impairment charge of $1.7 million related to the write-down of a non-agency asset-backed security that was downgraded by a rating agency during the quarter. We have no other non-agency asset-backed securities in the portfolio. We also had a $334,000 write down to fair value of a loan that did not – had been held for sale. The sale of this loan fell through the quarter which triggered the revaluation.

Our operating efficiency ratio was 56.7% in the second quarter of 2008 compared to 46.4% in the same period last year. Flat net interest income and the decline in revenues from SBA loan sales, combined with the 18% increase in total non-interest expense, caused the increase in the operating efficiency ratio.

Moving to the balance sheet, our growth loans were $2.12 billion at June 30, 2008 and annualized increase of 9% from the $2.07 billion at March 31, 2008. The growth was driven by 16% annualized growth in the commercial loan portfolio and 8% annualized growth in the commercial real estate portfolio. With respect to the commercial portfolio, we have developed an attractive niche as the preferred lender for ethnic grocery stores in the New York area targeting the South American community. This area was responsible for the strong growth we saw in the commercial portfolio this quarter.

New loan production was $146 million in the second quarter of 2008 compared to $176 million in the first quarter of 2008. The decline in loan production reflects the continuation of our tightened underwriting criteria and our desire to limit our exposure to certain industries as well as a decrease in loan demand due to the slowing economy.

Our total deposits were $1.93 billion at June 30, 2008, an increase of 16% annualized over the $1.85 billion at March 31, 2008. The increase was attributable to higher balances of money market deposits and brokered and safe treasure CDs.

Retail deposit growth will continue to be a challenge due to the competitive environment we operate in, as well as the effects of the slowing economy. However, we will address as we speak of avenues to grow our deposit needs. Online deposit accounts, new branches in growing areas and deposit campaigns are some of the plans in process. As an example of this, the deposit campaign launched in mid-April and running for approximately 30 days featuring a CD and a money market account raised over $60 million.

We have received some inquiries over the past week resulting from an analyst report that stated that due to the large percentage of jumbo CDs we have in our deposit mix, we were potentially vulnerable to deposit withdrawals as customers sought to minimize their exposure to one institution and maximize their FDIC insurance coverage. While the data in the report regarding our concentration of jumbo CDs is factually correct, the implication that this makes us vulnerable to deposit withdrawal is inaccurate.

I would like to address the concerns that were stated in the report. At June 30, 2008, we had approximately $1 billion in jumbo CDs, which represents approximately 50% of our total deposits. Of this amount, $200 million were California State Treasurer's deposits that are stable and secured by investment securities. Another $252 million were broker deposits, which are stable deposits and easily renewable given our IDC rating and better than low capitalized status. Of the remaining $566 million in retail jumbo CDs, only a fraction are in uninsured deposits.

While we have had inquiries from customers in the past week about how they can maximize the FDIC insurance coverage, we have not seen any deposit withdrawal activity that is concerning. Given our strong capital position and ample access to liquidity, concern among depositors is not a significant issue that we are facing.

In addition, as with the other community banks, we are participating in CDARS, a program that allows us to provide customers with FDIC insurance coverage up to $50 million.

Moving to the rest of the balance sheet, the increase in deposit balances during the second quarter allowed us to reduce our FHLB advances from $393 million at March 31, 2008 to $350 million at June 30.

Turning to asset quality, our non-performing assets were $26.6 million or 104 basis points of total assets at June 30, 2008. This compares to $20.2 million or 79 basis points at March 31, 2008. The increase in non-performing assets this quarter is primarily related to the three loans that Min discussed earlier. We are taking a very conservative approach with respect to our non-performing assets. We have some credits that have been restructured and are now paying as agreed. However, we are keeping them on non-performing status until they demonstrate a longer period of compliance with the new term.

While we did see an increase in non-performing assets, we also saw a decline in delinquencies in the 30 to 59 days at this category. Delinquencies in this category improved to $4.5 million at June 30 from $8.0 million at March 31 and $12.6 million at December 31, 2007. While this is too early to call a trend, it is a positive sign that front end of the NPA pipeline may have slowed a bit.

Our provision for loan losses was $9.7 million in the second quarter. This provision reflects the increase in special mention and classified assets and the higher level of charge-offs this quarter and the previous quarter, which in turn increased a lot of factors used in determining the quantitative loss reserve. The charge-offs during the second quarter included the construction loan that we issued a press release about after our first quarter earnings announcement. This participated loan has now been put into foreclosure by the lease lender.

The provision also reflects additional reserves taken against specific nonperforming or downgraded loans. The additional reserves taken this quarter reflect a more conservative approach to adjust loans down to their liquidation value, which is lower than fair market value. This reflects our intent to pursue the disposition on these assets and the values we are likely to obtain through such effort.

At June 30, 2008, our allowance for loan losses was 1.32% of growth loans receivable compared to 1.11% at March 31, 2008. The allowance coverage to nonperforming loans was 111% compared to 121% at March 31, 2008. Our net charge-offs were $4.9 million in the second quarter representing 93 basis points of average loans on an annualized basis.

In the first quarter of 2008, net charge-offs were $1.9 million or 37 basis points. Aside from the one construction loan charge-off, the remaining charge-offs primarily consisted of loans to retail businesses averaging approximately $100,000 per loan. Given the continuing weakness in the economy, we expect to see a further stress in our loan portfolio. However, given that we have minimal exposure to the two areas of the economy that has been hit the hardest, namely the housing market and residential construction, and that we have minimal exposure to the regions in California that has seen the most weakness such as the Inland Empire and the Central Valley, we believe that our losses will be manageable for the foreseeable future.

Now, I'll turn the call back over to Min.

Min Kim

Thanks, Al. At this point, we would like to update our guidance for 2008. For the full year, we now expect fully diluted earnings per share to range between $0.62 and $0.67. The reduction in earnings guidance is primarily attributable to three factors. First, our second quarter results were well below our expectations. Second, we believe our net interest margin will continue to experience pressure due to the competitive deposit pricing we are seeing in our market rate. And third, we expect that our provision for loan losses will remain elevated in the second half of the year, although it should moderate from the level we saw in the second quarter. We believe that the trends in most other areas including loans and deposit gathering and SBA production should remain relatively consistent for the remainder of the year.

Our capital strength provides the ability to continue making investments in the business and pursue attractive opportunities that may not be able to other banks that are experiencing greater difficulties. We believe our long-term perspective and commitment to strengthening our position in the Korean-American banking community will result in strong value being created for shareholders in the future.

Now, we will be happy to take any questions you might have. Operator, please open up the call.

Question-and-Answer Session

Operator

Thank you, we will now begin the question and answer session. (Operator instructions) The first question comes from the line of Brett Rabatin from FTN Midwest. Please go ahead.

Brett Rabatin – FTN Midwest

Good morning.

Min Kim

Good morning, Brett.

Brett Rabatin – FTN Midwest

First, housekeeping, can you please go back over the, as I understood, $6.8 million that you moved to the non-accrual, the three loans there, can you go back over those again – the retail center, I believe I heard and I didn't catch the amounts for that loan and the other two?

Min Kim

The first one was a retail strip mall and the second one was a single-tenant property and the third one was a commercial line of credit to apparel manufacturer.

Brett Rabatin – FTN Midwest

Okay. What were the amounts for those, do you have those?

Min Kim

Yes. The retail loan is $1.8 million.

Brett Rabatin – FTN Midwest

Okay.

Min Kim

And the single-tenant property is $2.6 million.

Brett Rabatin – FTN Midwest

Okay.

Min Kim

Credit is $2.4 million.

Brett Rabatin – FTN Midwest

Okay. And I'm a little confused about the guidance on how mention you think the past few trends are positive, but yet you talk about the loan portfolio will probably continue to have stress going forward, so I was confused by somewhat conflicting statements on what sounded to be – the credit trends maybe getting better but then also, by the way, we are having – we are seeing continued stress in our loan portfolio. Can you clarify that? And then I also wanted to ask some additional clarity on special mention and classified assets as well.

Al Kang

I think if you look – when we look at our delinquencies, we saw the front end, the 30 to 59 day showing some improvement, but the classified assets and the non-performing loans are already in the pipeline. We think those will either migrate to a work condition or will result in. So, we are seeing this progress through the pipeline, so that’s why we are not assuming that we are going have a drop-off and charge-off at the provisioning with the not as great as the second quarter, but hopefully lower than the second quarter of 9.7. So, it’s two different things.

Brett Rabatin – FTN Midwest

And now, what was the – you mentioned you increased specific allowance for certain impaired loans, what was that number and what is the total specific reserve for impaired loans at this point? And then, while you’re looking for that, I was curious if you could give – you did mention in the press release an increase in the special mention and classified assets, can you give us what those numbers were?

Min Kim

Sure. Our impaired loans at the end of June is about $35.9 million and we have reserve for impaired loans about $12 million, that’s about 33.7%. As far as increase in the special mention and classified loans, on the classified section, the increase is a little over $4 million and ex retail represents one borrower. The borrower, there’s nothing wrong financially with the loans, however the borrower is trying to obtain a franchise agreement from the major franchise in a hotel, so we are watching that loan. So, we are conservative. We put that loan on a special mention category and substandard category is what made the increases from the first quarter from $30.5 million to $42 million and majority of that is three loans we just talked about and we have a couple of loans that move into that category. We had in fact that – out of our $42 million in substandard category, we actually have about five loans totaling up to about $17 million that we have worked out an agreement or it’s in the process of actually being upgraded within the next couple of quarters. To be converted, we placed those loans, we named those loans on those grades [ph] to see the sustained performance according to the agreement.

Brett Rabatin – FTN Midwest

Okay, that’s good color. And then, Al, if you have those numbers for the specific reserve.

Al Kang

Well, (inaudible) do that on the non-impaired – on the impaired loans, $35 million of them in impaired loans and $12 million in reserves.

Brett Rabatin – FTN Midwest

$12 million, okay. I’m sorry, I’ve been having a hard time hearing – it’s a little soft on my phone. And then just lastly, I’ll let someone else jump in, the stresses that you’re seeing in the commercial real estate portfolio, you made some allusions to it in your prepared comments, but can you break that out by business? I know you’re – obviously SBA is one piece of it where there’s some stress, but are you seeing restaurant stress, are you seeing hotel/motel stress, what specific businesses are you seeing stress in that portfolio?

Min Kim

Restaurant area is definitely whether it’s a real estate or commercial, we do see the stress within that portfolio. On general and commercial real estate, we don’t have one particular industry or one particular reason that is throughout all our lending area.

Brett Rabatin – FTN Midwest

Okay, and let me call after the call. Thank you.

Operator

Thank you. Our next question comes from the line of Aaron Deer – Sandler O'Neill. Please go ahead.

Aaron Deer – Sandler O'Neill

Hey, good morning everyone.

Al Kang

Good morning, Aaron.

Aaron Deer – Sandler O'Neill

I was wondering if you could give some additional colors on the SBA loans in terms of what percentage of commercial real estate and what percentage of C&I are SBA loans? And then, of that, kind of what portion of those balances is guaranteed versus unguaranteed?

Min Kim

Well, on our – we only carry guaranteed portion and we carry quarter of – little over $100 million on SBA portfolio and the breakdown is real estate, SBA loan is about $63 million and business SBA loan unguaranteed portion is about $40 million.

Al Kang

She said guaranteed, she meant unguaranteed?

Min Kim

Yes, unguaranteed portion.

Al Kang

Okay. And then, I guess, if you could just give a little bit more color, Al, on the margin, I guess I'm surprised to hear you talking that you expect to see continued pressure on that, given that most of the banks are reporting that they've already reached an inflection point even those that are somewhat asset sensitive like yourself. So, I'm just – knowing kind of where your deposits are in the process of repricing, at what point would you expect, barring any changes from the Fed, would you expect to hit that inflection point where we start seeing the margin come back up?

Al Kang

Well, it could occur third, most likely the fourth quarter, assuming no further rate reductions.

Aaron Deer – Sandler O'Neill

Okay. And then the – sorry, I'm just looking, my question was – in terms of what you are looking at in terms of possible charge-offs this year, when you look at the stress that you have discussed, is it possible that we see charge-offs to exceed 1% of loans or do you still anticipate that we should remain below that level?

Min Kim

1% of the growth loans, Aaron?

Aaron Deer – Sandler O'Neill

Yes.

Al Kang

Well, yes, I think that we can never predict the one-off price situation that pops up, but excluding that, it is probably around that or maybe slightly higher than that.

Aaron Deer – Sandler O'Neill

Okay, great. Thank you.

Operator

Thank you. Our next question comes from the line of Erika Penala from Merrill Lynch. Please go ahead.

Erika Penala – Merrill Lynch

Good afternoon. I wanted to follow up on Brett's question regarding the signs of stress that you're seeing in commercial real estate, is there any specific asset class that you are watching more carefully or is showing the most stress in terms of lower occupancy or reduced rent?

Min Kim

Well, definitely, we are paying more focus on single tenant owner operator properties because their repayment source of the loan is based on their business cash flow. So, owner occupied property is more – we are paying more attention to that portfolio.

Erika Penala – Merrill Lynch

And what percentage of your commercial real estate portfolio is single tenant owner operated?

Min Kim

Owner occupied is little over 40%, but within that category assessment, single-tenant property is about $130 million.

Erika Penala – Merrill Lynch

$130 million? Okay. And Bonnie, could you give us what the loss rate was in C&I for the second quarter?

Bonnie Lee

For C&I loans, our second quarter loss came in – 50% of the loss came in from the real estate side. That's only mainly because of that $2.1 million loan that we reserved and announced in the first quarter. The other 50% is coming from the C&I portfolio.

Erika Penala – Merrill Lynch

Okay.

Bonnie Lee

And a smaller type we have loans coming from $20,000 loss to a little over $200,000, the average is about a little over $100,000.

Erika Penala – Merrill Lynch

Okay. And also, have you taken a deep dive within your – either your CRE owner occupied or C&I portfolio and sort of looked at given all the stress with those that are relied upon retail, have you sort of looked at who is touching retail even if it’s not directly impacted?

Bonnie Lee

What do you mean by touching?

Erika Penala – Merrill Lynch

I guess the apparel manufacturer in the retail strip mall, I mean, have you sort of examined what your overall retail exposure is, even if it’s not necessarily a small business, a store that could be directly classified as retail?

Bonnie Lee

What we call retail sector, we have about $230 million and breakdown of our retail is, we have about $140 million in the supermarkets and then rest of the market are liquor store, gas stations or dry cleaners. And then the manufacturing side, we have about $57 million are long-term and in the manufacturing sector and the apparel industry is actually (inaudible).

Erika Penala – Merrill Lynch

Okay and one housekeeping question. You mentioned that the tax rate in the second quarter was lower because of tax credit, is this lower tax rate sustainable going forward?

Al Kang

It should be above 40%.

Erika Penala – Merrill Lynch

Okay, thank you for your time.

Operator

Thank you. Our next question comes from the line of Joe Gladue from B. Riley. Please go ahead.

Joe Gladue – B. Riley & Co.

Yes, hi. Just I guess on the asset quality franchise, wondering if you could break out how things are looking in the New York and New Jersey market as opposed to, I guess, the California market.

Min Kim

Actually, our New York-New Jersey market is doing pretty well. Our Eastern business is doing relatively well. And the out of our (inaudible) past few – our New York-New Jersey business represent today a small portion.

Joe Gladue – B. Riley & Co.

Okay. I had a question on the SBA loan sale, correct me if I am wrong, but it looks like the premiums on the SBA loan sales increased in the second quarter from what you were seeing in the first quarter and if they did, I guess just wondering what that was due to, the tightened underwriting standards or what?

Min Kim

Well, I think the level of SBA premium will be relatively stable. We don't expect to see higher level of SBA premium percentage.

Al Kang

The gross premium did increase slightly, it went from – gross premium from $480 million to $530 million, but that's just the market. I don't think there's any particular reason for that.

Joe Gladue – B. Riley & Co.

Just one final question, it seems over the last two quarters, some of the bigger problems have come from products that don't seem to be part of the normal operating strategy now. In the first quarter, it was a syndicated loan or something that you didn't originate and I guess second quarter had a problem from this non-agency asset-backed security that's sort of one of a kind and of course, both of these things come in late in the quarter. It seems a little bit like some of the bigger problems are coming from areas where you're maybe stepping a little bit outside of the normal course of business. Is there any change in philosophy regarding doing those sort of things?

Min Kim

No, we continue to stick to our core business which is our C&I and also commercial real state. We have a small portion of the construction lending; however, that one particular construction participation with Adelanto was to learn more about construction land development which we thought that it will be a good opportunity to participate in and learn more about the knowledge and experience from the experienced lender. But it was more of the trial case rather than, we are not shifting our core business philosophy to the area that we have no experience and no expertise. So we continue to stick to our core business.

Joe Gladue – B. Riley & Co.

Okay.

Al Kang

The asset-backed security, actually we had purchased that security back in early 2005 and it had been performing very well even through the first quarter, but then the rating agencies revalued the assets and it went from an A3 down to CAA3; it went from investment rate to the junk overnight, which I guess the rating agencies are changing how they value all these securities including asset-backed securities. But that is the only one that we had in the portfolio, so everything else, other than our CRA investments, are agency-related securities.

Joe Gladue – B. Riley & Co.

Okay. And just a little clarification on that asset-backed loan, that's pretty much fully written down now?

Al Kang

Yes.

Min Kim

100%.

Joe Gladue – B. Riley & Co.

All right, okay, thank you, that's it from me.

Operator

Thank you. Our next question from the line of James Abbott from FBR Capital Markets. Please go ahead. And if you are on a speakerphone, please pick up your handset.

James Abbott – FBR Capital Markets

I'm sorry. Thanks, good morning.

Al Kang

Good morning.

James Abbott – FBR Capital Markets

Question on the underwriting standards, tell me if you can what you've changed in the underwriting standards and I'm also interested in what the competitive landscape has done to change underwriting standards. You're not the first to have discussed loan deterioration.

Min Kim

Basically, as far as underwriting fund is concerned, there is a certain type industry that we try to stay away, number one. And also there is additional due diligence and not only from the front lines, but also in the credit administration and as far as far peer-reviewing the packages loan coming through and the additional slide presentation and subject business or subject collateral.

So, in this kind of environment, especially in the commercial real state market, the information that we get and the appraisal is basically a market data that are couple of months old, and we used to go out and see, whether there is a change in the environment, in the neighborhood for the subject business. So there is a lot more hands-on approach to underwriting. And also we give more focus on the cash flow rather than this collateral value of the property or collateral value of the business, so we emphasize on the cash flow and also the principal's or guarantor's capability to be able to manage potential decrease of the sales or potential revenue.

James Abbott – FBR Capital Markets

Is this likely to lead to a longer – is this a long-term shift that the company has taken to underwrite the credits a little more with maybe a little stronger discipline and then if that’s the case, should we be thinking in terms of – especially longer-term horizon, not just the next six months, but longer term with the expense ratios to be higher in order to handle this type of underwriting.

Min Kim

Relatively, actually because our production-end has decreased, we are shifting the manpower from the production-end to the underwriting and to servicing the management of the portfolio.

James Abbott – FBR Capital Markets

Okay. I suppose there's not as much (inaudible) deferral and so forth, is that a fair assumption? What is the outlook for expenses in the upcoming quarters?

Al Kang

It would probably be closer to the first quarter run rate; that’s probably 14.5 to 15.

James Abbott – FBR Capital Markets

Okay. And then another question that I had related to C&I loans is the severity. So as you are charging off some of these C&I loans, are you just writing them to zero or are you writing them down to $0.50 on the dollar, and maybe if you could give us some sense as to the average severity or the median severity per loan, I would be curious to know how you are fairing on that front.

Min Kim

It is really difficult to give average. Every business loan, every C&I loan has its own cap rates on collateral value and (inaudible) retail manufacturer or wholesale. We’re going into liquidation versus a short sale of the business. So we look at every single loan going through the internal impairment calculation, provide a reserve, adequate reserve, are based on given our situation and then the better value cash flow.

James Abbott – FBR Capital Markets

Maybe we can take an example of the retailers, that apparel manufacturer, was there a charge taken on that loan, it’s a $2.4 million non-accrual loan at this point, was it originally a $3 million loan or what?

Min Kim

Outstanding is a little over $4.2 million. In this loan, we have (inaudible) by a little over $1 million real estate and the inventory liquidation value (inaudible) and then partially some cash collateral, as well as a constant part of the accounts receivable. So where we actually in the second quarter, where we lost (inaudible) we told you, it has an average (inaudible) of $100,000 from the smaller types of loans, but they do add up. A typical retail business, if they just close, we make it $0.10 on a dollar, but if we go through the short sale which we actively do, try to find a buyer with a better capital and better management skills, we may collect $0.50 or $0.60 on a dollar. On a wholesaler manufacturer, depending on the level of inventory, accounts receivable, other types of collateral, we may be able to get it higher.

So I guess that’s just about the average price, but again individually, we have to look at the loan and to the internal calculation.

James Abbott – FBR Capital Markets

Okay. And have you seen the competition do similar tactics, increase their underwriting standards?

Min Kim

Yes, I am sure all the banks are tightening their underwriting guidelines and it seems like definitely the small retail businesses are affected by the overall economy downturn and the real estate properties that are owned by the owner occupied or single-tenant, that’s definitely also being affected, and then you also have to look at in principle even in a commercial real estate what other leverages or other investments that they have within their financial portfolio.

James Abbott – FBR Capital Markets

Okay, all right. Thanks very much for your time.

Operator

Thank you. Our next question comes from the line of Leona Slongka [ph] from KBW. Please go ahead.

Leona Slongka – KBW

Hello, good morning.

Min Kim

Good morning.

Leona Slongka – KBW

Hi, I have another follow-up question on the SBA lending. What is the current non-performing level in your SBA balances and what was it at the end of March?

Min Kim

Okay. Let's see, non-performing loans on SBA as of June is about $1.8 million.

Leona Slongka – KBW

And as of March?

Min Kim

Non-accrual right?

Al Kang

She said actual non-performing loans.

Min Kim

Okay, no accrual of SBA loans.

Leona Slongka – KBW

Okay.

Min Kim

On SBA loans and non-accrual at the end of June for the real estate portion is about 1.9 and strictly SBA term loans is 1.8.

Leona Slongka – KBW

And that's on the balance of roughly $120 million, right?

Min Kim

$110 million.

Leona Slongka – KBW

$110 million. Sorry. Great, that was my follow-up question. Thank you very much.

Min Kim

Okay.

Operator

Thank you. Our next question comes from the line of Chris Stulpin from D.A. Davidson. Please go ahead.

Chris Stulpin – D.A. Davidson

Hi, two of my three questions have been asked but I’m curious, I hear some people saying that loan demand is up. What is your take or position? What are you seeing out there as far as loan demand is concerned? I know that you want to grow at a moderate rate with deposits, but I’m just curious to see what kind of demand you're experiencing in your market right now?

Min Kim

Well, I think a lot of lenders have been tightening their underwriting criteria and also due to their liquidated position, they've been very selective in terms of which loans they are going to entertain based on their visitor profile. So definitely, there has been lot of inquiries from the potential borrowers, but we are no exception in terms of selecting good loans based on our strengthening underwriting criteria. So, yes, there has been increase of demand, but we have been very selectively choosing which loans that we are going to book on our balance sheet.

Chris Stulpin – D.A. Davidson

Sure. Okay. Thank you.

Min Kim

One thing I would like to mention is that liquidity is not our concern, but we are more selective in terms of loan quality.

Chris Stulpin – D.A. Davidson

Okay.

Operator

Thank you. Our next question comes from the line of Dan Boston from Lazard's Advisors [ph]. Please go ahead.

Dan Boston – Lazard's Advisors

Hi, I had just a quick question. Given the continued weakness with the dollar, I'm just wondering if you are still seeing demand from mainland Korea in terms of commercial real estate here in the U.S. both on California as well as New York.

Min Kim

I think the activity has been slowed down quite a bit. So we don't see much activity within our marketplace. There has been a lot of a relax of policy from the Korean Government but we have not experienced a huge inflow from Korea or any type of investment opportunities.

Dan Boston – Lazard's Advisors

Are you seeing cap rates trend kind of flat to up, or where are those going?

Min Kim

Cap rate on the commercial real estate?

Dan Boston – Lazard's Advisors

That's correct.

Min Kim

It's kind of flat.

Dan Boston – Lazard's Advisors

Okay. Okay, thank you very much.

Min Kim

Okay.

Operator

Thank you. Our next question comes from the line of Don Worthington from Howe Barnes Hoefer & Arnett. Please go ahead.

Don Worthington – Howe Barnes Hoefer & Arnett

Good morning.

Min Kim

Good morning.

Don Worthington – Howe Barnes Hoefer & Arnett

Al, this question is regarding the securities portfolio. Would you expect to see some additional restructuring there that might lead to additional gain on sale?

Al Kang

Well, potentially, we still have fixed rate securities. Our intent is to try to move into adjustable rate maturities [ph]. So, there maybe some opportunities for further sales to change the mix in our portfolio.

Don Worthington – Howe Barnes Hoefer & Arnett

Okay. And then when is your next regulatory exam scheduled?

Min Kim

Actually our exam is taking place now.

Don Worthington – Howe Barnes Hoefer & Arnett

Okay. Thank you.

Operator

Thank you. And at this time, we show no more questions in the queue, I’d like to turn the call back to management.

Min Kim

Once again, thank you for joining us today and we look forward to speaking with you next quarter.

Operator

Ladies and gentlemen, this concludes the conference. You may now disconnect.

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