East West Bancorp, Inc. (EWBC) Q2 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the East West Bancorp Second Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Ms. Irene Oh, EVP and CFO of East West Bancorp. Please go ahead.

Good morning, and thank you for joining us to review the financial results of the East West Bancorp for the second quarter of 2016. Also participating will be Dominic Ng, our Chairman and Chief Executive Officer. 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 risk factors that could 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, 2015. Today’s call is also being recorded and will be available in replay format at eastwestbank.com. I will now turn the call over to Dominic.

Thank you, Irene. Good morning and thank you for joining us for our earnings call. Yesterday afternoon, we were pleased to report our financial results for the second quarter of 2016. Net income for the second quarter of 2016 totaled $103.3 million, or $0.71 per diluted share, a decrease of $4.2 million in net income, or 4% from the first quarter of 2016, and an increase of $4.5 million in net income, or 5% from the prior year quarter. The lower net income in the second quarter of 2016 compared to the prior quarter was largely due to an increase in provision for credit losses as a result of stronger loan growth and higher tax rate. For the second quarter of 2016, East West achieved a return on average assets of 1.27% and a return on average equity of 12.71%. Additionally, we’re pleased to state that tangible book value increased 3% quarter-to-date and 12% from a year ago. At East West, we’re committed to creating long-term value to our stockholders. We believe that our competitive advantage as the bridge between the East and the West together with strong financial return metrics and growth in tangible book value quarter-after-quarter, year-after-year enable us to provide a differentiated value proposition for our stockholders. Overall, we deliver a strong second quarter earnings performance. We increased total revenue 2% quarter-over-quarter to $297.8 million, while keeping our expenses in check with an efficiency ratio of 44.6%. In addition, despite an ongoing challenging industry environment, we’re able to maintain a stable net interest margin of 3.31%. Heading into the second-half of 2016, our focus will remain on growing our business profitably and prudently, in conjunction with our efforts to advance our risk management infrastructure and technology, while being mindful of expense control. Total loans receivable as of June 30, 2016 reached a record $24.3 billion, an increase of $490.8 million, or 2% compared with $23.8 billion three months earlier. The gross loan growth during the second quarter of 2016 was largely driven by increases of $345.6 million, or 4% in commercial loans and $82.6 million, or 3% in single-family residential loans. Within the commercial loans portfolio, we experienced good growth from the sectors of energy, specialty finance, private equity capital call lines, asset-based lending, and life sciences. Loan balances in Greater China remained stable at $1 billion as of June 30, 2016, or 4% of our total loans receivable. Also during the quarter, second quarter of 2016, we sold or participate out $166 million in loans largely comprised of $78 millions of commercial real estate and construction loans. $46 millions of multi-family loans, $21 millions of SBA loans, and $20 millions of commercial loans for a gain of $2.9 million. Similar to previous quarters, we continued to sell commercial real estate loans to ensure diversification, expand our secondary market channels, and reduce exposures. As of June 30, 2016, our commercial real estate concentration to risk-based capital ratio was reduced to 265% well under the 300% threshold as defined by the FFIEC for commercial real estate concentration. Excluding the impact of loan sales, the year-to-date loan growth was 8% on an annualized basis. In our earnings release yesterday, we revised our loan growth guidance for the remainder of the year downward to 6% annualized growth for the third and fourth quarters. Now, we’re on pace with an 8% loan growth year-to-date. However, given the challenge and market competition in this prolonged low rate environment, we thought it was prudent to moderate expectations for the second-half of 2016. Although, the loan pipeline is strong, we have been experiencing an increase in payoff and continued pricing competition as we remain disciplined about pricing, and profitability. Turning to the liability section of the balance sheet, total deposits were $28.2 billion as of June 30, 2016, a decrease of $379 million, or 1% from $28.6 billion as of the prior quarter end. Core deposits remained approximately the same at $22.5 billion at the end of the second quarter. The quarter-to-date decrease in deposit was primary due to a decrease of $332.4 million, or 5% in time deposits and $227.9 million, or 3% in money market deposits. These decreases in deposits were due to intentional efforts to reduce broker money market deposits and higher costs, public fund time deposits. Year-to-date, deposit was still up $741.3 million, or 3% due to the unusually a high level of deposit growth in the first quarter of 2016. Our liquidity remains strong and our loan to deposit ratio as of June 30 was relatively stable at 86%. Next, I would like to spend a few moments to discuss our ongoing remediation efforts to improve our Bank Secrecy Act and Anti-Money Laundering program. As previously discussed, as part of the written agreement, we entered with one of our primary regulators last year. We have developed an action plan, outlining the steps that we will be taking to ensure compliance with the BSA/AML rules and regulations. At this point, we are on schedule with our action plan, and I’m pleased to state that many improvements have been made in our BSA/AML software systems and controls. We still believe that the core function of the new BSA/AML software systems, we are implementing our on schedule to be fully operational by the end of this year. For the second quarter of 2016, total consulting expenses was $6 million and approximately 75% of it or $4.5 million of these costs were BSA/AML remediation related. Although, the remediation related consulting costs are still elevated, we are encouraged that for the second quarter of 2016, this consulting expenses were $2 million less than the first quarter. We now estimate that for the remainder of 2016, BSA/AML related consulting costs will decrease to approximately $3 million per quarter, resulting in full-year 2016 consulting costs of approximately $17 million, a decrease of about 24% from our previously estimated $20 million. Although maintaining strong probability is important to East West Bank, equally important is ensuring that our balance sheet, operations, and the compliance programs are strong. We’re committed to making all necessary investments in people and systems to strengthen our BSA/AML program and meet regulatory expectations. Within entrepreneurial spirit, we have always been a part of our philosophy. I believe this added to an approach had [ph] help us embrace the changes we have been making and we will continue to make in order to improve our BSA/AML compliance program and strengthen our operations, as we continue to grow. With that, I would now like to turn the call over to Irene to discuss our second quarter 2016 financial results in more depth.

Thank you very much, Dominic. I’ll spend a few minutes to go over the income statement items for the second quarter of 2016. Starting with net interest income, net interest income of $253.6 million for the second quarter of 2016 was $1.4 million, or 1% higher than the first quarter of 2016, and $26.1 million, or 11% higher than the second quarter of 2015. Net interest margin for the second quarter of 2016 was 3.31%, 1 basis point lower than the prior quarter. The deposit cost of 29 basis points for the second quarter of 2016 was 1 basis point higher than the first quarter of 2016, and the same as the second quarter of 2015. Cost of deposits was 35 basis points for the second quarter of 2016 compared to the 34 basis points and 43 basis points for the first quarter of 2016 and second quarter of 2015, respectively. In the second quarter of 2016, we had total accretion income of $13.3 million, of which approximately $4 million was due to accretion income recorded as a result of a large recovery of one loan. And our guidance for the remember – remainder of 2016, we’re assuming a more normalized accretion income of $8 million to $10 million per quarter. The average loan portfolio balance for the second quarter of 2016 was $23.9 billion compared to $23.8 billion and $21.9 billion for the first quarter of 2016 and second quarter of 2015, respectively. Loan yield of 4.28% for the second quarter of 2016 was the same as the prior quarter of 1 basis point lower from the prior year quarter. Moving on to non-interest income and expense. For the second quarter of 2016, non-interest income was $44.3 million, an increase of $3.8 million, or 9% from $40.5 million for the prior quarter and an increase of $3.7 million, or 9% from $40.6 million for the prior year quarter. The sequential quarter increase in non-interest income was largely due to increases of $1.8 million, or 22% in other fees and operating income, $1.14 million, or 15% in letters of credit fees and foreign exchange income and $1 million, or 50% in net gains on sales of loans. These increases were partially offset by lower net gains on sales of available for sale investment securities of $1 million, or 26%. During the second quarter of 2016, the company also recognized a gain of $2.2 million, mainly related to the sale of day in premise, which resulted primarily the increase in other fees and operating income. Non-interest expense for the second quarter of 2016 was $148.9 million, $2.3 million, or 2% higher than $146.6 for the first quarter of 2016, and $28.7 million, or 24% higher than the second quarter of 2015. The sequential quarter increase in non-interest expense was largely due to increase in compensation and employee benefits, legal expenses, and occupancy and equipment expense, partially offset by a decrease in consulting expense. Overall, our actual operating expenses incurred are slightly better than we projected and that is reflected also in the lower operating expense in our current guidance, as compared to the previous guidance. As Dominic has already discussed, the BSA/AML remediation initiatives are moving forward and the costs are tracking moderately better than we had previously anticipated. The efficiency ratio for the second quarter of 2016 was 44.59% compared with 44.53% and 40.36% for the first quarter of 2016 and second quarter of 2015, respectively. The company’s effective tax rate for the second quarter of 2016 was 27.7% compared with 25.7% for the first quarter of 2016 and 31.6% for the second quarter of 2015. The tax rate for the second quarter was slightly higher due to adjustments and our calculations were 48 and also adjustments for tax credits and tax losses for low-income housing tax credits. For the remainder of 2016, we expect that the effective tax rate will be 26%. Now, I would like to spend a few moments to review our credit quality. For the second quarter of 2016, the company reported a provision for credit losses of $6.1 million compared to a provision for credit losses of $1.4 million and $3.5 million for the first quarter of 2016 and second quarter of 2015, respectively. Net charge-offs for the second quarter of 2016 totaled $619,000 compared with net charge-offs of $5.1 million in the prior quarter and net recoveries of $4.1 million in the prior year quarter. The increase in provision for credit losses in the second quarter compared to the prior quarter was largely due to the loan growth during the second quarter. East West continues to maintain a healthy allowance for loan losses of $266.8 million, or 1.1% of total loans held for investment as of June 30, 2016, compared to the March 31, 2016 allowance for loan losses of $260.2 million, or 1.09% of total loans held for investment. Non-accrual loans were up $171.6 million as of June 30, 2016, an increase of $9 million, or 6 % from $162.6 million as of March 31, 2016. Non-performing assets as of June 30, 2016 were $176.5 million, an increase of $7.8 million, or 5% from $168.7 million as of March 31, 2016. Similarly, the non-performing assets to total assets ratio increased slightly to 54 basis points as of June 30, 2016, up 3 basis points from March 31, 2016. Lastly, I’d like to provide some additional color on our guidance for 2016. In the first quarter earnings guidance, we had assumed that the federal funds target rate would increase 25 basis points in September 2016. We generally use the federal funds for rate curve to model our earnings forecast and are now assuming though there will be no change to federal funds target rate in 2016. Based on this revised assumption, we are forecasting for the remainder of the year that the net interest margin will range from $321 million to $324 million. We also assume organic loan growth of approximately $265 million per quarter, or 6% annualized for the remainder of 2016. Provision of loan losses of $5 million per quarter and that non-interest expense will be approximately $155 million per quarter, including the amortization of tax credits and other investments of approximately $70 million per quarter. Finally, we are also assuming an effective tax rate of 26%. Based on these assumptions, we estimate that diluted earnings per share for the full-year of 2016 will range from $283 million to $287 million, an increase of $0.17 to $0.21, or 6% to 8% from $266 million for the full-year of 2015, and a small decrease from our previous disclosed guidance. The reduction in the guidance from what we previously had estimated is largely driven by the impact of eliminating the rate increase from our guidance and lowering the loan growth guidance for the remainder of 2016. These reductions in income partially offset by the current estimate that will be able to tighten up slightly on our expenses for the remainder of the year compared to before. Further, management currently projects that based on these assumptions, fully diluted earnings per share for the third quarter and fourth quarter of 2016 will range from $0.69 to $0.71. I will now turn the call back to Dominic.

Thank you, Irene. Well, in summary, we remained focused on growing our balance sheet and business profitably and prudently, while taking the appropriate risk management measures. We’re also pleased that while we are progressing well with our risk management and controls, we have also been able to make good strides in our efforts to contain expenses. So now, I would like to open the call to questions.

We will now begin the question-and-answer session [Operator Instructions]. And our first question comes from Jared Shaw of Wells Fargo Securities. Please go ahead.

Hi, good morning.

Good morning, Jared.

If I could – when you’re looking at the investment related kind of BSA/AML system, thanks for the color on the trends in the consulting side. Are there any – is there any shifts to higher headcount or higher compensation cost as you’re building out the system, or will it truly just really be more of a – an operating system that you’ll be able to handle with the current personnel?

Well, clearly the – in terms of headcount, and so what we used to had, it was definitely higher, because with the additional much more sophisticated system that we have and we have to hire the appropriate personnel to have the experience and the technical expertise to support that, not only at the implementation stage, but going forward in the future, we need to continue to have more senior level executive to help manage the program going forward. However, as of today I would expect that besides consulting expenses, we also have temporary employees that we bring in just to help out on the remediation program. So those type of expenses will turn off by 2017 and, in fact, most of them hopefully would not be there in 2018 and forward.

Okay. So when we look out at 2017 and forward, there should be a significant net savings from that run rate of – on the consulting side?

That’s correct, we do expect that. And just maybe to elaborate on what Dominic said, I think from where we started with the BSA team, we have definitely at this point in time increase the staffing and the costs have gone on But it’s in the run rate and the compensation right now.

Okay. And then shifting a little bit to the reduced loan growth guidance, are you – what’s really driving that? Is that more of a – on what you’re seeing from a competitive standpoint from the yields, or is that that you’re reluctant to get closer to that 300% concentration, while you’re going through this investment of the BSA? And I guess what’s the biggest driver of the lower outlook on loan growth?

Well, there’s a few different things. One is that, if you looked at the current rate, we – particularly on the commercial real estate side, first of all, I think we’ve done really well just for the last six months that we have quickly participate out and sold commercial real estate loans. And that the idea is not necessarily that, because even at the time the last six months, we never once really sort of like reach beyond the 300% concentration threshold set up by the head of IEC. But we wanted to always act ahead of schedule. So we’re using the last six months to quickly test out ability. That is that if we do need to sell down loans, can we do that? And we were quickly able to participate out a bunch of loans to other banks. And so that have proven our secondary market channel is working very well. So and then by doing that, we’re now down to 265%, so we definitely have a lot of cushion. If we wanted to make loans, we will, but we’re not going to go out there just to grow loan by doing some very low rate and depress our margin and then hurt our profitability. So it’s just a matter of like trying to balance profitability to growth. And we have pretty healthy growth for many years. East West has always been a growth organization. We have always been consistently for many, many years growing our earning per share and loan and deposit and so forth. So we’re not worried about the growth, but we wanted to make sure that we continue to have some pretty strong discipline in the margin. So recognizing what the Brexit and the rate coming down like this, we’re just being prudent. And at this point making an assumption that our rate will continue to stay low. Now, if for some reason as the Wall Street Journal yesterday talking about, maybe the Fed is ready to hike the rate in September that would change the dynamic, right? So – but I mean from our perspective right now, I’d rather be prudent at this stage and that’s one. The second part is that overall, as we look in our loan utilization – commercial loan utilization, I look at it – if I look at December 31, 2015, the utilization is at 76%, and has now dropped to 69%, and this is a common phenomenon throughout the entire country. Most of the business out there are not actively looking to aggressively expand and to borrow more money to expand, or to borrow money to advance, to borrow more money to purchase more inventory, or equipment and so forth. Business are very prudently watching their physical condition and trying to adjust accordingly. So, in that regard, despite the fact that we continue to grow on customer base, we are seeing our customers continue to slowdown in the utilization of the line of credit that they have. So that’s another part that – so far that’s been a direction. So we have not seen any signs that in the next six months that will change. In fact, it is the same way throughout the country. So I don’t think there’s going to be any different than any other banks. And third, what we’ve seen also is that, it just – now this is – there has been more, particularly in East West, there are many customers that we have that are working on some deals that we are actually in the process of closing some deals, just couldn’t get – get it close in the second quarter. So from that perspective, do we get lucky that maybe some of these deals that we’re supposed to close that in the second quarter it will happen. In the third or the fourth, we don’t know. So, we don’t know to – that specifically some times, is it just a matter of love, of course, it’s a matter of like, because everybody is being a little more cautious. So they take a little bit longer time to get some deals done. So, well, I guess time will tell. But at this stage right now, since some of the deals have not been closed and pipeline is really strong. It’s just not getting funding. So from that standpoint, we just think that it is just prudent to guide down the number. And so I look at it, hopefully, we get lucky and we’ll change the direction. But in the meantime, I think that we’re comfortable with a 6% annualized growth rate.

Great. Thank you very much.

Our next question comes from Jennifer Demba of SunTrust. Please go ahead.

Good morning. Just wondering if you can give us an update on your energy loan portfolio and what you’ve seen in terms of growth, if any in that bucket? And overall, what you’re seeing in Texas and what that market is providing you in terms of growth opportunities outside of energy?

Well, we are moving along prudently. So, in fact, as of March 31, and end of the first quarter, we had $53 million outstanding balance and then $65 million commitment. And then at the end of the second quarter, it went up to $103 million in outstanding and $132 million in total commitment. So the team is continuing to make strides. And I expect that in the third quarter, we’re going to see another bump again. So in terms of – since I mean, we started with zero, so the growth rate is very high. But then relatively speaking the number is not that big and we intentionally asked the team not to jump too fast, because while we enter the market at a very opportunistic time, November of last year, and our expectation were and that if we came in such a very depress environment, chances are the downside risk is very low and the upside potential is very high. And so, as of today, it turnaround exactly what we expected. And but still we didn’t wanted to go in, jump in too quickly, because we want to make sure that we can also organize and then not only that the team to understand the business quickly go out there and do what they need to do to capitalize on the opportunity. But in addition to that, we want to make sure that the rest of the organization that have anything to do with lending. So to understand and appreciate that business, and that do take a look at more time. And so, from that standpoint, if we wanted to grow that business by like another $100 million, $200 million, it’s actually very easy to do. But we chose to do it slowly and prudently. So that to make sure that we get it right, and then also to establish our name appropriately in the market.

Thank you very much.

Our next question comes from Dave Rochester of Deutsche Bank. Please go ahead.

Hey, good morning, guys.

Good morning, Dave.

A quick question on the expense side. Do you have any additional insight into the total expense trend heading into 2017? And do you think it could be possible to keep overall expenses flat with 2016 ex that tax credit amortization start?

Yes, I think so. At this point, certainly, with every quarter and moving forward on our BSA/AML remediation efforts, we have a little bit more clarity, and that’s also why we’re able to kind of reduce our expense guidance for the second-half of 2016, as well. And I think at this point, I’d say although as every quarter progresses as you know, we’ll come out with our guidance for 2017 in January of next year. But I do think we have more clarity. And if you look at the run rate, certainly, extra $62 million were actual and estimating for that tax credit amortization. I do think we could be in line.

Great. And then just switching to a loan growth guide, you made a comment about rates playing a role in your decision to grow. Are you anticipating this will be more of a temporary slowdown, where you ultimately end up raising that growth rate against at the end of 2017, or given what you’re seeing that you think this will be more of a permanent adjustment?

Well, this is really depending on the overall economy. We have – there were a lot of the news out there, like this, Brexit it’s something that this is quite unusual for 2016. And quite frankly, if you look at just whatever happened for the last few weeks, it looks like always much to do about nothing. But I think from my perspective, I would expect that likely not be that easy in euro. And so it maybe just a – I mean, it look like a temporary setback for few days and that the market rebound. But I do feel that those slowly gradually, there will be some ripple effect and then Europe and also in the global market. Now, I do wanted to point out though that from an East West perspective, as a financial institution, we are substantially in better shape than many other banks, because our sort of like the European exposure is almost done. We mainly focusing on U.S. and China. And so, therefore, there’s not going to be any sort of like very direct impact to us. But on the other hand, it will have an indirect impact in the overall economy and it will therefore affect interest rate and also the sentiments of many businesses throughout the country. And with that we just have a little bit more cautious and prudent mindset in terms of how to deal with that. And then who knows what’s going to happen in 2017 and after the presidential election. So a lot of things are happening, so we don’t know what’s going on. And so at this point that’s what we take the position. But on the other hand, the minute the market come back strong and people, I mean, let’s say business sentiment coming stronger and then focused on utilizing out just when focused on utilizing our line of credit more in a normal manner, we would immediately pickup substantially in terms of loan growth. I mean that along that we will have many more deals closing. And so I think that right now just looking at the amount of slowdown utilization with a huge difference in terms of growth.

Okay. So this in a situation at all the regulators have either remotely made a suggestion that you should slow growth rate?

No, no, not at all. I mean, again, our BSA issue have nothing to do with the loan growth. In fact…

Yes.

It’s really us trying to be prudent. And then the other thing is that, I mean, I can easily make that 10% or 12% loan growth. If I just going out there and doing more where there’s like loan to pricing on our CRE, our multi-family or single-family mortgage, we just lower the rate, and I can easily do 10% to 15% loan growth. So, I mean, that’s – growing is not – it’s not hard. But growing was – I mean, intentional diversification and growing with new sectors such as what we have been doing if you look at the last five years of East West Bank, we have been able to continue to develop business in new sectors that we were not in before using our strategy of being to bridge between the East and West. We’ve done really well in the entertainment business. We’ve done really well in the private equity, I think, particularly in the capital call line. We’ve done really well in cross-border transaction, and high tech, clean tech, life science, and now energy. Now and then I look at this quarter interesting enough. I’ve been talking about entertainment, high-tech and so forth in the past few quarters. And those two names were missed in this quarter, because while they were slowing down a little bit not that they were slowing down there, deals are now getting close. And then we turn off all deals that that got pay off, because in certain movies finish and then we got pay off. But then we turnaround and then this quarter that the one picking up the slack or the energy, or the specialty financing, or the life science, and the asset-based lending. So we have enough sectors that will continue to grow more and more of this different products, or industry on this type of business to allow us that at any kind of particular economic environment, we will be able to continue grow in a healthy manner. So and I think it’s very critical for us to continue to have that kind of diversification and continue to expand in that direction. So we look at some of our compensation, headcounts, and so forth. As we talked about last year, we have expenses growth. If we have, let’s say, challenges with spending more money on regulatory issues or why would we still want to hire more lenders. One of the fact is, if we find strong bankers that can help us to diversify our portfolio even more and then help us to grow our business in a more healthy manner, we’ll continue to go in that direction. And so far it’s been working out really well. So we would not be stuck that if one day suddenly real estate market is not good and then we run out of room. So keep in mind that East West started at the savings loan. We went from a savings and loan to become a commercial bank with a commercial bank even about seven or eight years ago, we were really real estate concentrated with our commercial real estate of being the lion share of our portfolio. And now we have not ratchet down by keep selling this real estate – commercial real estate that would continue to grow our commercial real estate. The only difference that we grew our commercial C&I loans much faster with a diversification on many different areas. So with that, I think, it allow us in a position today to have a much healthier balance sheet. So that’s the direction we’re going and we’re going to sticking – we’re sticking with it.

Okay. That was a lot of great color there, I would really appreciate that. Just one last one, if I could real quick on fee income. You had nice uptick there as the asset gains from various gains. Are you thinking you can continue to grow the fees from here, or is this, at least, a good run rate in the back-half of the year?

Yes, I think on the fee income, it does vary depending on the number of transactions and quite honestly the size as well. If you look at the individual line items LC, FX, both of those increased ever so slightly. So they were down a little bit in the first quarter. But I think, between $34 million, $35 million in the first quarter and where we were for the second quarter today $39 million, I think, it’s achievable.

All right, great. Thanks, guys. I appreciate it.

Our next question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.

Good morning.

Good morning, Ebrahim.

So a couple of my questions were asked. But on – moving to sort of on capital my understanding is that until you resolve BSA, I mean, you are unlikely to be doing any buybacks for M&A. Does that restrict your ability even in terms of increasing the dividend? And if growth is slowing and given your profitability, could you see the dividend be out going much about 30%?

So maybe I’ll just clarify. With the written agreement, we are essentially prohibited for any expansionary activity. Expansionary activity includes acquisitions and also de nova branching. We really don’t have any limitations from a capital perspective. We have strong earnings and I think there’s a fair amount clarity in our earnings as well along with our capital ratio. So the dividend, buyback, that’s really a function of where we see the growth and where we see opportunities. Certainly, I think with the dividend payout ratio, that’s something we internally and with the Board have discussions. Can we – we deploy those funds better and create better return for our shareholders, as we deploy that or in a buyback. So that’s something that we we evaluate on a – and discuss it with the Board. And we make that decision on an annual basis. Does that help you, Ebrahim?

Yes, that’s helpful. And I guess, I’m sorry if I missed it. But have you disclosed in terms of where the China Hong Kong loan and deposit balances were at the end of the quarter?

For China and Hong Kong, the loan balances were about the same as of the end of the first quarter $1 billion or so. Deposits also, I don’t think in total, they change that much.

Understood. Got it. And one thing….

…about $1.2 billion or so.

Understood. And is Dominic’s comments at all sort of competition and what’s happening in terms of as a resulting sort of slower growth in CRE and the other areas also sort of translate to what you’re seeing in terms of the China business term?

In China, it’s interesting. I think that, China is actually slowing. China is also going through a direction that they wanted to make sure that they have healthier GDP growth, so they are slowing down the growth and making sure that they are growing in a direction that would have a long-term sustainable benefit. So from that standpoint and then going through a very aggressive reform. So as you can – as I talked about in the past, they have for years been carrying the country with double-digit growth in the heavy industries, let’s say and the manufacturings and then the heavy commodity business, whether it’s the steel and a coal mining and a steel manufacturing and also a lot of those, let’s say, are making garments and toys and electronics products and so forth. That was the bread-and-butter business, export driven business for a few decades. And as the country continue to grow in the new direction and trying to go from an emerging country to a developed country, and they’re going to need to have stronger domestic consumption and also service industry has to be a primary driver. So we and witness now in China is that, the business are completely changing direction. The high growth business are the one in social media in the service-oriented business and in domestic consumption type of areas. And then the business that are going through a hard time and then really going in a negative direction in terms of growth rate are the one in these heavy manufacturing and export driven business. So from that standpoint, we at East West Bank and also are transitioning. And years ago, we had a lot more business that are exporting to United States. So the trade finance that we were involved with were in that direction. And also lately, we actually are helping move the studios from China investing in Hollywood and so forth. And then also company are looking into life science and technology business, and then business are looking and buying fresh foods and a high-quality food products from United States. And so that direction is changing and we are adjusting accordingly. And in addition to that if you look at China, what we witnessed is that, for example, the last two years, we’ve done a lot more cross-border transaction requiring standby letter of credits from major financial institution in China. And just the last six months that business have slowed down. And mainly, because many of the financial institutions in China currently because of reform and from the government direction, and they’re slowing down in terms of their liquidity and supporting and standby letter of credit. So from that standpoint and that slowed down our business on that hand. But on the other hand, we’re picking up a lot more business by hoping oversea direct investment from China investing in the United States in various kind of business, whether they’re investing in the clean tech sectors, or maybe actually in automobile industries in Midwest, or in California particularly in the movie industries, and we are actively engaging in that direction. Now – but when it comes to helping, these companies do acquisition and then provide financing for the acquisition. We have to – so sometimes put out the term sheet, but just stand on the sideline, waiting for the deal close in order for us to get funding. So in that standpoint, as I mentioned earlier, it’s not that like, for example, entertainment sectors are just losing any business to the competition and quite a contrary, we are gaining as much business like we have had before. The only thing is that, we are sitting on the sideline, waiting for some of the deals close and until that happened, we’re going to have some challenges in terms of growing our business and it’s a lot of time is timing. It just happened that sometimes there are quarters that deals that we’ve done a year or two ago now finally we got payoff. And then the deals were supposed to book, we haven’t been able to book, as I mentioned earlier. So that’s one thing, and that’s the part of China. Let me go back to maybe qualify what Irene just talked about on the BSA part. We are not prohibited to open branch or make acquisition. But we are – because of this consent agreement, we are required to seek regulatory approval before we move forward. So as – I mean like – for the last 25 years, I’ve been a CEO here that we always just do what we need to do, there’s right for the stockholders. And so now for the first time, I think that we do need to get approval ahead of time from the regulator before we consider like a major – these expansion like opening a branch or making an acquisition and something like that.

Understood. Thanks a lot for that clarification.

Our next question comes from Joe Morford of RBC Capital Markets. Please go ahead.

Thanks. Good morning, everyone.

Good morning, Joe.

I guess just – I understand it’s a lower margin guidance. Are there things you can do to help, defend the margin be it mix changes or running off more higher cost funding, or do you see it more of just an issue of not exacerbating it by booking lower price credits?

No, I think you listed out all the options of what we could do to defend the margin. And those are exactly all things that we’re working on, right, as far as trying to keep the pricing up, running off some higher cost deposits with our kind of a loan to deposit ratio and the liquidity, we’re comfortable doing that. And then also on the security side, it does help a little bit, but not that much candidly, given where rates are, our duration is pretty well. So that is something that we would be okay extending that a little bit as well. So all of those will help incrementally, and all things that we are looking at and actively seeing what we could do to improve that.

All right, okay, I understand. The other question is just on the expenses, given the expectations that consultant cost will be coming down in the second-half. What’s driving the increase in the overall run rate to that $155 million level other than obviously the tax credit investment amortization stuff?

Sure. So ex the tax credit, basically what we’re looking at is $138 million a quarter. The consulting we do expect to go down, consulting in general and then also specifically consulting for BSA. We do still expect the comp and employee benefit will continue to increase for the remainder of this year. Some of that because of what we talked about as far as pulling in the full kind of run rate of additional hires for BSA. Additionally, we are assuming as well higher FDIC assessments with the surcharge for banks over $10 billion. So those are probably the larger components. Other things, here and there if you look at second quarter, some are a little higher, some are a little bit lower, but relatively speaking that out.

Okay. That’s helpful. Thanks, Irene.

Our next question comes from Aaron Deer of Sandler O’Neill and Partners. Please go ahead.

Hi, good morning, everyone. Just wanted to follow-up on the – what’s going on with the loan portfolio there. But, Dominic, you’d mentioned that you guys have been doing some sales on the – or participation out of the some of the commercial real estate production. I wondered if given the strength that you’ve had in C&I if you’ve been doing any of that on the C&I side, or conversely if you have been doing any participations yourself where you’re not the lead bank and start to contribute at all for the growth?

Yes, in fact, we actually just in the second quarter, we participate out $20 million entertainment loans. Again, this is to test the market and want to make sure that, because the size of the entertainment growth are getting larger. And in addition to that, we are now having an opportunity to be the syndicators, and as well may get more and more established in the field. And so we think that there will be plenty of opportunity particularly in the future if there’s any kind of like potential acquisitions or deals from China to the United States. We feel we’re confidently, do we have the capability to be syndicators. And we’vce got to make sure that we have the network set up properly. So we’ve done one about selling $20 million to another bank. And then we’ll continue – you would expect that we would do more of that going forward just because the fact that that will be to make a direction that we’ll be going. And in addition to entertainment field, I think private equity capital call line and make some of the high-tech area, we’re going to see larger deals coming to us. And, but with our discipline about staying focused and not trying to stretch ourselves in that too big of exposure per individual borrower, we most likely will find participants to support us.

Okay. And then the residential book also was a big contributor to the growth. I’m wondering, is that still predominantly in the kind of non-QM products? And also curious how much of that has been driven today by foreign purchasers versus say what it was a year or two ago?

Well, it’s a combination. We started also the Fannie Mae product. So, I mean, it’s – we always going to have a – the lion shares of what I call our portfolio products for our retail customers. And in addition to Chinese investors that coming to this country buying homes. And so we have a combination of that and our traditional core retail customers, and then with our additional solo like Fannie Mae products, so those are the combination of residential mortgage that we’re making right now.

Okay. And any change in the mix of customers in terms of foreign versus domestic, that is kind of the trends have changed and restrictions on capital flows?

No, it’s really not that. We never really was that sort of like active in terms of like every single one of these foreign investors in the homes come to East West for loan, that’s actually not quite a contrary, that’s not the case, because most of these foreign buyers pay, I mean, cash to buy their home. And so now most of the – now, we do have plentiful of what I call Chinese investors that have made a decision that move the family here to establish their household in United States whether it’s in California, or New York, or Texas, et cetera, or like up in Seattle. And we do have – I would say the lion share on that kind of business. But these are customers that I’m not like a one-time deal with us. They actually made a commitment to make a home purchase here. Now, the husband often times feel traveling back and forth, doing business between sort of U.S. and China, or maybe doing most of the business in China, but their family moved to United States. So we do a lot of that type of mortgages for these type of household. But then in terms of folks that are coming out here like a – on a tour bus and then a whole – like a whole bus of folks buying properties in San Bernardino and then Las Vegas and things like that or Florida. We haven’t been actually been fortunate to do any business like that. I mean, most of those folks are buying homes with cash.

Sure, sure. I understand. Okay, great. Thanks for taking my questions.

Our next question comes from Matthew Clark of Piper Jaffray. Please go ahead.

Hey, thanks. Just a couple of quick ones. SBA gains, any expectation for those gains to step up here in the second-half?

I’m sorry. I didn’t quite hear your question of what gains?

Your SBA gain, just wondering, I know it’s – a lot of the…

Oh, SBA?

I know a lot of the gain on sale this quarter came from portfolio loan sales. Just curious what you might be seen in SBA in the second-half?

Yes, SBA, during the second quarter, I believe we sold about $21 million of SBA loans, that contributed largely to the gain of $2 million or so. Overall, I would say that what we have been seeing and we’ve been hearing is that for the secondary market for SBA, these are the 7A loans. And the gains are in general coming down, let’s say, even last year we’re talking about a double-digit gain, and now we’re seeing lower level. So I don’t think as a percentage of loan origination, you’re going to see an increase in that. Certainly, we’re encouraging the team to increase originations of those, and I think that there’s some more opportunities there for us, but I don’t think that the gain percentage is going to increase that much.

Okay. And then do you have the trade finance balance in terms of loans outstanding at the end of the quarter?

I don’t know if I have that right off the top of my head in – we could give you that at the end of the call. I think overall, although it was down a little bit from where it was in the first quarter.

Okay. Thank you.

Our next question comes from Chris McGratty of KBW. Please go ahead.

Hi, good morning. Thanks for taking the question.

Hi, good morning.

I may – good morning. I may have missed in the prepared remarks. The security yields went up additional amount this quarter. I’m wondering if there’s anything unusual maybe this quarter, or maybe in the first that we should be considering for the back-half?

Yes, nothing that is usual. Overall, to look at point-to-point, the duration actually decreased from March 31, at $630 of the portfolio. But the yield – there was also a mix of – we had during the quarter of the first quarter much more liquidity, which we knew some of that would exit during the year. So that impacted the yield more so.

Okay. So the $155 million is – that’s a good number for perspective, okay.

Yes, that’s right.

How should we be thinking given where rates are, the overall size of the portfolio? Are you putting, I know in your prepared remarks, you said you maybe extending a little bit. But should the size of the book kind of maintain or we’d fund loan growth of liquidity?

We really – I think as the size of the loan book, I don’t think, we’re expecting it to change substantially. I think as we continue to grow the balance sheet and we look at the mix as far as the earning assets, loans versus a security and then also obviously from a funding perspective and try to balance that out, maintain that profitability as well. A lot of excess kind of liquidity that we have is what we deploy in the securities book and by securities, I mean, available for sale or repose on short-term as well. But that overall mix shouldn’t change that much.

Great.

First quarter was a little unusual given the high volume of kind of deposits that we ever had.

Okay, that helps. Maybe one more if I could on the reserves. We’re approaching 1%, obviously your credit numbers look really a little bit strong. How should we be thinking about ultimately a trough in that ratio as we head out to the back-half?

Yes. So the allowance ratio, certainly, it is a mathematical equation. We are given that generally speaking credit trends are positive, it has continued to kind of creep downward. We would realistically like to keep it above one. But certainly, it’s a function of what happens to the overall kind of loss rates, the migration, et cetera.

Great. Thanks a lot.

[Operator Instructions] Our next question comes from John Moran of Macquarie. Please go ahead.

Hey, thanks. I just hear you on the caution around CRE. I think in your prepared remarks you said BC call lines in life sciences were good pockets of growth in C&I for you this quarter. I think some of the competitors that you guys have in that space sort of been a little more cautious saying that there’s some froth there. I’m wondering if you’re pulling back there too, or do you sort of continue to see an opportunity to take share and good risk-adjusted returns there?

Well, in terms of the private equity capital call line, we have been having some pretty healthy growth. And at this stage right now, again, we’re not going to be expecting some extraordinary high growth in that area. And because mainly from a – as a internal discipline point of view, because we really would not allow any particular sector within the overall low portfolio to just suddenly charge up and go in a substantially higher rate than direct simply, because we don’t wanted to create a dramatic imbalance. So our position has always been that we will continue to make impact in the market. And then to remind is that, we have a very unique value proposition, many of the banks out there whether if you look at from a private equity capital call line from a –what was entertainment and more – a lot of the other business sectors they’re in, they’re coming from a more generic angle. And we on the other hand, we pride ourselves the bridge between the East and West. And we always have a unique value proposition. Our knowledge about the Greater China region, the business that are coming from China. In fact, instead of decreasing as everybody talked about that China is slowing down economy and slowing down GDP and so forth. But actually have increased more dramatic than ever had before. They have more money coming from Greater China region to United States and they’re investing in many different sectors. So we naturally have the advantage of being one of the first to greet these potential investors and to get into various kind of business. So with that in mind, I think that with our unique value proposition, we have a little bit different kind of angle. What we win business is not like a traditional way in going out there and then lower the pricing or world’s tradition way and China do it a little bit more aggressive. But actually, we provide unique value proposition that the other banks were not able to offer. And with that and then we’re able to win some business. So we’re going to grow in that direction. And so whatever we can get, I mean, and that kind of like as general direction is, what we end up going. And then with a discipline of making sure we don’t get out of control, because as I said earlier about the energy and that’s kind of like with no burden from the stress energy credit and to go out there in the Texas market with the capital and with the balance sheet to be supported, we could have grown substantially a bigger portfolio today than I look hundred some odd million commitment as of today. But we try to do it prudently. And so we’re going to be following the same kind of pattern with all of the areas that we are being – we’ll be working on.

Great. Thanks very much. The rest of mine are – has been answered.

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

Well, thank you all again for joining our call. And I and Irene are looking forward to talking to you again in October. Bye.