Good day, and welcome to the East West Bancorp's Second Quarter 2020 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. Please note this event is being recorded. I would now like to turn the conference over to Julianna Balicka, Director of Strategy and Corporate Development. Please go ahead.

Thank you, Alison. Good morning and thank you everyone for joining us to review the financial results of East West Bancorp for the second quarter of 2020. With me on this conference call today are Dominic Ng, our Chairman and Chief Executive Officer; and Irene Oh, our Chief Financial 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. Forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties. For a more detailed description of the Risk Factors that could affect the company's operating results, please refer to our filings with the Securities and Exchange Commission, included in our Annual Report on Form 10-K for the year-ended December 31, 2019. In addition, some of the numbers referenced on this call pertain to adjusted numbers. Please refer to our second quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures. During the course of this call, we will be referencing a slide deck that is available as part of the webcast and on the Investor Relations website. As a reminder, today's call is being recorded, and we will also be available in replay format on our Investor Relations website. I will now turn the call over to Dominic.

Thank you, Julianna. Good morning and thank you, everyone for joining us for our second quarter 2020 earnings call. Before we go into our financial results, first-off, I would like to thank all of our 3,200 associates for their dedication to providing our customers with seamless service during these unprecedented times. Our teams' commitment to putting our clients first is a true reflection of our values. As a government designated essential service, we remained open and our branch associates were out there every day to help customers. Back in early April, out of 125 locations, we strategically closed 13 branches for the purpose of creating excess resource capacity as part of our business contingency plan under the pandemic. All branches were opened and resumed normal hours at the end of June. As an organization, our number one priority is to provide a safe operating environment for both our associates and our customers. To that end, we adapted all of our locations with enhanced safety and cleanliness measures. We continue work-from-home plans for non-branch associates, and the transition to remote work has been very successful in terms of productivity. We have developed a detailed return to office plan with gradual phased return for associates. Now, mindful of our mission to support our customers and communities that we serve through these challenging times, we funded $1.8 billion of SBA PPP loans during the second quarter for over 7,200 small to medium-sized business and nonprofit organizations, that accumulatively support over 170,000 employees. The medium loan size that we funded was 60,000 and over 60% of the loans were under 100,000 in size. In addition, over 1,200 of the customers, we provided PPP loans to are new customers for East West Bank. For East West, the bottom line is that our customers were thriving…

Thank you, Dominic. Turning to Slide 13 for a review of our allowance for loan losses, and Slide 14 for a review of our asset quality metrics. Our allowance for loan losses was $632 million as of June 30 or 1.7% of loans held-for-investment compared to $557 million or 1.55% of loans as of March 31. Quarter-over-quarter, the allowance coverage of the oil and gas portfolio increased by 112 basis points to 9%, the coverage of all other C&I increased by 28 basis points to 2.6%, and the coverage of CRE increased by 38 basis points to 1.5% driven by increases in reserves for hotel and retail commercial real estate loans. During the second quarter of 2020, we booked $102 million provision for credit losses compared to $74 million in the first quarter. The quarter-over-quarter increase in the provision expense was primarily driven by a more adverse macroeconomic forecast as of June 30, 2020, relative to March 31, as well as loan risk rating downgrades during the quarter. All else equal, if the macro economic outlook stabilizes, we would expect the provision expense to decrease from current levels. As you will see on the next slide, excluding oil and gas loans, we are not seeing significant deterioration in our portfolio by any particular industry or asset class. So low loan to values of our real estate portfolio provide a buffer against losses and the rate of deferrals remain manageable. Net charge-offs in the second quarter were just under $20 million and the net charge off ratio was 21 basis points of average loans annualized. Charge-offs in the second quarter were primarily from oil and gas, which accounted for $14 million or 64% of gross charge-offs. Turning to Slide 14, criticized loans were 3.4% of total loans as of June 30…

Thank you, Irene. Well, this has been a quarter like no other, given not only tough economic conditions, but also the toughest of health and social circumstances. I'm proud of the way our associates have handled the challenge and deliver for our clients exemplifying East West values and culture. As an organization, we remain vigilant about credit risk management, and maintaining a strong balance sheet with above peers capital ratios. We're committed to delivering responsible growth, managing controllable expenses, and building sustainable profitability. I will now open up the call to questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. The first question today comes from Ebrahim Poonawala of Bank of America. Please go ahead.

Hey I guess first mention, Dominic, thanks for going through all the details on credit. But maybe if you could just spend some more time there after the review that you talked about. Talk to us just in terms of the downside risks to your reserve levels, when you think about one the energy portfolio. We saw one of the banks take a 50% mark and sell some of these loans. So if you could adjust your energy book in the context of that? And then also on the CRE book, like is the 50%, 55% LTVs which looks relatively low, are those a good kind of buffer when we think about certain hospitality properties that may never recover from this pandemic. Could you give us a sense of your comfort around both those portfolios, if you could please?

Okay, first on the oil and gas. When you -- we -- I mean I can't really comment much about Hancock Whitney because our portfolio quite different to a certain extent. And why the motivation of selling at such a steep discount. We've done pretty much most of our Spring redetermination, we do not see the type of deficiency like that will be causing us to wanted to take this kind of massive discount. And basically we're going through just loan by loan and looking at the current situation, and most -- most updated financial information and engineering report from the Spring redetermination and come up with the reserves that is needed. We feel that we have very adequate -- very adequately cover our oil and gas portfolio as of today with a 9% of reserve coverage. So we feel pretty good of that. And we are appropriately classified the loans that need to be classified and so forth. Now let's go to the CRE, yes, the 50 some odd percent loan to value is very, I think is very good in terms of as a cushion to help against losses. We have 30, 40 years of history at East West in many different credit cycles that year-in and year-out when it comes to income producing properties; the low loan to value makes a big difference. I think for the hotels, it also add that we are doing business with hotel operators that are very experienced in this trade and these are high quality operators, and also many of them have substantial liquidity. Many of them also have put in their personal guarantee. So yes, there are some hotels, there is going to be having some challenge because of the current pandemic that's causing the occupancy rate dropping very low. But the fact is, so far what we have seen is that some of these hotels have gradually reopened. I know that they're all going to be always some setback with certain states and certain cities that they have to shut down for a brief period of time. Eventually, the economy has to open up. We just have to find ways to protect ourselves whilst still working. So I would expect that some of these hotels will gradually still open back up. And we do have our borrowers who have more liquidity and have their personal financial network at stake that I think will be substantially more motivated. So from that standpoint, we want to look at pretty much almost all of the hotel loans and we do feel pretty comfortable right now that we've more than adequate reserves to cover the commercial real estate portfolio.

Thank you. The next question comes from Jared Shaw of Wells Fargo. Please go ahead.

Hi, good morning. I guess the first question sticking with credit, when we look at some of the most troubled I guess CRE loans, whether that's hotels or retail or restaurants. How are you looking at sort of the long-term resolution, should we assume that those just stay on sort of a continued deferral, that's allowed under the CARES Act, or would you expect to see more of an active restructuring of the most troubled loans before year-end and try to get them onto a new system or a new structure?

Well, first of all, I think as I mentioned earlier, over 90% of our payment deferrals are actually only three months. So based on our conversation with the customers, the one that request a deferral, really don't anticipate that they will need another three months or six months deferral and so forth at this stage. Well, granted some of them have support from PPP loans. So we'll have to see whether beyond the PPP, what the stimulus package that may be coming from the government or maybe some of them possibly qualify for the Main Street Lending program and so forth. So there are many different sources of support. But all in all, when I look at particular for the hotel and some of the retail customers, when we go through loan by loan, so many of them did not even ask for payment deferral. I mean keep in mind, the vast majority, if you look at it, only 10% of our -- only 10% of our CRE customer ask for payment deferral. The vast majority of our customers don't even need that, because they have their personal liquidity or for whatever reason, the nature of that particular income producing property, allow them to still have enough cash flow to service the debt. And that's the beauty about having first trustee low loan to value loan because the mortgage payment for P&I combined are not as taxing as those, what I call conventional borrowers who borrow 70%, 75% and struggling a little bit. So I think from that standpoint that there's no question that we're going to have a few more customers potentially may have to come back due to whatever various reasons that we have to do maybe somewhat of a additional modification and we'll work with them one-by-one. But at this stage right now, I think overall, it's looking pretty good for us.

Thanks. And then on the C&I loan pipeline, last quarter, you seemed I guess a little more cautious on growth, this quarter it sounds like the pipelines are starting to boost again. How are you looking at underwriting in this environment? And I guess what's the -- what do you view is the opportunity for near-term C&I growth as we finish up the year here?

Yes, I think ever since, in fact, ever since late January, when the pandemic first happened in the Wuhan, we have implemented internally the COVID-19 review. Every single loan that we approved has to go through the sort of like evaluation about how does COVID-19 affect this particular business. So that in addition to looking at the like for example like back in February, and March, or so in addition, just looking at the financial statement as of 12/31 and then everything looks fine and dandy. We look at the situation as it and say that, hey with the pandemic, how would this business going to be able to carry on in the next six months, 12 months, they have enough liquidity to get by, are they in the business that actually have benefiting from the pandemic because they're in the e-commerce business, or they are in some type of business, they are making facemasks that actually are helping them. So we looked at all of the different factors or there's something that is positive, to what extent this positivity can only last for six months, and so forth. So we looked at all of those different factors to determine that the credit worthiness and making sure that we do not go in here now and go into make a loan using a formula pre-COVID-19 and then end-up getting ourselves in more problem a few months down the road. So that's the kind of rigor that we will use. And so far I think that we find business that we're able to sort of like bring in as new customers. And we also have existing customers now start going back and doing more business and we continue to support these type of endeavors.

Thank you. The next question comes from Ken Zerbe of Morgan Stanley. Please go ahead.

Okay, thanks. I guess my first question for Irene, could you just help us understand the benefit of the PPP loans this quarter, because if I look at the math, you have $1.7 billion of loans, but you have $23 million -- sorry $21.3 million of fees or income, which kind of amounts to about a 5% annualized yield, which seems a bit high, help us understand that please.

Sure. I'd be delighted to do that for you. So if you look at that $21 million of PPP related loan income that is the one part of it, it's 1% that we're accruing and additional we estimated what we thought the life would be for the PPP loan, loan by loan. And based on that, we have accreted part of that fee income during the quarter. So the combination of that is a $21 million. So, I'll break that down for you. The amount that we accreted was about $17.5 million in the second quarter. So we're estimating that the life of the loans will be shorter than the contractual periods, which for us was generally two years in total for some of the loans, some of them just based on the activity on what we're seeing and what we know about the customers, we are assuming that they'll go through the full contractual life of the two years plus.

Got it. So in essence that if you assume a loan has say a six months life, and you get 3% fee on that loan, you're basically taking the entire 3% fee over the six month period, is that the right way to understand that?

That's correct.

Got it, okay. And if I can just sneak in sort of a second question. Just in terms of provision expense, Irene, you did mention that provision expense should decline, which I think we all generally agree provision expense should decline, if there is no further deterioration to your macroeconomic assumptions. Maybe is there anything unique about East West that would lead that provision to decline a little bit less or more, or I am just trying to get a magnitude of whether it goes from $100 million down to $80 million or $100 million down to $20 million if there's no further deterioration?

Yes, that's a great question. I don't know if you look at it portfolio-by-portfolio, I don't know if there any kind of unique characteristics and that's why are relative to others with the same macroeconomic environment, we use Moody's the baseline as the backbone of our allowance calculation would be that different from other banks, quite frankly. I do think kind of in continuation of the comments that we've made, as far as the resiliency of our customers, income-producing commercial real estate, the review that we've done, the single-family customers, the amount of equity that they have, those are portfolios, I’m very confident that ultimately, the loss content will be reasonable -- reasonably low relative to others. But I don't know if aside from the oil and gas which we talked about, we see anything really systemic at this point.

Thank you. The next question comes from Michael Young of SunTrust. Please go ahead.

Hey, thanks for taking the question. Maybe just a quick follow-up on that point, Irene, just within the C&I portfolio I think you've got a little over 2% reserve on the remaining loans ex-oil and gas, can you talk about what areas you are watching more closely in there? Whether it be entertainment and what's in that bucket or tech and life sciences, are there other things that we should be keeping an eye out forward as it does seem like those might be the higher loss given default areas?

Yes. Candidly speaking, I think we are looking at all the portfolios. Especially with the pandemic, the concerns, the cash flows, the different circumstances are very different than before the pandemic. So we're looking at as far as what's happening with our business, what's the cash flow, strength of the guarantors, and the borrowers as well. From our allowance perspective, specifically, I don't think that aside from oil and gas, if you look at industry-by-industry, there's anything very unique with how much we reserved, there are certain portfolios for example, we have a equipment leasing portfolio, it's a longer life, the amount of reserve for that is higher. But aside from that, I wouldn't say that there's anything very unique industry-wide.

Okay. And this one may be a bit of a oddball question, but kind of just bigger picture on what's going on with Hong Kong, right now in China and U.S. rhetoric ratcheting up again. Are there any things that we should be thinking about relative to kind of a Hong Kong specific or China Mainland operations that could flow back through to East West if you know things were to deteriorate there?

Well, I think on the Hong Kong situation, let me just maybe see we can break it out into a few different scenario. Let’s just say the worst case scenario; the worst case scenario will be let's say that U.S. government order all U.S. banks to retreat back to U.S. and no longer allow to be doing business or no longer allowed to have offices in Hong Kong or something like that as to I look at the worst case scenario. But keep in mind that we have so far as of today only 3% of our loans are in Greater China region. So for example, you look at $37 billion of loan outstanding today, only $1.2 billion in Greater China that's even including Hong Kong. So if you cut that half of that in Hong Kong, China and Hong Kong combined, half there in Hong Kong. So we will have to talk about less 1.5% or so of our total loan portfolio. And if you look at our history, for the last 13 years in Hong Kong, the loss rate delinquency, non-performing asset and so forth has been extraordinary low. So as of today, if we look at what's been happening, Hong Kong went through the pandemic for six months and we had no losses. So I feel pretty good that if we end-up just having to all come back home, we will talk about revenue risk is very minimal. We obviously just last quarter grew our loans by 15% annualized. So there's really no reason for us to worry about a 1.5% loan reduction. So we feel pretty good about even if the worst case scenario, we're not going to have any losses. We're going to -- and we talked about revenue risk, we can get it covered.…

Thank you. The next question comes from Chris McGratty of KBW. Please go ahead.

Great, thanks for the question. Dominic, in your prepared remarks, you spoke of the consistency of your efficiency ratio in the high 30s. Understanding, we're in a different world with interest rates. Maybe you could talk about your expectations for this metric going forward and maybe speak of it excluding the impact of the PPP program. Thank you.

Well efficiency, I mean -- I think I've said it before efficiency ratio is just a soft revenue of income minus expenses. So there's not much to it. I just basically work with our associates and then I tell them that hey, wish, I mean don't take any losses, but then book as many loans as you can, and then bring in all these good low cost deposits. And so that generate some meaningful profit, like net interest income, and then get more fee income, core fee income, and then control the expenses and then something good will come out. And then my definition if something good come out is that these high-30s, low-40s kind of numbers. And that's it. That's all we focus on. And then I don't really, really get into that much about we have a target, anything like that. I just -- we just make sure we do the right thing.

Understood, great. Maybe I could ask one more on the expenses. You guys have, I think done a great job adjusting to the revenue environment by slowing the expense growth. I guess two part question. The lower expenses, the core expenses this quarter, was there any benefit from the PPP program, the originations? And two, how do we think about just investments in this kind of environment, the pace of investments into 2021? Thank you.

Chris, this is Irene. I'll take that. Yes, there was a benefit during the quarter for loan costs that were deferred. Our gross fees are roughly $50 million and in the quarter deferred about $7 million of loan costs fees associated with the origination of the PPP loans. On a go-forward basis, if you look at the pace of investments, we have actually many very exciting investments and projects underway to help our customers improving our systems, our platform, the digital onboarding. Those investments started before the pandemic are underway -- just to share, well underway, rather, we're implementing the new online banking system for Hong Kong and that will integrate our U.S. online banking and our Hong Kong online banking. We're also implementing a new global FX system and we also have many smaller projects underway to improve digital onboarding and then processes. I think with the pandemic, the investments that we have been continue to make in these areas are perhaps maybe even more important. So to a certain extent, these are things that we're continuing to do, have started before, and will continue to do. And in a way many of these will also help us as far as the efficiency and the productivity of our team and our ability to continue to serve our customers without adding on as much incremental cost.

Thank you. The next question comes from Lana Chan of BMO Capital Markets. Please go ahead.

Thanks. Just two questions. One, is there any update on the tax credit investments and the associated tax rate going forward?

Update, there's no update. If you're asking what the amortization of the tax credit will be for the full-year, we are assuming around $100 million.

Sorry, sorry, to clarify we are assuming $100 million of tax credits with a tax rate amortization in the low 90% against those $100 million.

Got it, thank you. And is there any way you can quantify the reserve build this quarter? How much of it was associated with the change in economic forecasts versus loan downgrades and new loan growth?

Yes, great question. First and foremost, I would say the vast majority of it on kind of, there are a lot of moving parts with the allowance, but the vast majority of the increase had to do with the more adverse economic scenario. Secondarily, I would say it's a downgrade particularly for C&I.

The next question comes from Dave Rochester of Compass Point. Please go ahead.

On the credit slide on Slide 14, you're showing classified and special mention in C&I ex-energy and PPP going down this quarter in terms of the ratio versus last quarter. Was just looking for some color there, was that the PPP effect shoring up customer balance sheets or something else going on just little color there would be great?

Yes, definitely not the PPP. What we had in the quarter-over-quarter, there were some loans that were resolved during the quarter that were classified last quarter.

Got it. And then for my second question, you guys had mentioned pipelines were building in June in commercial, you mentioned few industries there, I was just wondering if you could just talk about what's driving that build, if you're taking share in those areas or if you're hearing more confidence or any positive sentiment amongst commercial customers? And then I guess on the flip side in the rest of the C&I book, is the expectation that you'll have some more pay downs in energy and maybe see an unwind of some of those draws from the first quarter as we go through the back half of this year?

Okay. For the pipeline that we're beginning to see in June, in fact we started booking some of these loans now in July. In PE, private equity those are just traditional capital call lines and mainly existing customers that have new funds, so much distress situation going around the world. There are more people now. I mean just like putting in substantial amount of liquidity and start new funds to capitalize on these opportunities. And we have these very, very strong borrowers that are starting new funds coming to us. And we're able to actually start booking some of these private equity capital call line business. We just have happened to be taking up some more, I think for the last few weeks, versus in the second quarter, when people need to just timeout and size up what's going on. And on the entertainment side, I think our team just being very diligent while staying at home, but dialing the phone non-stop with the studio executives and then getting these deals that we're able to find to finance and against very strong collateral support type of deals and then things that we, without any question to be more than happy to jump into this kind of type of transaction even during the pandemic. So we feel very good about it, these kind of opportunities. And the third category that I thought we saw some really nice pickup, our cross-border business. Keep in mind that in the first and second quarter, Hong Kong and China have taken a more draconian type of measurement against in terms of just I would say discipline on fighting the pandemic. Both of them have been extraordinarily successful. But with that, I think that obviously business been somewhat shutdown in a big way, so they weren't having as much business as you -- as we indicated. In the second quarter, no second quarter, we actually have $2 million, the 2% reduction of our Greater China loan portfolio. But they started getting back in the business as usual, business as normal, both in Hong Kong and China. And so our teams in Greater China are picking-up some more business, we feel that there's more opportunities there. And same thing for the cross-border team in the United States. Frankly, when everybody looked at U.S., China as something that they don't want to get anywhere close to, if someone just looked very hard and deep, they can always find some golden opportunity in there. And we're trying to make sure that we do the best we can to capitalize on some of these remaining good opportunity. So at this point, we see these three industry verticals may have some pretty good traction for now. I mean, but still we're in July and it's too early. So we don't know what the next two months will be like. We'll see. But at this point, it looks pretty promising.

Thank you.

What's the next --?

The next question comes from David Chiaverini of Wedbush Securities. Please go ahead.

Hi, thanks. First question is on credit and the provision you mentioned about how it could be lower if the macro environment remains stable. I was curious if the stimulus bill being contemplated is delayed to late August or September. Would that change your economic forecasts?

I don't know. It's just the stimulus bill being delayed would change the economic forecasts. Certainly, if it impacts the expectation a lot of drivers for our forecasts, some of the many drivers. But for us, if you look at it, GDP growth, unemployment and then to the certain extent for single-family, the housing starts numbers. So those are the things that drive at the most. But certainly, I would say that if the bills are delayed and that impacts the expectation around these key metrics, that that will have an impact, but not just by itself.

Okay, thanks for that. And separately, anecdotally, it appears more retail stores are becoming vacant, I was curious. Do you know how much of your CRE borrowers no longer have tenants?

Well, we actually went through the CRE retail customers' loan review. As I said, we review over 50% of these CRE loans in a loan by loan review basis and then getting the most current information, our Relationship Manager actually have the most updated information for the customers. Every one of them have a -- maybe a little bit unique situation. We have some that have maybe 30% of the tenants have to -- cannot pay full rent. And we have some that actually have a few of the tenant just say that I'm out. And then there were others that are still paying as agreed fully occupied. So every one of them are a bit different. For a few of them that may have some more severity in terms of tenant not paying. Somehow the borrowers have strong financial ability to continue to carry the payment and knowing that eventually, he will be able to find a way to release it to some -- some other new tenants down the road. So it’s just multiple different scenario. But one thing we do know is that because we went through this review loan by loan, we know exactly what the situation is and we know what the stress situation is currently. And at this stage, we feel pretty good and comfortable about the portfolio where it stand today. And we feel that we absolutely from a CRE point of view, we have more than adequate reserve to cover any potential losses.

I'd also just like to add a lot of the comments Dominic made were about tenants and their payments. And especially given in light that many of the stores are closed, specifically as it relates to occupancy the -- the buildings, most of -- as we went through these loan reviews, the occupancy pre-pandemic was pretty high on most of the properties. Most of them were fully occupied.

Thank you. The next question comes from Brock Vandervliet of UBS. Please go ahead.

Thanks. Just an accounting question here. I noticed there was a negative provision in single-family residential in the quarter, could you give some color around that, please?

Yes, the slight negative provision in single-family, it's very modest in many ways, but the results -- the reason for that was the allowance that was required, did reduce slightly from the forecast that we used at the end of March to our forecast as of the end of June that we use for our June allowance close, it was really driven by the less severe impact for housing prices with the HPI improving over the prior forecast.

Got it, got it. Okay. And did I understand correctly that the next major cliff of deferral expiries is August?

Yes. Based on -- so I'll categorize the deferrals, we have the big groups as far as the commercial deferrals and then also the single-family. Single-family a little earlier, for the commercial deferrals, it is August and September; most of those will come up in a wave then.

Thank you. This does conclude our question-and-answer session. I would like to turn the conference call back over to Dominic for any closing remarks.

So again, thank you all for joining us for the call and we're looking forward to speaking to all of you again in October. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.