East West Bancorp - Q2 2023

Transcript

Operator (participant)

Good morning, welcome to the East West Bancorp's second quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one your telephone keypad. To withdraw your question, please press star then two. We ask that you limit yourself to one question and one follow-up. Please note that this event is being recorded. I would now like to hand the conference over to Diana Trinh, Vice President and Investor Relations Officer. Please go ahead.

Diana Trinh (VP and Investor Relations Officer)

Thank you, Anthony. Good morning, and thank you everyone for joining us to review the financial results of East West Bancorp's second quarter 2023. Joining me are Dominic Ng, Chairman and Chief Executive Officer, and Irene Oh, Chief Financial Officer. This call is being recorded and will be available for replay on our investor relations website. The slide deck referenced on this call is available on our investor relations site.

Management may make projections or other forward-looking statements, which may differ materially from the actual results due to a number of risks and uncertainties, and management may discuss non-GAAP financial measures. For a more detailed description of the risk factors and a reconciliation of GAAP to non-GAAP financial measures, please refer to our filings with the Securities and Exchange Commission, including the Form 8-K filed today. I will now turn the call over to Dominic.

Dominic Ng (Chairman and CEO)

Thank you, Diana. Good morning. Thank you everyone for joining us for our earnings call. I will begin the review of our financial results with slide three of our presentation. This morning, we reported solid results, revenue, pre-tax, pre-provision, profitability, efficiency, and earnings all improved from a year ago. Second quarter 2023 net income of $312 million and diluted earnings per share of $2.20 were both up 21% from the prior year period. For the second quarter, both deposits and loans grew 7% linked-quarter annualized to $55.7 billion for deposits and $49.8 billions for loans. A hallmark for East West has been our consistent financial performance throughout various interest rate and market cycles, while maintaining high capital ratios. Our profitability and return levels continue to be industry-leading.

For the second quarter, we returned 1.85% on average assets and 21% on average tangible common equity. Net interest margin of 3.55%, although down from the first quarter, was a healthy margin in the current environment. Asset quality continued to be outstanding, with net charge-offs 6 basis points annualized. Slide four presents a summary of our balance sheet. As of June 30, 2023, total loans reached a record $49.8 billion, an increase of $906 million, or 7% annualized from March 31st. Second quarter average loan growth was 6% annualized from first quarter. Growth in average residential mortgage and Commercial Real Estate loans was partially offset by a decrease in average commercial and industrial loans.

Total deposits were $55.7 billion as of June 30, 2023, an increase of $921 million, or 7% annualized from March 31. Second quarter average deposits were up from the year-ago quarter, but down $669 million or 5% annualized from the first quarter. During the second quarter, growth in average interest-bearing checking and time deposit were offset by decline in other deposit categories, which reflect customers seeking higher yields in a rising interest rate environment. Our deposit book is well diversified by deposit type, and 30% of total deposits were in non-interest-bearing demand deposits as of June 30, and our loan-to-deposit ratio was 90%. Turning to slide five, as shown on this slide, all of our capital ratios expanded quarter-over-quarter due to the strength of our earnings.

East West capital ratios continued to be among the highest for regional banks. Also on this slide, our pro forma capital calculation as of June 30. The key takeaway is that our capital is very strong. The pro forma capital ratios, adjusting for investment security marks and the allowance for loan losses not already included, show very solid capital ratios. Including these items, tangible common equity improved to 9.37% as of June 30. Quarter-over-quarter, our tangible book value per share increased 3%. East West Board of Directors have declared third quarter 2023 dividends for the company's common stock. The quarterly common dividend of $0.40 per share will be payable on August 15, 2023, to stockholders of record on August 1, 2023. Moving on to a discussion about loan portfolio, beginning with slide six.

As of June 30, 2023, C&I loans outstanding were $15.7 billion, up by $28 million, or 1% annualized from the prior quarter end and up 2% year-over-year. As shown on this slide, our C&I portfolio continues to be well diversified by industry and sector, where the China loans decreased 11% linked-quarter annualized to $2.1 billion as of June 30.

Slide seven and eight show the details of our commercial real estate portfolio, which is well diversified by geography and property type. Further, we have a seasoned customer base and a low LTV CRE portfolio. The average loan-to-value for our commercial real estate portfolio is 51%. Also, we typically originate amortized loans with a final maturity of seven to 10 years.

As of June 30, only 3% of the income producing CRE portfolio matures in the second half of 2023, and another 7% only matures in 2024. Total commercial real estate loans were $19.9 billion as of June 30, 2023, up 10% annualized from March 31st, and up 7.5% year-over-year. Credit quality for our loan portfolio remains very strong. Criticized CRE loans to total CRE loans decreased from 2.4% as of March 31st to 1.8% as of June 30, due to upgrades for loans with improved cash flows and loan payoffs. We remain vigilant and proactive in managing our credit risk.

Given the attention on CRE, we have provided more details about our office and retail commercial real estate loans on slide nine and 10. As you can see on slide nine, our office commercial real estate portfolio is very granular with few large loans. We have only six loans that are greater than $30 million in size, which is only 11% of our office CRE loans.

The weighted average loan-to-value of our office CRE portfolio is a low 52%. The loan-to-value is consistently low across the different loan size segments. The portfolio is well diversified by geography, with limited exposure to the downtowns or central business districts in the office markets we primarily lend in. On slide 10, you can see that our retail commercial real estate portfolio is also very granular, with few large loans.

We have only eight loans that are greater than $30 million in size, which is only 7% of our retail CRE loans. The weighted average loan-to-value of our retail CRE portfolio is a low 48%, and the loan-to-value is also consistently low across different loan size segments. The portfolio is well diversified by geography, and the footprint largely reflects our branch network.

In slide 11, we provide details regarding our residential mortgage portfolio, which consists of single-family mortgages and home equity lines of credit. Our residential mortgage loans are primarily originated through our branch network. I would like to highlight that 81% of our HELOC commitments were in first lien positions as of June 30, 2023. Residential mortgage loans total $14.2 billion as of June 30, up 12% linked quarter annualized and up 13% year-over-year.

Slide 12 breaks out our deposit mix by segment and further by industry for commercial deposits. Our deposits total $55.7 billion as of June 30, 2023, an increase of 7% linked quarter annualized and 2% year-over-year. We have over 570,000 deposit accounts at East West as of June 30, and our average commercial deposit account size is approximately $366,000. Our retail branch-based consumer deposit total 32% of our deposits and have an average size of approximately $38,000. Our commercial deposits are well diversified by industry. We do not have significant depositors or sectors concentration. I will now turn the call over to Irene for a more detailed discussion about asset quality and income statement. Irene?

Irene Oh (CFO)

Thank you, Dominic. Good morning to all on the call. Turning to slide 13. The asset quality of our portfolio remains strong. During the second quarter, we recorded net charge-offs of $7.5 million, or 6 basis points, a modest increase from net charge-offs of 1 basis point in the first quarter. The increase primarily came from higher C&I gross charge-offs, partially offset by higher recoveries. Quarter-over-quarter, criticized loans improved 11%. The criticized loans ratio improved 24 basis points. Non-performing assets as of June 30th increased modestly to 17 basis points of total assets from 14 basis points as of March 31st.

Reflecting loan growth, our stable asset quality metrics, and the current macroeconomic outlook, we recorded a provision for credit losses of $26 million in the second quarter, compared with $20 million for the first quarter, increasing the allowance for loan losses to $128 million. Now, starting the discussion of our income statement on slide 14. On this slide, we detailed out the specifics on the tax credit investments as the amortization and effective tax rate can fluctuate quarter-over-quarter, reflecting the timing of when tax credit investments close. We currently anticipate that for the third quarter, the amortization of tax credit investments will be approximately $40 million, and for the full year of 2023, the effective tax rate will be approximately 20%. Turning to slide 15.

Second quarter of 2023, net interest income was $567 million, a decrease of 5.5% from the first quarter. Net interest margin of 3.55%, compressed by 41 basis points quarter-over-quarter. As you can see from the waterfall chart on this slide, this was largely due to the impact of higher interest-bearing deposits costs and the deposit mix shift, partially offset by expanding asset yields. Turning to slide 16. The second quarter average loan yield was 6.33%, an increase of 19 basis points quarter-over-quarter. As of June 30, 2023, the spot coupon rate of our loans was 6.45%, compared with 6.21% as of March 31. In this slide, we also present the coupon spot yields for each major loan portfolio for the last five quarters.

In total, 61% of our loan portfolio was variable rate as of June 30th, including 27% linked to prime rate and 28% linked to SOFR. Over the last several years, while rates were low, we continued to help many of our CRE and C&I customers, to a lesser extent, hedge against rising rates through the use of swaps, caps and collars. Fixed rate and synthetically fixed rate loans are 65% of the total CRE book as of June 30th. These clients are protected against the rising debt service costs in a higher rate environment. Turning to slide 17. Our average cost of deposits for the second quarter was 212 basis points, up 52 basis points from the first quarter.

Our spot rate on total deposits was 228 basis points as of June 30, equivalent to a 44% cumulative beta relative to the 500 basis point increase in the target Fed funds rate since December 31, 2021. In comparison, the cumulative beta on our loans has been 60% over the same time period. Moving on to fee income on slide 18. Total non-interest income in the second quarter was $79 million. Fee income was $69 million, reflecting growth across all fee income categories during the quarter. For the second quarter, other investment income of $4 million was up $2 million from the first quarter, largely reflecting higher income from Community Reinvestment Act investments. Moving to slide 19. Second quarter non-interest expense was $262 million.

Excluding the amortization of tax credits and CDI, adjusted non-interest expense was $205 million in the second quarter, up a modest 1% sequentially. Second quarter compensation and employee benefits expense was lower by $5 million due to a higher seasonal cost in the first quarter. The second quarter adjusted efficiency ratio was 31.8%, compared with 30.5% in the first quarter. Our adjusted pre-tax, pre-provision income was $440 million in the second quarter, and our pre-tax, pre-provision ROA was an industry-leading 2.61%. With that, I will now review our updated outlook for the full year of 2023 on slide 20.

For the full year of 2023, compared to our full year 2020 results, we expect year-over-year loan growth in the range of 5%-7%, unchanged from the prior outlook. Year-over-year net interest income growth in the range of 12%-15%. Underpinning our net interest income assumptions is the forward interest rate curve as of June 30th, which assumes 1 Fed funds rate hike of 25 basis points in October, with a year-end Fed funds target rate of 5.50%. Adjusted non-interest expense growth in the range of 9%-11%.

We expect our revenue and expense outlook to result in positive operating leverage year-over-year. In terms of credit, for the full year of 2023, we currently expect to record a provision for credit losses in the range of $110 million-$130 million.

The provision for credit losses for 2023 will be largely driven by loan growth and changes in the macroeconomic outlook. Today, asset quality is excellent, and we believe the potential losses from any problem loans are limited and very manageable. Finally, we expect that our effective tax rate for the full year will be approximately 20%, based on approximately $150 million of tax-led investments, excluding LIHTC investments, and an estimated related tax credit amortization of $145 million for the full year. With that, I will now turn the call back to Dominic for closing remarks.

Dominic Ng (Chairman and CEO)

Thank you, Irene. In closing, we are pleased with our consistent financial performance and strong core earnings.

Although net interest income decreased, given the deposit competition, our revenue and pre-tax, pre-provision profitability remains very strong. The East West business model is resilient and diversified. Our balance sheet is healthy. We operate with high capital levels. We are well-positioned to deliver earnings growth and strong profitability. I will now open the call to questions. Operator?

Operator (participant)

We will now begin the question and answer session. To ask a question, you press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Again, we ask that you limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question will come from Ebrahim Poonawala with Bank of America. You may now go ahead.

Ebrahim Poonawala (Managing Director and Head of North American Banks Research)

Hey, good morning.

Dominic Ng (Chairman and CEO)

Good morning.

Ebrahim Poonawala (Managing Director and Head of North American Banks Research)

I guess my first question, Irene, for you on NII. It was a decent step down in the second quarter. If I have it right, your guidance implies that NII stabilizes about $565 million per quarter in the back half of the year. One, give us your assumptions around terminal deposit betas, NIB mix underpinning the NII guide, and what leads NII to being at the lower end of your guide at 12 versus 15?

Irene Oh (CFO)

Yeah, great question. First of all, when we look at where we stand today, what's positive, although with the deposit competition, you know, the cost of deposits did increase in the second quarter. What's positive is we keep growing, right? We're bringing on new customer deposits, and through that, we have the opportunity to lay off some of these higher cost broker deposits that we placed on the balance sheet, you know, after the mid-March disruption. I'll just share, since June 30th, we've laid off about a little over $600 million at 5.15 and replaced that with lower cost customer deposits. The momentum is here, and that is one of the underpinning drivers for why we think NII will stabilize. Of course, you know, the expectation is that the Fed will increase rates next week.

That'll help a little bit on the yield side as well. The min-max around the guidance, I do think a lot of that is going to be how successful we are. As I mentioned, we're positive and the momentum is there on the deposit side, but how successful we are in growing those customer deposits over the course of the year. Of course, also a little bit as far as the range of where we'll be on the loan book.

Ebrahim Poonawala (Managing Director and Head of North American Banks Research)

Where do you expect the NIB balances to stabilize, Irene?

Irene Oh (CFO)

Yeah. Right now, my expectation is from the level that we were at June 30, it will decrease a little bit. I'll share that also. Quarter to date has been positive, and we're at 31%, as of yesterday.

Dominic Ng (Chairman and CEO)

DDA.

Irene Oh (CFO)

DDA. I'm sorry, yeah.

Dominic Ng (Chairman and CEO)

Just to clarify. As of June 30, you know, DDA was 30%. I mean, as of two days ago, it's now 31%. Just another perspective is that the spot rate for deposit as of June 30 is 2.28%, as two days ago, it's 2.27%. We actually, you know, are maintaining the deposit rate pretty steady. Quite frankly, if you look at even if we reflect back even in May and June, the deposit rate relatively was very stable, around close to 2.28%. The fact is, it was just the Silicon Valley Bank and, you know, situation in March, which caused a spike in April.

To a certain extent, we try and do it on our own, too, because we wanted to be extraordinary cautious and prudent, and we did not need that much deposit to come in. We have very good loan-to-deposit ratio. Could have just let some of the deposit outflow and not worrying about shoring up deposit, but we didn't. We actually brought in broker deposits and so forth. Once we saw it stabilize after April, so we now decided that we can just ease it off because the momentum of new customer deposit, existing customer deposit and whatnot, all together, give us some confidence that things are stabilizing and we can move forward and by replacing the higher cost, you know, institutional money to retail and commercial clients' deposit.

We think that with that, we should be able to in a, in a much more stabilized situation going forward.

Ebrahim Poonawala (Managing Director and Head of North American Banks Research)

Got it. If I may, Dominic, one more just around capital. You have a lot of excess capital. A lot of your peer banks have reported and are building capital, exiting certain lending businesses. Talk to us in terms of just given where we are, how are you looking at market share growth opportunities? Are you leaning in, or is the macro way too uncertain to look for growth opportunities right now?

Dominic Ng (Chairman and CEO)

Yeah, I think that you just said it, kind of like answer my question with your question. The macroeconomic situation, it is uncertain. It is uncertain. I mean, anyone said that they know exactly what's going on in the future, is kidding themselves. We really don't know. I mean, I thought that the recession should have been here, actually, with the rate high spike, you know, like that, I thought the recession have already arrived, by now, it didn't. May turn out to be a soft landing, and that'll be great, but it may not. The economic environment is certainly not something that we can bet on. In the meantime, the market environment has never been as ideal as it is today.

When I say market environment, is that, you know, for decades, we've been competing with, you know, some very competitive neighborhood bankers out there. And they are, you know, good at, you know, some of them good at, you know, venture capital, PE, some of them good at making, you know, very high net worth customers, mortgages. And quite frankly, for price, for whatever reason, we decided not to be able to compete. Today, they're gone. We have just so much less competition, and with our size, and with our sort of like, being able to continue to have senior management engagement with clients, we are in a very good sweet spot. From a market perspective, I've never seen East West to be in better position than we are today. The macroeconomic environment is certainly not clear.

Then you reflect back on another perspective, which is, well, if I'm making 21% return of equity, why do I want to go crazy right now to try to do all kinds of stuff? We are watching the market. We're taking advantage of one customer at a time. When there's some other customer from other bank to want to explore a relationship with us, we're welcoming them. We are doing it prudently, not trying to go out there and then, in order to make certain kind of earnings, and that we have to go out there and make a big group of hirings here and there, and then so forth. That's not necessary because we like where we are right now. We have a very diversified loan portfolio, very diversified deposit portfolio, and that's good.

If there's any good prospect coming in, we certainly will entertain and, but we'll make sure that we stay disciplined with our East West Bank credit metrics and pricing metrics. That's what we are. We still feel that there is opportunity to grow. Not. I'm not that certain about in the next two quarters, how much opportunity that is, but I'm 100% sure in the next two or three years, it's gonna be really good.

Ebrahim Poonawala (Managing Director and Head of North American Banks Research)

Got it. Thank you.

Dominic Ng (Chairman and CEO)

Thank you.

Operator (participant)

Our next question will come from Jared Shaw with Wells Fargo Securities. You may now go ahead.

Jared Shaw (Senior Equity Analyst)

Hey, good morning.

Dominic Ng (Chairman and CEO)

Good morning, Jared.

Good morning.

Jared Shaw (Senior Equity Analyst)

Yes, maybe just sticking on the capital theme. You know, as you go into year-end, with the broker deposits running down and the BTFP likely to be paid off and assuming cash flows down, that capital will continue to grow. How high is too high for capital? You know, what else can we expect for capital management if the payout ratio is only 22% here?

Dominic Ng (Chairman and CEO)

I think how high is too high is based on, again, the macroeconomic environment. The way I see it is that, as we do a lot of these relativity comparison, that is that, well, if we I mean, many banks out there are buying stock because they can't generate the kind of EPS or return that is required, that's what they need to do, what we need to do. We obviously, today, with a very high capital ratio, we still have industry-leading ROE. This is obviously not something that we have to urgently do for our shareholders, in light of we also have dividend increase year after year, right?

From that standpoint, but we are shareholders friendly, so when we think that we come to a point, it is capital ratio getting too high, there is really not much risk in the horizon, in the market, no, in terms of the economic outlook. Then we've, for whatever reason, feel that there's so much earnings, it's just not gonna be possible for enough growth, we absolutely would consider that buyback scenario. We've done that. We've done that before, and we will do it again. In this kind of uncertain economic environment, where we don't know whether there will be recession coming or how aggressive the Fed wants to keep the rate high, for how long, that may cause a major downward spiral on the economic condition that affects certain industries and so forth.

This may create a much better opportunity for potential acquisitions or anything that is available out in the market. We don't want it to spend the money on buyback and having excess capital to strike for much better opportunity. After all, we don't run our bank as a quarter-to-quarter kind of basis. We run our bank on a long-term, you know, sustainability basis.

You know, for the last three quarters I've been here, we always look at year after year of record earnings and year after year of sustainable growth. We wanna be able to do that. To do that, we constantly have to make investment. Just like even in challenging deposit environment, like the last quarter, we still investing in our infrastructure.

We're still investing in our enterprise risk management platform to make sure that we continue to have the ability to sustain the long-term growth, like the way we have done for the past decades. Very simple, actually, a very simple kind of strategy, you know, and then it's just like, whatever makes sense. If it makes sense, we'll do what the right thing.

Jared Shaw (Senior Equity Analyst)

Okay, thanks. I guess just wanna follow up, looking at the single-family residential, great growth there. What are some of the dynamics driving that? Are you still seeing strong immigration coming in? Is it additional capital coming into the country, or is this just the existing customer base and maybe, you know, the existing potential customer base that's already in the U.S. doing more?

Dominic Ng (Chairman and CEO)

It's a combination. There's always, you know, immigrants, you know, coming to U.S. The fact is, we just become bigger and our brand stronger. Our branch networks all over the place, people recognize the brand. More and more of the customer in the Asian American community that, you know, from our retail branch, banking footprint, are coming to East West Bank because they know that they can get East West to make a decision to approve credit in a timely manner. We'll close the loans, also fund the loans on a timely manner, both from services and, you know, that our broad outreach within the branch footprint allow us to continue to have a very strong momentum so far.

You know, again, this also surprised me a little bit. I would expect that with the rate rising like that, people are not buying homes, but I guess people are still buying homes. It's not just, by the way, just, as, particularly, different at East West. In fact, throughout the country, we see the statistics, from this economic report that, people are still buying homes, you know, so, we just getting their fair share of the benefits.

Jared Shaw (Senior Equity Analyst)

Thank you.

Operator (participant)

Our next question will come from Dave Rochester with Compass Point. You may now go ahead.

Dave Rochester (Managing Director and Director of Research)

Hey, good morning, guys.

Operator (participant)

Good morning.

Dave Rochester (Managing Director and Director of Research)

Morning. On the margin, you mentioned the rate hike coming up would be helpful. I was just curious how much of a lift you guys expect to get from that in the margin? Just to reiterate, you're not assuming a hike in July. You have an October hike in your guidance, so this July hike would obviously be a better situation right off the bat versus your guidance here, right?

Irene Oh (CFO)

That's right. That's correct. I think, just to clarify, our guidance is based on the forward curve as of June 30th.

Dave Rochester (Managing Director and Director of Research)

Yep.

Irene Oh (CFO)

market expectations moved a little bit since then. Let me get you that number. I don't see, I don't have it in front of me, Dave, certainly it helps, given the variable rate loans that we have.

Dave Rochester (Managing Director and Director of Research)

Yep.

Irene Oh (CFO)

I'd also say that rate hike or not, you know, given the current environment, I think we're being conservative on kind of the deposit beta assumption, with the expectation that, even if rates do not increase from this point in time, you know, they may stay elevated for a period of time before rates decrease. That's also underpinning our kind of NII and NIM guidance. I'd also share, kind of in continuation of my comments earlier. About, we laid off about $600 million or so quarter to date. You know, our plan is about, $1.7 billion over the course of the second half of the year.

With the pipelines and what we're seeing on the deposit front, we think that's very achievable as far as $1.75 billion of broker higher cost deposits that will run off.

Dave Rochester (Managing Director and Director of Research)

Got it. Is that part excluded from your guidance? Is that just sort of icing on the cake, or are you including that?

Irene Oh (CFO)

That's included, but, you know, we're modeling around a range around that. How about that, Dave?

Dave Rochester (Managing Director and Director of Research)

Yep. Nope, that's great. My follow-up on the expense guide, it would just be great if you could, you know, talk about the drivers for the increase in that, versus your prior guide, and if you see any potential cost save opportunities that you guys could pursue.

Irene Oh (CFO)

Yeah, great question. I think when we look at the expense guidance and also, you know, the increase from our prior guidance, a couple of things: One, year to date, the actual results of and the expenses that we've incurred thus far. When we look at the remainder of the year and kind of just the sentiment around things, now, certainly things are a lot different than they were at the start and mid-April. That's certainly part of, you know, the reflection on what are the expenses, what are the investments that we need to do to sustain the growth. As Dominic talked about, you know, we are continuing to see opportunities to grow, frontline, back office.

Also from a risk management perspective. Those are the real drivers around that. Nothing really unusual in nature, but we are hiring, headcount is over, it is up year-over-year. I think drivers to reduce, certainly, I think the environment changes. Now, there's some levers there as well, but I think at this point in time, we don't expect that, Dave.

Dave Rochester (Managing Director and Director of Research)

Okay, great. Thanks.

Manan Gosalia (Executive Director and Senior Equity Analyst)

Our next question will come from Manan Gosalia with Morgan Stanley. You may now go ahead.

Hi, good morning. Thanks for taking my questions.

Dominic Ng (Chairman and CEO)

Good morning.

Manan Gosalia (Executive Director and Senior Equity Analyst)

I just wanted to get a sense of what you're seeing in terms of new customer gains in your footprint, you know, both the loan and the deposit side, you know, especially given the strong growth that you're seeing on in resi. Are there any gains in business that you're getting from either legacy Silicon Valley Bank or First Republic customers, in your footprint?

Dominic Ng (Chairman and CEO)

We're getting some. I mean, like I said, we are not, like, aggressively pursuing, like, this HSBC, you know, bring the whole team over, you know, that kind of things, or a bunch of people going to JPMorgan. We are very selective and, you know, obviously, you know, with what happened to those institutions, there are a lot of, there are a lot of bankers seeking new homes.

I mean, with us being in California, without a doubt, there are many inquiries, coming to us. We just find, you know, the right people with the right cultural fit, with the right type of, mindset that fit into in our model. We bring them on, you know. Same thing for customers.

We have, you know, I personally have more inquiries, you know, from our clients referring their friends who were customers or well, who still are customers for these failed banks, and they're just looking for a new home. We're very busy, you know, in discussion with many of those. Some of those loans booked. I mean, if you look at C&I, you notice that, you know, commitment gone up 15%, but outstanding balance gone up 1%. We book a lot of commitment, but it's gonna take a little while to do the drawdown. Same thing for deposit. We opened a lot of accounts, but it's taken a little while to start getting them operating and start getting deposits, you know, flowing.

We're not trying to hurry up in doing that because, again, it's not like that we have one quarter or two quarter or three quarters finish line, and then we're done. We're running a long-term business, and so we just gradually start taking on these new clients, making sure that they get the right experience. Then we also don't want it to get overwhelmed for the surge of these inquiries and ending up neglecting our existing customers. In addition to that, we also wanted to continue our journey of further enhancing and upgrading our whole enterprise risk management.

This work cannot be sort of, like, put aside just because there are inquiries from customers from these failed banks and have wanted to migrate over, and then we stop, you know, taking care of all the other fundamental business that we need to take care of. All in all, you know, we're just, like, doing all of that at the same time, and I would expect that slowly, gradually, we'll get more of these customers, not only from the failed banks, by the way, some of these other regional banks or that also have some sort of challenges, that also have their customers gonna be start looking at East West. You know, many of these clients are gonna be looking at who are the banks have a high likelihood.

They don't have to worry much about the future. Banks that have very high capital ratio, and year in, year out, always put out strong numbers, and don't always get in and out of jail with the regulators. Those are the ones that, in general, are gonna be well sought after. Therefore, we wanna keep it that way. We don't wanna go crazy, I mean, and get all excited about this opportunity and then get ourselves back in jail or something like that. That wouldn't be good, right? That's where we are.

Manan Gosalia (Executive Director and Senior Equity Analyst)

Totally hear you. Thanks for that. I guess related to that, in terms of investing in the business, you know, I know you moved your expense guide up slightly. Can you talk about, you know, what's driving that revision? Is it mainly investment spend? Is it some opportunity you're seeing in this environment? Then, you know, how we should think about just expenses overall, even going into next year, is, you know, maybe you continue to invest in the business, but also, you know, as I guess the bank industry as a whole sees more of an impact from regulation, if there's anything else you need to do there, given your asset size.

Dominic Ng (Chairman and CEO)

We are less than $100 billion, far less than $100 billion. You know, we are $68 billion, to be exact. This is around two-third, just about two-third of that threshold. Right now, looking at organic growth, it's gonna take a while to get to that $100 billion. Also, if you think about it, even if we're $100 billion, we always do whatever we need to do, to make sure that we are above and beyond the minimum requirement that require from the regulators.

With our capital ratio, it's really not much an issue at all, because you look at a lot of banks are really struggling with the potential new regulatory proposal because the capital ratio is low, and once they start, you know, adding here and one items here and there, and then next thing they may not meet the threshold. We're way above it. One way or the other, it doesn't make any difference. I wanted to keep reminding folks on the call that we're actually only two-thirds the size, so we're not, we're not qualified to worry, you know. In the meantime, getting back to the slight increase of guidance of the expenses.

As Irene mentioned earlier, that as of April, in the mid-April, when we start putting in the guidance after the first quarter earnings, in the midst of the Silicon Valley Bank, Signature Bank, and First Republic kind of situation, we didn't expect as much opportunity to grow at that point because we expected there's be a, probably a recession coming, right? Fed's gonna drop rate and all of that. Didn't happen. In fact, not only it didn't happen, and we saw that our deposit also kind of stabilized a little bit. The customer demand for much higher rate, that was very much so in March and April, but by May or so, it somewhat subside.

In addition to that, there was inquiries from customers of these banks that got into trouble, start coming, you know, 'cause once it stabilized, they start looking at that, well, maybe some of the new parents that acquired those banks are not the right fit, and they start talking to us. When we start looking at all that, we feel that it is appropriate to start, you know, hiring some of the talented bankers, and it is appropriate that we continue to stay vigilant to invest whatever we need to invest. We're not over-investing. We'll never over-invest. East West always invest incrementally, you know, from a technology, from operation infrastructure, and in terms of hiring, you know, but we are absolutely out there looking at the talents to see whether they fit into our culture and bring them on.

We do not get way over concerned about, well, with that, a fact that, you know, 1% or 2% of our expenses, and then therefore, we should wait. Sometimes you wait, you don't get them. Why we feel comfortable about doing all that is because we still have positive operating leverage today. One way or the other, we're still making more money, because the revenue growth is still gonna be bigger than the expense growth. We feel very confident that this is the right thing to do in light of what our, you know, very high return of equity ratio compared with the industry. Let's just continue to keep doing what's right, what's good for the bank.

Manan Gosalia (Executive Director and Senior Equity Analyst)

Right. It sounds like the expense and the investment spend is coming more from a growth mindset rather than anything that regulators might even ask banks well below $100 billion to do. I appreciate that. Thank you.

Dominic Ng (Chairman and CEO)

Yep.

Operator (participant)

Our next question will come from Brandon King with Truist. You may now go ahead.

Brandon King (Managing Director and Senior Equity Research Analyst)

Hey, good morning.

Dominic Ng (Chairman and CEO)

Good morning, Brandon.

Manan Gosalia (Executive Director and Senior Equity Analyst)

Good morning.

Brandon King (Managing Director and Senior Equity Research Analyst)

I noticed, you know, criticized loans have declined quarter-over-quarter, and it stands out amongst your peers who are actually seeing the opposite effect. If you could please elaborate on what you're seeing with your customers that's driving that effect.

Dominic Ng (Chairman and CEO)

Well, what we've seen is that we've seen nothing. That's the scary part. Well, actually, we do, you know, regular loan-by-loan review. That's part of East West Bank. You know, it's been we've been doing this for, you know, years and years. I've been concerned about potential CRE portfolio five, six years ago. We do loan-by-loan review, and we continue. Well, I guess because of that vigilance, we do have pretty high asset quality from this, from our portfolio, and we do the same thing for C&I. We just-- even with the pandemic, I thought it's gonna be, I mean, we started, let's get back to earlier. We started with the tariff, we said, "Wow, with that tariff, you know, our trade finance portfolio is gonna be getting hit hard.

Let's just review one by one." We review one by one. We managed this credit really closely, monitor very closely. We have discussion with clients, ask them to do what the right thing, and then at the end of the day, we didn't take any losses. I guess we do that. Now becomes, tariffs becomes, just a normal day-to-day business. We go into pandemic. We thought, "Wow, we're gonna lose a lot of money.

We're taking a lot of losses with all these hotels, strip centers get shut down and tenants not paying rent in the apartments. At the end of the day, we didn't take any losses. When this interest rates spike in this very, very aggressive manner, we said, there's no way our clients can pay this kind of interest rate at some point. As of today, they're paying it, and they're doing fine. Well, I think, granted, it helps when we have very low loan to value, which give a lot more incentive for clients to stay on with the property. In addition to that, our clients have a lot of liquidity, and many of them have personal guarantee. All of these characteristics help to keep this portfolio strong in the commercial real estate side.

You know, granted, you know, as I mentioned, as part of my script that we talked about earlier, loans mature in 2023. There's only 3% of our CRE loans will be maturing for the remainder of 2023. In 2024, only another 7%. Altogether, for the next 18 months, we only have 10% of our loans coming due. We just happen to have very stable portfolio that there's not a whole lot that we need to worry about. We don't have these big high-rise building in downtown that cause us, you know, cause other banks concern. I think it's all of that that helps.

The criticized asset improved in terms of ratio. Some of that have to do, again, because we've been prudent and conservative. These loans that we downgrade during pandemic, we wanted to give it a little bit more time to make sure we could have upgraded, you know, probably, six, nine months ago. I mean, because when, you know, after the pandemic, you know, things get a bit normal from the business back, getting back on track, we didn't immediately upgrade. We wanted to see how it operate, do they have a sustainable, good cash flow? When things getting better, really better, and then we upgrade back. To a certain degree, maybe some of these upgrade is a little bit of a timing difference.

It's not like suddenly today, these credit perform even better than two months ago or three months ago like that. It just, there are some, I would say that, loans should have been upgraded earlier, but we took care of now, through the just the last two months. The other thing will be, you know, here and there, a couple of loans here and there that are having some challenges. We find a way to help the clients to pay off these credit, and then that also help reduce, the criticized loans ratio. All in all, that's I think that's the reason.

Brandon King (Managing Director and Senior Equity Research Analyst)

Thanks. Thanks. That's really great color. Then I noticed, you know, C&I utilization ticked down a bit in the quarter, and I know there have been some deleveraging from your customers, I'm wondering just what you're seeing on the front lines there, and you're expecting that continuing towards the back half of the year?

Dominic Ng (Chairman and CEO)

Did you?

Irene Oh (CFO)

Second half of the year. Yeah. C&I think, quite candidly, with just kind of the environment right now, the utilization did tick down a little bit, Brandon, as you mentioned. I would share, though, as we look to a certain extent, there's only so much we could do with that, right? As Dominic mentioned, commitments are up. I would share, though, you know, when we look at the pipelines and when we talk to our team leaders, you know, the expectation for the second half of the year of new client acquisition is something where it is increasingly positive. That's certainly something that we have factored in for the second half of the year. With that said, given the current environment, I would say that we're not necessarily expecting that that utilization rate will increase substantially from this point.

I would also say no specific kind of areas or concentrations of where that growth is coming from. It's pretty broad-based.

Brandon King (Managing Director and Senior Equity Research Analyst)

Got it. Thanks for taking my questions.

Irene Oh (CFO)

Thank you.

Our next question will come from Matthew Clark with Piper Sandler. You may now go ahead.

Matthew Clark (Managing Director and Senior Research Analyst)

Hey, good morning. Thanks for taking the questions. Just to close the loop on the margin, Irene, can you give us a sense for, you know, where you think the cycle beta, deposit beta might shake out at the end of the day? I think low 60s% is what you were previously targeting, but we're there on a spot basis. If you had the monthly NIM in June, we'll take it.

Irene Oh (CFO)

Yeah. The monthly NIM in June was the same as the month-end spot of 2.28%. Also, I'll share up until now, in July, it's been the same.

The cost of deposit. That's right. Yeah, I'm sorry. On the cost of deposits, not the NIM. All right. I think the expectation for NIM is that it will decrease modestly from the second quarter, still NII, with the drivers that we're talking about, we expected that to, you know, flatten out and improve.

Matthew Clark (Managing Director and Senior Research Analyst)

Got it. Then just on the media and entertainment portfolio, I know it's only 4% of loans, but can you speak to the Hollywood shutdown and how that might impact the portfolio and what you might have in place in terms of structure to protect yourselves?

Dominic Ng (Chairman and CEO)

Yeah, from a credit risk perspective, we don't have any concern. From a production, like growth volume on loan origination point of view. Well, actually, we booked a lot of entertainment content production loans. If there's a strike, they're not going to draw down. We hope that strike doesn't last too long, but if it's sustained for an extended period of time, then we will have some loans that may not have the kind of drawdown that we would like to have, and it's not going to have any credit quality issues. The beauty of this is that that's why we have a very diversified loan portfolio.

If entertainment content production, financing slowing down a little bit, some of the others just have to make it up, or we're going to have to get our lending officers to continue to work on, you know, these new prospective clients and get those loans funded to offset against the slowdown in the entertainment side. All in all, I looked at it, is that it's not going to be any credit quality issue. It's just all coming back to get outstanding balance, you know, on that particular portfolio.

Matthew Clark (Managing Director and Senior Research Analyst)

Great. Thanks for the color.

Dominic Ng (Chairman and CEO)

I do want to mention, if you look at the chart, page six, we highlight that there's 4% of our loans that are in media and entertainment. I want to highlight, it's media and entertainment. We do have also a good, decent-sized portfolio of digital media, and they're not affected by strikes. You know, these are the ones that, you know, building video games and then some of the other things. They are not part of the Hollywood, you know, labor forces, you know, it's very different. It's a combination that make up to 4%. It's not as sizable, you know, as what we reflected here, you know, on page six.

Irene Oh (CFO)

I'll just add, I answered Matthew's question incorrectly. The answer as far as the monthly NIM for June was 3.51%.

Matthew Clark (Managing Director and Senior Research Analyst)

Thanks again.

Operator (participant)

Our next question will come from Gary Tenner with D.A. Davidson. You may now go ahead.

Gary Tenner (Managing Director and Senior Research Analyst)

Thanks. Good morning.

Irene Oh (CFO)

Morning.

Gary Tenner (Managing Director and Senior Research Analyst)

Irene, I wanted to kind of revisit your comments about the planned $1.7 billion of broker runoff back half of the year. I know you don't give kind of deposit growth guidance, as we're thinking about the balance sheet, should we be thinking of that $1.7 billion being replaced by customer deposits and then an additional growth on top of that, basically equal, plus or minus your loan growth in the back half of the year? Is that kind of the way to think about the right side of the balance sheet?

Irene Oh (CFO)

Gary, that is the plan.

Gary Tenner (Managing Director and Senior Research Analyst)

Okay. You know, the second part of that question, I guess, is the $600 million or so that you've kind of let roll off, you know, so far in July, and replaced by customer deposits. What's the, what's the incremental or the marginal cost of the new customer deposits that are coming in? It sounds like it must be pretty close to kind of the June 30 spot rate, because it's, doesn't sound like that's moved very much.

Irene Oh (CFO)

Yeah, well, I think actually, that's a great question. The incremental new deposits, new customers, new CISs, you know, that's there is a little bit kind of marginal increase that is happening. Some of that has been, you know, a little bit of migration that we've seen with the higher rate environment to CDs, especially on the consumer side. Predominantly, when we look at.

Gary Tenner (Managing Director and Senior Research Analyst)

The mix coming in is more CD oriented?

Irene Oh (CFO)

Yeah. Well, the consumer side. Let me clarify. I think the growth, dollar-wise, is commercial side, but overall, on the consumer side, especially with CDs, you know, that is something that continues to be a pressure on the margin in total, but new customer acquisition, generally, that has been commercial oriented and lower in rate.

Gary Tenner (Managing Director and Senior Research Analyst)

Okay, thanks. I guess one more question on the, on the kind of data and deposit pricing. You know, historically, you think of there being kind of this long or multi-quarter, you know, deposit catch-up after the Fed stops raising rates. In this scenario, where, you know, a hike next week is the last one, and that has some impact on the third quarter, and given the amount of catch-up we've had over the last couple of quarters, that's been, you know, incredibly rapid. Is your sense that fourth quarter, that kind of delta, you know, assuming no additional hikes after next week, moderates pretty significantly to where the lag after the Fed, you know, the Fed's last hike is much shorter in nature, or do you have any sense of how that might play out?

Irene Oh (CFO)

Yeah. I mean, Gary, honestly, your guess is as good as mine, right, around that. Realistically, as we're kind of modeling it out, our assumptions are that there will be a lag. Okay?

Gary Tenner (Managing Director and Senior Research Analyst)

All right.

Irene Oh (CFO)

The deposit costs will remain somewhat elevated for a period of time. Now, there have been different examples in the relative kind of recent history as well. Let's say, when the pandemic hit and rates change dramatically, where we were able to go in and dramatically lower deposit costs as well. As we're modeling out and with our guidance for the rest of the year, you know, we're not assuming that.

Gary Tenner (Managing Director and Senior Research Analyst)

Yeah, no, I'm certainly not suggesting that deposit costs go back the other direction, but more so that the lag following the Fed hike is shorter, perhaps than it's been in the past. Okay. All right. Thanks for taking my questions.

Dominic Ng (Chairman and CEO)

Yeah, at this point, I think, logically, I would expect that, I mean, it will ease. I mean, if you look at the rate spike, you know, it affect the entire banking industry. It's because of, you know, March eighth, March ninth, you know, the news of Silicon Valley Bank that it caused a dramatic change on the rate environment, you know, that it sort of heightened the attention for consumer and consumer retail or commercial customers, and then everybody start looking at either moving deposit out or asking for a higher rate. It's sort of like a one big two to three weeks time, and then this caused this big surge of interest rate.

Obviously that has subsided dramatically, so we don't see that, another 25 basis points is gonna make that much of a difference by now, because the banking industries have stabilized. I assume that the other banks would also be a little bit more prudent in terms of not going out there and then keep putting out their high rate to attract deposits. When that's the case, the competition ease, and no one has to really put up higher rate. When the competition go crazy, and then, we all have to sort of like somewhat move along in the same direction.

Operator (participant)

Our next question will come from Chris McGratty with KBW. You may now go ahead.

Chris McGratty (Head of U.S. Bank Research and Managing Director)

Great. Just a quick one, Irene, on the margin. The quarter-on-quarter change from two cuts to one additional hike was the reason for the trimmed guide. If the forward curve plays out and we get cuts next year, can you just make a comment or two about how you, how you think the margin may react?

Irene Oh (CFO)

Great question. I think, first of all, we will give guidance for 2024 in January, and that's not something that we're planning to do today. Given the variable nature of our loan book, that is something, Chris, that we've tried to be disciplined around and putting on swaps and hedges to preserve, you know, the net interest income and the interest income on loans as much as possible. This year, that's been tough as far as the impact of that to the interest income on loans and also AOCI, quite frankly. Certainly, I think if the rate cut, rate cuts happen, you know, that'll be something that, you know, we were fortunate to do in prior periods.

Chris McGratty (Head of U.S. Bank Research and Managing Director)

Okay, thanks.

Operator (participant)

Our next question will come from Brody Preston with UBS. You may now go ahead.

Brody Preston (Equity Research Analyst)

Hi, everyone. How are you?

Irene Oh (CFO)

Good.

Brody Preston (Equity Research Analyst)

Irene, I just wanted to, I know it's not a huge driver of quarterly results, but I just wanted to ask if you had any thoughts around fee income moving forward, if you thought kind of, you know, this, you know, I would call it probably $77 and change in kind of core, you know, modelable items going forward, if you thought that this was a good run rate or, you know, where that would shake out.

Irene Oh (CFO)

Yeah, great question. In fact, you know, I think the growth rate on that has been something that has also been, you know, a great surprise for us as far as transaction volume, notional amounts, FX volume, consumer, commercial, you know, the growth that we've seen there, that's been great. From the IRS swap teams, again, same thing, volumes are increasing. In fact, across the board, wealth management, you know, loan fees a little bit, and even the account deposit fees have all been up quarter-over-quarter, which is quite positive. I'll just share, though, with the total fee income, there is also a little mark-to-market, and with the kind of movement in the tenure, that played a factor as well. With that said, I think that the momentum is pretty good.

I do think that, maybe this quarter is a little bit higher than normalized. Certainly, when we look at the rest of the year and 2024, you know, the pipeline looks great. We are acquiring new clients. That is something that is, you know, very positive.

Brody Preston (Equity Research Analyst)

Okay, got it. Could I ask just on the fixed rate loan portfolio? I know that, you know, a good chunk of it is single family resi, but, you know, just I guess when you look at the fixed rate loan book, you know, what's the dollar amount that's repricing over the next 12 months, and what are the current yields look like on those loans? You know, if you could bifurcate it, maybe, you know, between the CRE and everything else, that would be helpful.

Irene Oh (CFO)

Yeah. Over the next 12 months, we have approximately $800 million of fixed and hybrid fixed loan CRE and single family maturing or repricing. If you kind of break that down, it's a little different per category, but on average, we're talking about probably a weighted average interest rate of 4.75% that we expect to move up.

Brody Preston (Equity Research Analyst)

Got it. Did you mention already what the new origination yields, would look like for those loans?

Irene Oh (CFO)

Yeah, it, To clarify, some of this is maturity and some of this is hybrids that are going to step up. I think in the current environment, the hybrid step up, especially for the single family, you know, there is a cap on that. With that said, if we look at the new originations, generally speaking, C&I has been about prime flat, CRE for hybrid and variable rate, a blended maybe 7.4. Single family, if you look at the current originations, it's been about 6.5. As we noted, you know, a lot of these, where price has been locked a while ago and they started the applicants started the process. The current rate sheet is a seven and eight for a 30-year fixed mortgage, no points.

Brody Preston (Equity Research Analyst)

Got it. Thank you. I did want to ask, do you happen to know what the effective duration of your AFS portfolio is and what the conditional prepayment rate you're assuming in that duration calculation is?

Irene Oh (CFO)

The effective duration has slightly reduced quarter-over-quarter. Just a little bit, honestly, more of the tenor and the change. We're probably 389 right now, down modestly. The CPR, I think if we look at the MBS and also the CMBS, I generally, I mean, the prepayments have slowed dramatically. I can get you the specifics of that later.

Brody Preston (Equity Research Analyst)

Okay, great. The last question that I had was just, you know, it sounds like, excuse me, you know, there's some improvement in the mix shift in June, and you've got the brokered rundown. You know, if maybe we stabilize, mix shift can kind of steady out here, at least on the NIBs. I guess I was hoping that maybe you could help me think about the bifurcation between commercial clients and retail customers at this point, and how mix and beta acceleration between those customers are maybe differentiated at this point in the cycle.

I guess my baseline thought was that you would have gotten a lot of commercial mix and beta catch up done, you know, earlier and already, and then maybe you're going to have more of a catch up on the retail side just because they're a little bit slower to move. I just, you know, was hoping that maybe you could speak to that.

Irene Oh (CFO)

Yeah, I think that's a great question. I would say that probably what we have seen is that you're right. You're exactly right. On the commercial side, it was earlier. On the consumer side, there was a lagging impact, and part of that is the nature of the customers that we have. Brody, we have many, many customers, thousands, where their primary personal checking account is at East West. That is, you know, still, you know, as of today, as of 6:30, you know, $4 billion of the DDA balances are consumer checking accounts. Now, in this current environment, we've had trouble growing that, quite candidly, as clients and customers are moving their excess liquidity to CDs.

One of the things that we saw in the second quarter is that although there was quite a lag overall on the consumer deposit betas up until the second quarter, with this mix shift and the pivot a little bit to CDs and DDA consumer balances remaining stable, which quite candidly, in the current environment, tough to do, but, you know, without growth, stable at about that $4.41 billion point. The betas on consumer did increase from where we were at 331. At this point in time, quite honestly, if we look toward the future, I think with the growth that we continue to see and the opportunities on the commercial side, you know, perhaps over time, you know, on the commercial side, I think as consumer, it will kind of moderate, right?

You know, to a certain extent, if you haven't been alerted to the interest rate environment, or you're probably not going to at this point in time. We're not seeing that continual migration as well on the consumer side, but the commercial side, as we continue to onboard new clients, I think that will help us.