East West Bancorp, Inc.

Good day and welcome to the East West Bancorp third quarter 2020 earnings call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist 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 on your touch tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Juliana Balica. Please go ahead.

Thank you, Sarah. Good morning, and thank you, everyone, for joining us to review the financial results of EastWest Bancorp for the third 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 and other forward-looking statements regarding events or future financial performance of the company within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties. For a more detailed description of risk factors that could affect the company's operating results, please refer to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2019. In addition, some of the numbers referenced on this call pertain to adjusted numbers. Please refer to our third 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 site. As a reminder, today's call is being recorded and will also be available in replay format on our Investor Relations website. I will now turn the call over to Dominic.

Thank you, Juliana. Good morning. And thank you, everyone, for joining us for our third quarter 2020 earnings call. I will begin with a review of our financial condition and results on slide three of this presentation. This morning, we recorded, we reported, Third quarter 2020 net income of $160 million, or $1.12 per share, up 61% from second quarter net income of $99 million, or $0.70 per share. Our third quarter return of average assets was 1.26%. Return on average equity was 12.5%. And return on average tangible equity was 13.9%. Our profitability rebounded from the trough of the second quarter as provision for credit losses declined. Deposit growth this quarter was very healthy, with especially strong growth in non-interest-bearing demand accounts, which grew 28% annualized quarter-over-quarter based on period and balances, and 22% annualized based on average balances. As of September 30, we reached a record $41.7 billion in deposits, including a record $14.9 billion in demand deposit accounts. We generated positive loan growth also in the third quarter, reaching a record $37.4 billion in loans as of September 30, 2020, despite a challenging backdrop of slow economic activity, due to the COVID-19 pandemic. The biggest driver for the quarter over quarter increases in net income was a reduction in the provision for credit losses, which was 10 million in the third quarter compared to 102 million in the second quarter. In the first half of the year, we recorded 176 million in provision for credit losses compared to net charge-offs of 20 million substantially building our reserve level. Based on an improved macroeconomic outlook, we modestly decreased our allowance for loan losses as of September 30. Overall, credit continues to be very manageable, as demonstrated by net charge-offs at annualized 26 basis points of average loans. Also in the third quarter, We earned $219 million of pre-tax pre-provision income on total revenue of $374 million. Our pre-tax pre-provision profitability ratio was 1.74%. The steep decline in interest rates this year has impacted our revenue. However, as the downward repricing of our earning assets to benchmark rates is largely complete, and we continue to reduce the cost of funds as maturing CDs replies lower. We anticipate that our pre-tax, pre-provision income and profitability will stabilize going forward. Importantly, our efficiency remains industry leading and is a key variable to maintaining above average pre-tax, pre-provision profitability. Efficiency ratio in the third quarter was Moving to slide four for a summary review of our balance sheet. Our balance sheet is strong. We have high levels of liquidity and capital. And as of September 30, 2020, we crossed over the $50 billion in assets milestone, ending the quarter at $50.4 billion. This translates to an organic compound annual growth rate of 10% over the past five years. Quarter over quarter, total loans of $37.4 billion increased $208 million or 2% linked quarter annualized. Total deposit of $41.7 billion increased $1 billion or 10% annualized. Our deposit growth combination of onboarding new clients, expanding existing relationships, and our clients maintaining high levels of liquidity. We believe the momentum of strong deposit growth can be sustained post-pandemic. Due to our deposit growth this quarter, our loan-to-deposit ratio as of September 30 was 89.8% compared to 91.5% as of June 30. Now turning to slide five, you can see that East-West capital ratios are strong and growing. and are some of the highest amount of regional banks, particularly for common and Tier 1 equity. Our book value and tangible equity per share were both up 3 percent from the prior quarter, and our tangible equity to tangible assets ratio increased to 9.3 percent. You can see from the chart that all our capital ratios increased quarter over quarter. East-West Board of Directors has declared fourth quarter 2020 dividends for the company's common stock. The common stock cash dividend of 27.5 cents is payable on November 16, 2020 to stockholders of record on November 2, 2020. Moving on to a discussion about loan portfolio, beginning with slide six. CNI loans, excluding PPP, were $11.5 billion as of September 30, or 31% of total loans. Total CNI commitments excluding PPP were $16.3 billion as of September 30, a quarter-over-quarter increase of 5% annualized. Month-over-month growth of loans outstanding turned positive in September. reversing a trend of negative monthly growth since March. Overall, CNI loans outstanding excluding PPP decreased by 144 million between June 30 and September 30, a decrease of 5% annualized compared to a decrease of 29% annualized in the second quarter. Moving to slide seven, as of September 30, Our total commercial real estate portfolio was $14.7 billion, or 39% of total loans. Total commercial real estate loans grew $171 million, or 5% annualized, from June 30. The portfolio is well-balanced across the major property types of retail, multifamily, office, industrial, and hotel. Our exposure to construction and land loan remains low at 1.5% of total loans. You can see on slide eight that the weighted average loan-to-value of our total commercial real estate portfolio is 51%, with an average loan size of only 2.4 million. Nearly 90% of our commercial real estate loans have an LTV of 65% or lower. In the chart on the right, you can see that the weighted average loan-to-values of our loans by property type range from 49% to 53%. On slides 9 and 10, we provide additional details regarding our single-family residential loans and home equity lines. Combined, residential mortgage and other consumer loans make up 25% of our total loan. As of September 30, our single-family residential portfolio was $7.8 billion, up by $126 million, or 7% annualized from June 30. In the third quarter, we originated $768 million of residential mortgage loans, consistent with the pace from the first half of 2020, and up by 19%, year over year, from the third quarter of last year. We expect a similar pace of origination for the fourth quarter. The average loan size in our residential mortgage portfolio is only $386,000, and the weighted average loan-to-value is 53%. Again, 90% of our residential mortgage loans have an LTE loan-to-value, 60% or less. On to slide 10. On September 30, we had 1.5 billion of home equity lines outstanding, plus 1.6 billion in undisbursed commitments, translating into a utilization rate of 48%, unchanged from last quarter. Home equity lines outstanding increased 52 million quarter over quarter, or 14% annualized. And total commitments increased 11% annualized. The average size of our home equity commitments is 367,000, and the weighted average combined LTV is only 48%. 97% of our home equity commitments have an LTV loan-to-value of under 60%. I will now turn the call over to Irene for a more detailed discussion of our asset quality and income statement.

Thank you, Dominic. I'll start by discussing loans on COVID-19-related deferrals on slide 11. As of October 20th, loans on full payment deferral were 1.9% of total loans. including loans on partial payment deferral, suddenly were modifications of principal and interest payment to interest-only loans on deferral totaled 3.4%. Overall, 55% of commercial loans on deferral are still making partial payments. Quarter over quarter, loans on COVID-19-related deferral decreased close to 50% between June 30th and September 30th and decreased a further 20% month-to-date in October. The largest improvement was in residential mortgage deferrals, which decreased by 79% since June 30th, reflecting the resiliency of the East-West customer base. Similar to the second quarter, the deferral rate on CNI loans continued to be very low. Commercial real estate loans on deferral have also decreased, down to 6.6% as of October 20th, comprised of 3.8% on partial payments and 2.8% on full payment deferral, largely reflecting the longer COVID-19 impact on cash flows for certain properties. Turning to slide 12 for review of our allowance for loan losses and slide 13 for review of our other asset quality metrics. Our allowance for loan losses was $618 million as of September 30th, our $1.4 65% of loans held for investment, modestly down from 632 million or 1.7% of loans as of June 30th. Since January 1st, post-ceasal, our allowance increased 135 million and the coverage ratio increased by 26 basis points from 139. The current macroeconomic forecast has improved projecting less severe economic conditions compared to June 30th. This in turn decreased the expected lifetime losses for the loan portfolio. The forecast-driven reduction to the allowance was partially offset by increased qualitative reserves for oil and gas and commercial real estate loans. The allowance coverage of our oil and gas portfolio was 10% as of September 30th, up for 9% as of June 30th. Net charge-offs for the second quarter were just under 25 million, and the net charge-off ratio was 26 basis points of average loans annualized. Charge-offs in the third quarter were primarily from oil and gas loans, which accounted for 22 million, or 91% of net charge-offs, while charge-offs from other loan classes remain at low levels. Reflecting these drivers and assumptions, we recorded a 10 million provision for credit losses during the third quarter of 2020, compared to $102 million in the second quarter. Turning to slide 13, on this page, we detail out the components of criticized assets. Criticized loans were 3.9% of total loans as of September 30th, totaling $1.5 billion. The largest concentration within criticized loans by either industry or property type remains oil and gas. Other criticized C&I loans are diversified by industry, and the criticized commercial real estate loans are likewise largely diversified by property type. Special mention loans were 1.9% of total as of September 30th in the amount of $723 million, up from 1.5% of total loans as of June 30th, an increase of 26%. The quarter-over-quarter increase in special mention loans was largely due to inflows from commercial real estate. As of September 30th, 10.5% of oil and gas loans, 2.8% of all other CNI loans, and 2.1% of commercial real estate loans were graded special mention. Classified loans were 2% of total loans as of September 30th in the amount of $758 million compared to 1.8% as of June 30th, an increase of 11%. The quarter-over-quarter increase in classified loans was largely driven by downgrades of oil and gas loans, followed by downgrades of all other CNI loans. As of September 30th, 23.5% of oil and gas loans, 2% of all other CNI, and 1.6% of commercial real estate loans were classified. Non-performing assets were 52 basis points of total assets as of September 30th in the amount of $260 million, compared to 41 basis points as of June 30th, an increase of 29%. The quarter-over-quarter increase in non-performing assets was primarily due to net inflows of previously classified oil and gas loans to non-actual status. Lastly, accruing loans, 30 to 89 days past due, were 85 million or 23 basis points of total loans as of September 30th, a quarter-over-quarter improvement of 25% from 113 million or 30 basis points of total loans as of June 30th. As you can see in our credit quality metrics, outside of oil and gas, asset quality is holding across our other loan portfolios. In terms of oil and gas, I'd like to note that we continue to reduce our exposures through paydowns, workouts, and tar drops. Oil and gas loans outstanding are down 8% quarter over quarter and down 12% year-to-date. Including undisbursed commitments, total oil and gas commitments are down 8% quarter over quarter and down 17% year to date. In terms of hedges in place for our EMP borrowers, 52% of their planned 2021 oil production is hedged, and 59% of their planned 2021 gas production is hedged. And now, moving to a discussion of our income statement on page 14. This slide summarizes the key line items of the income statement, which I will discuss in more detail on the following slides. Amortization of tax credit and other investments was $12 million in the third quarter compared to $25 million in the second quarter. The quarter-over-quarter change reflects timing of tax credit investments, and we expect this number to be approximately $20 million in the fourth quarter. The effective tax rate for the third quarter was 90%, up from 12% in the second quarter of 2020. The quarter-over-quarter increase in the tax rate reflects the increase in pre-tax income. Third quarter income before taxes was $196 million, a 75% increase from $112 million in the second quarter as we increased our estimate for the full-year effective tax rate to 15%. The 19% effective tax rate for the third quarter includes a trip to the higher full-year effective tax rate. The effective tax rate in the fourth quarter should be close to the full-year effective tax rate of 15%. I'll now review the key drivers of our net interest income and net interest margin on slides 15 through 18, starting with average balance sheet growth. Third quarter average loans of $37.2 billion grew quarter over quarter. Growth in commercial real estate, residential mortgage, and PPP loans was offset by a decrease in CNI loans. Third quarter average deposits of $41.2 billion grew grew 13% linked quarter annualized, driven by strong growth in demand and checking accounts, offset by a reduction in high-cost time deposits. Average non-interest-bearing deposit accounts grew 22% linked quarter annualized and made up 35% of total deposits in the third quarter, up from 34% in the second quarter, and 29% in the year-ago quarter. With a strong deposit growth in excess of loan growth, the average loan-to-deposit ratio decreased to 90% in the third quarter, down from 93% in the second quarter. Excluding PPP loans, where we matched funded 75% with the PPP-LF, the average loan-to-deposit ratio was 86% in the third quarter. Accordingly, average interest-bearing cash and deposits with banks increased by $1.5 billion in the third quarter and made up 10% of average earning assets, up from 8% in the second quarter. This growth in lower yielding assets was a headwind to the net interest margin this quarter. We continue to deploy excess liquidity into available-for-sale securities, but given the low interest rates and the flat curve, attractive opportunities are limited. In the current environment, we are comfortable in managing the balance sheet with a higher level of liquidity and recognize that when loan growth accelerates, as it is starting to, This headwind to the net interest margin will largely self-care. On slide 16, you can see that third quarter 2020 net interest income of $324 million decreased by $20 million, or 6% in quarter, and a net interest margin of $272 compressed by 32 basis points from the prior quarter. However, excluding the impact of PPP loans and the PPPLF, Third quarter adjusted net interest income of 318 million, declined by 2%, or 5 million quarter over quarter, exhibiting relative stability. Third quarter adjusted net interest margin of 277, compressed by 19 basis points from second quarter. PPP loan interest and deferred fee income was 6.5 million in the third quarter, down from 21 million in the second quarter. The quarter-over-quarter fluctuation is due to changes we made to our estimate for expected forgiveness of PPP loans by the SBA, resulting in reduced deferred fee accretion for the third quarter. The quarter-over-quarter change in net interest margin breaks down as follows. Negative 14 basis points from lower loan yields, negative six basis points from lower other earning asset yields, negative 12 basis points from excess liquidity, with higher balances of interest-bearing cash and deposits with banks, as well as a negative 13 basis points of negative impact from less PPP income, partially offset by 12 basis points from a lower cost of deposits and one basis point from a lower cost of borrowing. Headwinds and NIM have been deposit growth in excess of loan growth, a lack of attractive redeployment yields for excess liquidity. But we see several tailwinds that should improve the NIM and the net interest income going forward. For the fourth quarter of 2020, we anticipate that our GAAP net interest income will grow by 3% to 5%, and that our GAAP net interest margin will range from $275 to $285, including PPP income. The drivers for our net interest income and NIM outlook are as follows. First, continued reduction in deposit costs from the repricing of maturing CDs. We have $1.4 billion in CDs at a weighted average interest rate of $145 maturing in the fourth quarter and another $1.3 billion at a weighted average interest rate of $126 in Q1 of 2021. Second, partial repayment of the PPPLF ahead of PPP loan forgiveness for our customers, a process that we have already begun. Month to date in October, we've repaid $524 million. Also, we expect to recognize 15% million of PPP loan deferred fee and interest income in the fourth quarter. And thirdly, general stability for loan yields as downward repricing of variable rate loans has largely run its course. Now, turning to slide 17. Third quarter average loan yields of 360 contracted by 38 basis points from last quarter reflecting downward repricing of variable rate loans to benchmark interest rates as well as the reduced fee income accreted on PPP loans. Excluding the impact of PPP, the third quarter adjusted loan yield of 370 contracted by 20 basis points, quarter over quarter. In the second quarter, the quarter over quarter contraction in the average loan yield, excluding the impact of PPP, was 81 basis points. 65% of EastWest's loan portfolio is variable rate, And by now, these loans have largely repriced. Nearly 90% of variable rate loans we have are linked to benchmark interest rates with a duration of three months or less. In the upper right quadrant, we've laid out a new chart showing our average loan yields by portfolio. As you can see, our single family residential mortgage product is a least rate sensitive portfolio and continues to carry attractive yields. To organically reduce asset sensitivity, we have been growing fixed-rate loans, notably in single-family. Year over year, fixed-rate loans, excluding PPP, increased by 30 percent. Turning to slide 18, against the backdrop of materially lower interest rates, declines in earning asset yields have been partially offset by decreases in the cost of funds. Our average cost of deposits for the third quarter dropped to 33 basis points, down from 47 basis points in the second quarter an improvement of 14 basis points. The spot rate of total deposits as of September 30th was 29 basis points. Our third quarter average cost of interest-bearing deposits dropped to 50 basis points, down from 71 basis points in the second quarter, an improvement of 19 basis points. The spot rate of interest-bearing deposits as of September 30th was 46 basis points. In the lower left quadrant, we present our third quarter 2020 cost of deposit by deposit category compared to the cost of deposits in the third quarter of 2015, which was the last full quarter under a zero interest rate policy before the Fed raised rates in December 2015. At that time, the average cost of deposits was 28 basis points, and the average cost of interest-bearing deposits was 40 basis points. We included this chart in the deck as we believe it provides additional context of the repricing lever within our cost of deposits. You can clearly see that our CD book has not fully repriced down to historic ZERP levels. We expect to continue to reduce our average cost of CDs, maturing CDs over the next six months repriced lower, bringing the total cost of deposits down further. The rate paid on originations or renewals of domestic CDs in the third quarter of 2020 was 43 basis points, and the retention rate of branch CDs has been an excellent 92%. Quarter to date, rates paid on our CD originations and renewals have been lower than in the third quarter. Also, as of yesterday, the spot rate for our cost of interest-bearing deposits is down to 42 basis points, and for our total cost of deposits, it's down 27 basis points. Moving on to fee income on slide 19, total non-interest income in the third quarter was $50 million compared to $59 million in the second quarter. Fee income and net gains on sales of loans was $48 million in the third quarter, down by $4.8 million quarter-over-quarter. Lending fees of $19 million decreased by $3 million, largely reflecting valuation changes for warrants received as part of lending relationships. Third quarter Lending fees included $4 million from an increase in the valuation of warrants. In comparison, second quarter included $8 million from an increase in the valuation of warrants. Included in lending fees are customer-driven letters of credit fees, which increase quarter-over-quarter in parallel with increased customer activity. Reflecting an increase in the number of customer accounts and customer-driven transactions, deposit account fees and wealth management fees increase quarter-over-quarter. Foreign exchange fees decreased quarter over quarter due to downward revaluations of FX-denominated balance sheet items, partially offset by an increase in customer-driven transactions. Moving on to slide 20, third quarter non-interest expense was $168 million, a decrease of 11% linked quarter. Excluding amortization of tax credits and other investments and core deposit intangible amortization, adjusted non-interest expense was $154 million in the third quarter, an increase of only 1% quarter over quarter, and a decrease of 3% year over year. I would also note that excluding the impact of PPP loan origination costs deferred in the second quarter, third quarter compensation expense of $100 million decreased 4% quarter over quarter, from $104 million in the second quarter. In the second quarter, $7 million of compensation expense associated with PPP loan originations was deferred. The quarter-over-quarter increase in computer software expense reflects amortization of previously capitalized investment spend. Our third quarter adjusted efficiency ratio was 41.3%. Over the past five quarters, our efficiency ratio has ranged from 37.7% to 41.3%. As an organization, we remain committed to controlling expenses across the board in order to support our strong profitability. With that, I will now turn the call back to Dominic for closing remarks.

Thank you, Irene. Well, in summary, our net interest margin is stabilizing, our loan growth is positive, we remain disciplined about efficiency, and credit remains manageable. Business activity for our customers is picking up and we are looking forward to helping them rebuild and expand into the future. Here I would like to thank all of our associates for the dedication during these unprecedented times and wish everyone continued good health. I will now open up the call to questions. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star then two. Please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question comes from Abraham Bunawala with Bank of America. Please go ahead. Good morning. Good morning, Abraham.

If we could just start with credit, Dominic. When we look at the provisioning level, I think assuming that the macro doesn't deteriorate from here, just talk to us in terms of your comfort around the portfolio, uh, uh, one, like what, what do you expect with the rest of the deferrals that are still outstanding as we get towards the end of the year? What percentage of those do you expect to go into non-accrual versus, uh, go back to paying? And, uh, what have you learned about the portfolio in the last six months to, to, uh, give us comfort that you're not going to have negative credit surprises in 2021?

Well, uh, we've been, uh, actually, uh, looking at our credit portfolio, you know, sector by sector and within the CNI, also in commercial real estate, you know, in the CNI with all the different industry vertical, each vertical get reviewed loan by loan. CRE, you know, we break it down by, you know, for the hotel, office building, multifamily, and then region by region. and obviously our single-family mortgages hardly have any problem and has always been for many years. So we've done all of that kind of review, and we, as of today, feel pretty good about where we are today. We think our reserve is definitely adequate, you know, and in terms of our risk rating, you know, classification and so forth, you know, And we feel that we are very much current in terms of the classification. From the deferral point of view, as you can see, from June 30 to September 30 and all the way, even we showed the deferral as of two days ago, it continued to show great progress. And we, at this point, do not see a lot of concern about surprises.

Got it. And just in terms of capital, I think, Dominic, you mentioned on CET1, even on tangible equity, you have one of the stronger capital levels. You were conservative coming into the cycle, not buying back stock. Just talk to us in terms of how you think about capital allocation, maybe not in the next couple of months, but as we look into the first half of next year and your, I guess, desire to buy back stock if it stays where it is.

Well, we have... board meetings every two and a half months or so. So this is always, I would say, a standing agenda. So we update the information, financial condition, and balance sheet, and also mainly the economic outlook with the board members. And then with those information, we are deliberate. And then we have discussion of whether we take any kind of action. So at this stage right now, I would say that We're still in that pandemic environment. We are not going to be looking into buying back stock. On the other hand, comes 2021, things can change dramatically in terms of economic outlook, and then we will do whatever is right accordingly based on the circumstances at that point.

Our next question comes from Ken Derby with Morgan Stanley. Please go ahead.

All right. Great. Thanks. I guess maybe just looking for a little more detail on the NPA increase. I know you said it was driven by oil and gas. I guess, you know, the concern that we would have is does, you know, does it continue, right? I mean, obviously, you still have a sizable portfolio. It is running off. But the worry is does it continue and slash do you have to build reserves for the additional portfolio as it deteriorates? Thanks.

Yeah, Ken, that's a great question. When we look at the increase in non-accrual loans and also charge-offs, you know, really over the course of last year and beyond that really, you know, a lot of that has come from the oil and gas portfolio. And we have also increased the reserves, let's say quarter over quarter, 9% to 10%. So when I look at it from the perspective of where the loss content is, I do think it's still in our portfolio in oil and gas. I would say, though, when these loans were previously classified, they are identified. And one thing that is positive is that we're not seeing an ongoing kind of downward deterioration into classified assets.

Yeah, I would say you can. Let me just maybe add on to what Irene just shared, is that would there be likelihood of any more potential charge-off losses from the oil and gas portfolio? Definitely, there is that probability. The difference is that we feel very confident because we only have so many loans. in the oil and gas portfolio, and it's dwindling down. And there are just so many loans in there, and we have looked at every one of them, and we continue to classify them in the right bucket. And the macroeconomic condition as of today is actually more positive than a few months ago. We all recall, you know, back in late March and early April, the crude oil prices, you know, just dropped to a level that is unheard of. But it's been pretty much stabilized at that $40 per barrel. And then the gas price actually have gone up quite nicely. And then keep in mind also that our portfolio, as Irene shared earlier, I mean, substantial percentage of these loans are properly hedged even going into 2021. So it's not like these are the loans that on a daily basis, they are going one by one, going into trouble. I think what we experience in terms of the charge-off is somewhat relative to peers in that industry, and everyone gets the link from the oil and gas business. So from our perspective, it's that this is a portfolio that is getting smaller and smaller, and we have substantial reserve to provide for it. and we feel confident that we can manage that. And in addition to it, we have plenty of profits and income to offset against these losses and still come up with a decent return of equity and return of assets.

Yeah, and is it a long-term plan just to keep running it off? Because I guess it's just hard for us to see how this segment generates positive risk-adjusted returns given every few years it almost feels like there's a problem and losses spike. I'm not talking positive or just returns over like a multi-year period.

We are managing it down. And then we started managing it down, you know, last year. And then we continue managing down. But, you know, the environment keeps changing. Who knows what's going to happen, you know, from the demand around the world or United States or even technological advancement that changed the dynamics That we have no ability to project. I mean, as a bank, we basically facilitate financing with a very, very focus of risk management. If we feel that this is going to be an industry going forward, that we can manage the risk very effectively, there's no reason why we're not into this segment. I think it's all get back down to we will be always very prudent to watch what's going on in the future and do the right thing accordingly.

Our next question comes from Jared Shaw with Wells Fargo. Please go ahead.

Hi, good morning.

Good morning, Jared.

Looking at the expense side and the efficiency side, do you think, given the broader low-rate environment, we can get back to a sub 40% efficiency ratio? Or will that really depend on, you know, seeing some broader rate improvement? Or is there anything you can do on the expense side to help accelerate that?

Yeah, Jared, I'll take that question. You know, I think the largest variable for that would be on the revenue side. You know, as we talked about earlier in our prepared remarks, we do feel strongly fourth quarter and beyond that that revenue net interest margin and I will increase. You know, I think we have a long history of proven ability to control the expenses. And that's something that we feel confident in this type of environment that we'll be able to continue to do so while still making the appropriate investments that we need to, to support our growing business.

Okay. Um, Shifting a little bit to the CRE portfolio and the growth you saw this quarter, how much of that was refining somebody else's loan? How are you getting comfort putting on new CRE product now? Is that translating into better terms and conditions and pricing? Maybe your thoughts around what you're seeing and doing on the CRE side.

In terms of with CRE loans that we originated, you know, most of, I mean, almost all of them are with customers that we've been doing business for a long time. And these are customers have very strong financial and balance sheet and that we feel comfortable. And then obviously these are the properties that are less impacted negatively by the pandemic. And that's what we you know, originated, these new loans. Some of them are not refined. Some of them are just also taking shares from other banks and so forth. The pricing is getting better than, slightly better than it was, I would say, six, nine months ago. You know, obviously, CRE pricing was extremely competitive last year. It's no longer as competitive. So we will be I would say that originating CRE loan with a slightly better pricing going forward. In terms of volume of CRE loans, I would think that in 2021, we probably may not have as nice of a robust growth of CRE origination like we did in 2019. So you would expect that 2021, the growth rate will be tempered somewhat because of the lack of, you know, great quality asset to be financed. But we will continue to look. And I looked at it and said East West is not a giant institution. It's not that difficult for us to keep looking and finding gems, hide around the bushes, and then just make up enough to show positive growth rate.

Our next question comes from Chris McGrady with KBW. Please go ahead.

Great. Thanks for the question. I want to ask about everyone's favorite topic in taxes. Given the market's expectation that there could be a tax rate increase next year, could you walk us through the potential sensitivity on the tax line and also the amortization line, given that you guys have been a little bit more proactive in managing your taxes over the years?

Yeah, Chris, so when we look at the changes that might happen from a corporate tax rate, 21% to 27%, of that at this point in time, although there are a lot of moving parts, we think if that happens, the impact to us will be about 4%. On the rest of it with the amortization, you know, once we have this call in January to talk about fourth quarter, we can give you a little bit more details on that. Along with that, if that happens, I'll add at this point in time, we have about 20 million in DTAs that would reverse as well.

Got it. And then assuming just status quo, just for modeling purposes, I think you said for the fourth quarter amortization of 20 million, that would bring it to around 75 for the year. All's equal, is that about... Is that the right math for next year, you know, 15% tax rate and 75% or so on the amortization?

We'll talk about that in January.

Got it. Thanks.

Our next question comes from Dave Rochester with Compass Point. Please go ahead.

Hey, good morning, guys.

Good morning.

On credit, you talked about the reserve release a bit. I was just wondering if you could – Maybe just give a little bit more detail on your comfort level reducing that reserve on your CRE book at this point, where there's still uncertainty in the economy and how the remaining deferrals in that book are going to pan out. This quarter, we saw other banks building that reserve in that particular bucket. So I was just wondering what your thoughts were for this quarter. And then if you could talk about how much stimulus that you have baked into your outlook at this point, that would be great.

Okay, so if we look at kind of the breakdowns of our allowance, you know, the amount of reserve that we have set aside for our real estate loans is just over $200 million, so on income-producing real estate and also multifamily. So, you know, ultimately, I would say right now, deferrals, what we're seeing in the we're very comfortable with that allowance level. Depending on what happens with the forecast, you know, we'll look and see as far as is a level appropriate. For our allowance calculation, we rely on Moody's and the economic forecast there to kind of tailor to our portfolio. We do use a multi-scenario approach, baseline, you know, S1 and S3. Because of S3, is a more severe adverse scenario. Overall, I'll share that the reserve, the quantitative reserve that we set aside is higher than the baseline.

Okay, and then how much stimulus is baked into your overall outlook at this point? What are you guys assuming for additional government stimulus?

Yeah, so in, and I think I'll just break it down with the scenario. So baseline did assume 1.5 trillion dollars The S3 assumed none. So as I mentioned, the overall quantitative reserve that we have is higher than the baseline.

Our next question comes from Gary Tenner with DA Davidson. Please go ahead.

Thanks for morning. A lot of questions have been answered, but I was curious on your comments on prepaying the PPP. I think you said $524 million month to date in terms of the liquidity facility, how much of that do you expect to exit by year end?

So we paid off the $453 million. We'll evaluate and see as far as, excuse me, $423 million. We'll evaluate and see if we'll pay off more. I think more than the $523 is expected. Depending on how much and the timing of that, we'll look and see as far as the liquidity that we have and then also the pace of the forgiveness of the PPP loans, which has started for us.

Okay. And then just in terms of overall balance sheet, you talked about kind of holding some of that liquidity you have in anticipation of longer improving. Do you have any... and also continuing to grow deposits even post-pandemic at a good pace. I'm just wondering what your thoughts are for expectations over overall liquidity flows given the amount of excess funding in the system right now.

Yeah, I mean, I think that's a great question, especially in this quarter. What we've done, especially as the deposit flow has continued, I think we've gotten a little bit more comfortable reinvesting some of that into securities. And also with our securities book, our AFS securities book, we have extended out the duration a little bit. So, you know, I think if you look at the month of September, not quoted a date, and the average yields in the portfolio, it is up a little bit, close to 2%. If you look at duration, you know, at 630, we're about 226, and we're at about 38 as of 930. Okay.

Our next question comes from Matthew Clark with Piper Sandler. Please go ahead.

Hey, good morning. Maybe first on on special the increase in special mention, you touched on the fact that the commercial real estate migrated a little bit. Can you give us some specific examples of what migrated this quarter?

Yeah, Matthew, when we look at kind of the migration into a special mention during the quarter, it was really to a certain extent throughout the portfolio. I'll share, regardless of whether a customer is on deferral, we're making sure that the grading is appropriate if necessarily we are downgrading these loans. So some of the loans we downgraded were loans that were on deferral But across the board, I would say in different kind of asset classes, office, multifamily, and also retail.

Okay. And then just on the deferrals, the CNIX energy has been fairly muted to date. Can you give us a sense for why that is and what your customers are saying at this point, whether or not that might increase in the future? Sure.

It doesn't look like that at this point in time. You know, I think we shared about this last quarter as well. You know, we did initially, as an accommodation for our customers, help them with a one-month, we called it a skip-a-pay. Certainly, I think that helped us kind of reach out and have those conversations with our customers. On the CNI front, you know, I think the requests and kind of conversations that we've had, the requests for deferrals and the conversations we've had with our customers around their cash flows has generally been relatively positive.

Our next question comes from David Chivarini with Wedbush Securities. Please go ahead.

Hi, thanks. A couple of questions. The first one on loan growth, you hit on a couple of the categories already about CRE expecting lower growth next year versus this year in single-family residential. You mentioned about similar trend going forward. But on CNI, if we exclude PPP, what type of growth are you expecting in that loan category?

Well, for 2021, we do plan to provide guidance for at the next earnings release. I mean, at this point, it will be too early for us, you know, right in the midst of this upcoming presidential election with, you know, the mystery about when the vaccine will be available, all the sort of things that are happening right now. I just feel that it will be much better for us to have the loan growth guidance to provide to you in January. But in the meantime, all I can share as of today is that in the second quarter, April, May, and June, we spent a lot of time focusing on PPP, skip a payment, deferral. We took a lot of time. Number one thing is to focus on keeping our employees in great health. And thank goodness, as of today, you know, we do not have one employee actually went to a hospital for COVID-19. And so all of us are in very good health. We're going to continue to stay vigilant to keep everyone in good health so that we can take care of our customers. And that's the number one thing that we're focusing on. And then PPP kept us very busy. And while we're doing PPP, we're also looking into potential deferral and so forth. Some customers just get confused. They didn't need a deferral. They just thought they have to get a deferral. So a lot of conversation going on back then. So not until sometimes in the third quarter, when these kind of issues all settle, our frontline relationship managers and branch managers start really reaching out and then looking for new businesses. The good news is that, as we highlighted in our talk earlier, that in the latter part of September, we start really booking some nice CNI loans. And we start seeing growth in CNI. And actually, many of these loans that we originated are brand new customers. I think that, to a certain degree, we're fortunate by being active, helping our customers, and even non-customers for PPP or other type of matters that are banking related caused some of these very good prospects to decide to move their banking relationship from banks to East West. So we're picking up some new business. So that's positive. The first three weeks of October, we also continue to bring in new business from other banks. And that has been very, very helpful for us. And we hope this trend will continue. Now, given the fact that we are still in the midst of pandemic, there are not going to be a lot of commercial business that are out there aggressively, you know, putting capital investment or growth other than the one that who happened to be in the business that the pandemic helped them. You know, for those who are in some of the traditional business, the pandemic may not help them I think their utilization rate for their line of credit would probably continue to stay a little bit lower. So we don't expect that many of the existing customers are going to have a strong push to draw down the line dramatically higher to cause a substantial growth there. But we are getting new customers that supplement the growth. So all in all, I think at this point, we feel that fourth quarter looking more positive from a CNI side. And by the way, it's not just coming from one particular industry or one particular geographic region. It's pretty much across the board for EastWest Bank. Several industry verticals, even our entertainment business, are growing nicely back. Our digital media business are coming back strong. And so our clean energy, the project finance, those type of business are all coming back stronger. than before. So we hope this trend will continue and in 2021, but for the detail of providing some sort of a forecast for growth on the lending side, we'll move it to the fourth quarter, 2021, in January, 2001.

Yep, that's helpful. Thanks for that. And then shifting gears to fee income. You mentioned about how, you know, customer transaction activity, you know, increased in the third quarter. Curious as to what the outlook is for the fourth quarter of that customer transaction activity. You know, that momentum continued into the fourth quarter, and we should expect, you know, either stabilization or rebound. Just curious as to your thoughts there.

Yeah, as you can see, the fee incomes are, you know, for customer-related transactions, customer related banking transaction type of fee income have all picked up so if you look at for example like deposit account fees that has a lot to do with with these new banking relationship that I talked about earlier and some of the existing customers you know expanding the relationship with us that combination of two result in us generating even stronger cash management fee income. Keep in mind, though, we talked about, for the last few years, about investing in the internal infrastructure and product enhancement, technology improvement. All of those costs that we put in are generating tangible results. We built a cash management system that can not only just accommodate but actually offer great services to many of the more sophisticated larger size business who now can just comfortably move their banking relationship from large banks to East West Bank because we have the capability to handle their cash management needs. So that result in more fee income for us and larger BDA account deposits. And we see that trend as very positive that we are able to do all of that while a lot of us are still working at home under the pandemic. So what we're looking forward to is to continue to keep pushing and both working with existing customer, expanding and deepening the banking relationship and also getting new customers from the outside. So I looked at from the cash management, wealth management, And even trade finance, you know, we have a 9% pickup in terms of business. So all in all, I looked at it is that we just going to continue to focusing on making sure that we take good care of our clients. And then hopefully we'll get more new business through this referral from our good clients and so forth. And then one step at a time and then getting more meaningful full fee income coming to the bank in 2021.

Our next question comes from Brock Vanderbleet with UBS. Please go ahead.

Thanks. Dominic, you've talked a lot in the past about the political environment, or at least a bit in the past about it. It's obviously been pretty fraught between the US and China. As we look at potentially a Biden win, how do you think this could potentially change your business?

We are always sort of like an organization that's very nimble in terms of adjusting comfortably with whatever the political environment that is out there. Do you recall four years ago, the U.S. government policy has been very, very much wanted to bring in investments from China and also investing in China and so forth. And for the last couple of years, you know, due to presidential election and then the political rhetoric had turned hostile and that had changed the dynamic dramatically. And we looked at, you know, even with the trade war in place for the last few years with the tariffs, As you have seen so far, we have such a big trade finance portfolio, import-export business, and then also with greater China exposure. But at the end of the day, we hardly have any losses. Now, the business slowed down a bit because we're being more cautious temporarily. And then also, of course, because of the pandemic, actually China shut down for a few months And so that had affected the growth aspect. But in terms of a risk aspect, we managed very, very well and have almost no losses. So with that in mind, I would say that looking forward, Joe Biden had made it very, very clear about his foreign policy, which is to get back, instead of American gold loan, And against the world, an American is going to work with allies and is going to take leadership back into, you know, United Nations, WHO, WTO, et cetera, and U.S. is going to get back into the front seat. And I am 100% sure when U.S. wanted to get back into the front seat and engage with the allies, and China will be more than delighted to step back, to stick a second or third or fourth seat and to collaborate with United States for climate change and all the other activities that all the nations around the world need to work together. So I would expect that if that happened, there's no question, whether it's Republican Party or Democrat, at the end of the day, US will compete with China economically And I think it's the right thing to do to compete. There's nothing wrong to compete. But on the other hand, I think that I have also strong confidence that there's going to be a lot more business exchange between US and China. Just reflect back for the last few months. Now, while it doesn't get a whole lot of news coverage, but JP Morgan, Citibank, Morgan Stanley all increased their stake in the joint venture in China are taking majority ownership. BlackRock, Neuberger, Berman, and a few others in the fund management business are getting new licenses. Insurance company getting new license. Every day, American Express getting new license. Costco opening more stores. Starbucks opening more stores. In fact, US business never stopped never stopped expanding into China. And the Chinese government also have never stopped bringing them in and giving them even more business opportunities than had ever been given before. In fact, just last week, a senior minister in China talking about additional intellectual protection right for foreign direct investments in China. So on a day-to-day basis, for people like us that are constantly watching what's happening between US and China and actually do look at regulation instead of just mainstream media news, we are seeing China making an aggressive effort to continue to open up the market, letting foreign investors to take on either majority ownership or full ownership in multiple different industries, granting license that they've never granted before, and then changing the law in terms of intellectual property protection, and also penalizing companies that force transfer of technology and so forth. All of the things that we've been hearing many, many times from the U.S. trade representative, like Heisinger, all of those things that we've been hearing, they are making the changes to it. Now, they're not broadcasting all over the world, but they are making the changes, and these businesses, whether from U.S. or from Europe, are directly benefiting from it. So in the East-West position is that, well, most of those are irrelevant to us to a certain degree because we're not going there to get some big big invest capital investments and then get certain license for certain type of new business. Our position is that the cross-border business is still strong and China has emerged from the pandemic back to business as usual. Many of my colleagues in Shanghai and Shenzhen, they go out to movie theaters, having dinner with their friends, don't even have to wear a mask. So I'm happy for them. So they are doing business. And we absolutely are there doing business also. You look at Hong Kong. Hong Kong, the stock exchange is going to overpass U.S. in terms of IPO listing because companies are all going there, lining up unicorn after unicorn, lining up in Hong Kong or in Shanghai Stock Exchange, Shenzhen Stock Exchange. Through these IPOs, there can be a lot more U.S. millionaires to billionaires, and they all need to make investments. They all need to have their personal wealth management, and they're buying properties around the world. U.S. still one of the preferred places for either real estate investments or other investments. So we do feel comfortable that business is going to be there. So we have no ability to predict what the outcome is for the election coming on November 3rd, but one way or the other, one thing I can guarantee everyone, East West know how to adjust and adapt and find a way to thrive under whatever circumstances.

Thanks, Dominic. Looking forward to a better backdrop there. Thank you.

Thank you.

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

Thank you again, and thank you for joining us all. And we are looking forward to speaking with all of you in January. Bye-bye.

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