Good day, and welcome to the East West Bancorp's Third Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Julianna Balicka. Please go ahead.

Thank you, Sarah. Good morning and thank you everyone for joining us to review the financial results of East West 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 or other forward-looking statements regarding events or future financial performance of the company within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may differ materially from the actual results due to a number of risks and uncertainties. For a more detailed description of the Risk Factors that could affect the company's operating results, please refer to our filings with the Securities and Exchange Commission, 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 website. 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, Julianna. Good morning and thank you everyone for joining us for our third quarter 2020 earnings call. I would begin with the review of our financial condition and results on slide 3 of this presentation. This morning we reported third quarter 2020 net income of $160 million a $1.10 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 rebound from the trough of the second quarter as provision for credit losses declined. Deposit growth this quarter was very healthy but especially strong growth in non-interest bearing demand account which grew 28% annualized quarter-over-quarter based on period end 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 account. We generate a 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 including our reserve level based on an improved macro economic 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…

Thank you Dominic. I will start by discussing loans on COVID-19 related deferrals on slide 11. As of October 20, loans on full payment deferral were 1.9% of total loans including loans on partial payment referral suddenly were modifications of principal and interest payment to interest only, loans on deferral total 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 30 and September 30 and decreased a further 20% month to date in October. The largest improvement was in residential mortgage deferrals which decreased by 79% since June 30 reflecting the resiliency of the East West customer base. Similar to the second quarter the deferral rate on C&I loans continued to be very low. Commercial real estate loans on deferral have also decreased down to 6.6% as of October 20 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 a review of our other asset quality metrics. Our allowance for loan losses was $618 million as of September 30 or 1.65% of loans held for investment modestly down from $632 million or 1.7% of loans as of June 30. Since January 1 post-season 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 30. 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…

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 customer 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. [Operator Instructions] Our first question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

Good morning.

Good morning Ebrahim.

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 one like 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 go back to paying and what have you learned about the portfolio in the last six months to give us comfort that we're not going to have negative credit surprises in 2021?

Well we've been actually looking at our credit portfolio sector by sector and within the C&I also in commercial real estate in C&I with all the different industry vertical each vertical gap review loan by loan. CRE we break it down by for the hotel, office building, multi-family and then region by region and obviously our single family mortgage is 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 and in terms of our risk rating classification and so forth 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 that 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 stocks. 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 I guess a desire to buy back stock on if it stays where it is?

Well we have board meetings every two months, two and a half months or so. So this is always like I would say that a standing agender. So we update the information, financial condition and balance sheet and also the mainly the economic outlook with the board members and then with those information we deliver it and then we have discussion of whether we take any kind of action. So at this stage right now I would say that and 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 in the based on the circumstances at that point.

Our next question comes from Ken Zerbe 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 I was driven by oil and gas I guess the concern that we would have is does it continue right I mean obviously you still have a sizable portfolio it is running off but is the worries it doesn't continue and slash do you have to build reserves for the additional portfolio as it deteriorates? Thanks.

Yes Ken that's a great question. When we look at the increase in non-accrual loans and also charge-offs really over the course of last year and beyond that really a lot of that has come from the oil and gas portfolio and we have also increased the reserves let's say a 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.

Yes. I would say, Ken let me just add maybe add on to what Irene just shared is that would there be likelihood of more potential charge of 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 our own portfolio and it's twinkling 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 had 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 somewhat relative to peers in that industry and everyone get the link from the oil and gas business. So from our perspective is that this is a portfolio that is getting smaller and smaller and we have substantial reserve 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 asset.

Yes and this is 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 adjust to returns given every few years it almost feels like there's a problem and losses spike. I'm talking positive risk adjusted returns over like a multi-year period.

We are managing it down and then we started managing it downs last year and then we continue the managing down, but the environment keep changing who knows what's going to happen from the demand around the world or United States or even a technological advancement that changed the dynamic 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 is 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 in 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 seeing some broader rate improvement or is there anything you can do on the expense side to help accelerate that?

Yes Jared I will take that call, a question. I think the largest variable for that would be on the revenue side. As we talked about earlier in our prepared remarks we do feel strongly fourth quarter and beyond that that revenue that interest margin NIM will increase. 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 support our growing business.

Okay. Thanks and then shifting a little bit to the CRE portfolio and the growth you saw this quarter I guess how much of that was refining I guess somebody else's loan and what gives you, how are you getting comfort putting on new CRE product now and is that translating into better terms and conditions and pricing or I guess maybe your thoughts around what you're seeing and doing on the CRE side?

In terms of with CRE loans that we originated most of the, I mean almost all of them are with customers that we've been doing business for a long time and these 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 originated. These new loans; some of them are not refi 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 obviously CRE pricing was extremely competitive last year. It's no longer as a competitive so we will be, I would say that originating CRE along with a slightly better pricing go forward. In terms of volume of CRE loans I would think that in 2021 and 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 great quality asset to be financed, but we will continue to look and then I looked at it is that East West is a 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 McGratty with KBW. Please go ahead.

Great. Thanks for the question. I want to ask about everyone's favorite topic and taxes given the market's expectations 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?

Yes. 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 you know there are a lot of moving parts we think if that happens the impact test will be about 4% on the rest of it with the amortization 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 will add at this point in time we have about $20 million of DTAs that would reverse as well.

Got it and then assuming this 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 else equal is that the right math for next year 15% tax rate and 75 or so on the amortization?

So 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.

Hey 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 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 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 multi-family. So ultimately I would say right now deferrals what we're seeing in the portfolio our customers we're very comfortable with that allowance level depending on what happens with the forecast 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 S1 and S3 because of S3 is a more severe adverse scenario overall I will 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 do you guys assume for government, additional government stimulus?

Yes so in and I think I will just break it down with the scenario so baseline did assume 1.5 trillion -- 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 D.A. Davidson. Please go ahead.

Thanks. Good morning. A lot of questions have been answered but I was curious on your comments on pre-paying 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 will 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 expectations over our liquidity flows given the amount of excess funding in system right now.

I know it was a great question especially in this quarter. What we've done especially as the deposit flow have continued and I think we've gone a little bit more comfortable reinvesting some of that into securities and also with our securities book, at that securities book. We have extended out the duration a little bit. So, I think if you look at the month of September not quarter-to-date, and the average yields in the portfolio it is up a little bit close to 2%. If you look at duration, you have 630, we're about 2.0 2.6 and we are at about 38 as of 09.30.

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

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

Yes. And Matthew, when we look at kind of the migration into special mentioned during the quarter, it was really to a certain extent throughout the portfolio of share, that 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 C&I x energy has been sort of muted the date. Can you give us a sense for why that I sand what your customers are doing at this point. Whether or not that might increase in the future?

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

And next question comes from David Chiaverini 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 loan growths next year versus this year in single-family residential, you mentioned about similar trend going forward. But on C&I, if we exclude PPP, what type of growth are you expecting in that loan category?

Well, for 2021, what we do plan to provide guidance at the next earnings release, I mean at this point that will be too early for us in the right in the midst of this upcoming presidential election with that mystery about when the vaccine will be available, all sort of things that are happening right now. I just feel that it will be much better for us to have the gross guidance to provide to you in January. And but at the mean time or I can share as of today is to have, in the second quarter April, May and June, we spent a lot of time focusing on PPP, skip of payment deferral. We took a lot of time, number one thing is to focus in on keeping our employees in great health and thank goodness as of today we do not have one employee actually who 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 they will can take care of customers. I mean, that's number one thing that we're focusing on. And then PPP kept us very busy. And now we're doing PPP, we're also looking into potential deferral and so forth. Some customers just get confused, they don’t really need, they didn’t need a deferral, they just thought they have to get a deferral. So, there's a lot of conversation going on back then. So, not until sometime in the third quarter, when these kind of issues all settled, in our frontline relationship managers and branch managers have start I mean really reaching out and then looking for new business. Then good news is that as we highlighted in our talked earlier that…

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

Yes. As you can see it the fee income side, for customer related banking transaction type of fee income had all picked up. So, if you look at for example like deposit account fees, that has a lot to do with this new banking relationship that I talked about earlier and some of the existing customers expanding the relationship with us. That combination of two result in us generating even stronger cash management fee income. Keep in mind of we talked about for the last few years about investing in the internal infrastructure and COVID enhancement technology improvement, all of those cost that we put in are generating tangible results. Or rebuilt a cash management system that can manage us accommodate but actually will offer great services to many of the more sophisticated larger sized business. We now can just comfortably move the banking relationship from large banks to East West Bank because we have the capability to handle the cash management needs. So, that result in more fee income for us and larger the DDA account deposits. And we see that trend as very positive that we are able to do all of that but well 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 or working with existing customers, expanding and deepening the banking relationship and also for the new customers on the outside. So, I looked at from the cash management, wealth management, and even trade finance. We have a 9% pickup in terms of business. So, all now I looked at it is that we just continue to focusing on making sure that we took 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 or fee income coming to the bank in 2021.

The next question comes from Brock Vandervliet with UBS. Please go ahead.

Hi, thanks. Hi Dominic, you've talked a lot in the past about the political environment released a bit in the past about it. It's obviously been pretty fraught between the U.S. and China. As we look at potentially at buy it and win. How do you think this could potentially change your business?

We are always sort of like an organization does, very nimble in terms of adjusting comfortably with whatever their political environment that is out there. To recall, four years ago or the U.S. government policy has been very much of lot of to about bring in investments from China and also investing in China and so forth. And for the last couple of years due to presidential election and the political ladder heads had turned hostile and that had changed the dynamic dramatically. And we looked at even with the trade war in place for the last few years with the terror, as you have seen so far we have such a big trade finance portfolio, import export business and then also with greater China exposure, is that at the end of the day we hardly have any losses. Now, the business slowed down a bit because we'd be more cautious temporary and then also of course because of the pandemic, actually China shutdown force a few months. And so, that had effect the growth aspect. But in terms of then the risk aspect, we manage very well and have almost no losses. So, with that in mind I would say that looking forward, Joe Biden had made it very clear about his foreign policy, now which is to get back instead of American gold loan and against the world and American is going to work with allies and is going to take leadership back into United Nation, WHO, WTO, et cetera and U.S. and then get back into the front seat. Then I am 100% sure when U.S. wanted to get back into the front seat and engaging with the allies and China will be more than delighted to step back to stick a second or third or four…

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 and closing remarks.

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

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