East West Bancorp Inc Q2 FY2023 Earnings Call

Good morning, and welcome to the East West Bancorp Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Diana Trinh, Vice President and Investor Relations Officer. Please go ahead.

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.

Thank you, Diana. Good morning, and thank you, everyone, for joining us for our earnings call. I will begin the review of our financial results with Slide 3 of our presentation. This morning, we reported solid results, revenue, pretax 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 billion for loans. The 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 1.5% on average assets, 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 and asset quality continued to be outstanding with net charge-offs of 6 basis points annualized. Slide 4 presents a summary of our balance sheet. As of June 30, 2023, total loans reached impacted $49.8 billion, an increase of $906 million or 7% annualized from March 31. Second quarter average loan growth was 6% annualized from the 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. The 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 deposits were offset by a 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 noninterest-bearing demand deposits as of June 30, and our loan-to-deposit ratio was 90%. Turning to Slide 5. 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 of 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's Board of Directors declared third quarter 2023 dividends for the Company's common stock. The quarterly common dividend of $0.48 per share will be payable on August 15, 2023, to stockholders of record on August 1, 2023. Moving on to a discussion of our loan portfolio, beginning with Slide 6. As of June 30, 2023, C&I loans outstanding were $16.7 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. Greater China loans decreased 11% linked quarter annualized to $2.1 billion as of June 30. Slide 7 and 8 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 61%. Also, we typically originate amortized loans with a final maturity of 7 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 grew to $19.9 billion as of June 30, 2023, up 10% annualized from March 31 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 31 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 9 and 10. As you can see on Slide 9, 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 in the low 52%, and 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 of 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 totaled $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 totaled $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 deposits totaled 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 concentration in any sector.

Thank you, Dominic, and 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%, and the criticized loans ratio improved 24 basis points. Nonperforming assets as of June 30 increased modestly to 17 basis points of total assets from 14 basis points as of March 31, reflecting loan growth alongside our stable asset quality metrics. In 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. Starting the discussion of our income statement on Slide 14, we detailed out specifics on the tax weighted investments, as the amortization and effective tax rate were fluctuating quarter-over-quarter, reflecting the timing of when tax price investments closed. For the third quarter, we currently anticipate that the amortization of tax for 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 2023 net interest income was $567 million, a decrease of 5.5% from the first quarter. Net interest margin of 3.55% declined by 41 basis points quarter-over-quarter due to the impact of higher interest-bearing deposit costs and 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. On 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 due, including 27% linked to the 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, collars, fixed-rate, and synthetically fixed-rate loans for 65% of the total CRE book as of June 30. 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 noninterest 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 noninterest expense was $262 million, excluding the amortization of tax credits and C&I, adjusted noninterest expense was $205 million in the second quarter, up a modest 1% sequentially. The 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 13.5% in the first quarter. Our adjusted pretax pre-provision income was $440 million in the second quarter and our pretax pre-provision ROA was an industry-leading 2.61%. And with that, I will now review our updated outlook for the full year of 2023 on Slide 20. For the full year 2023 compared to our full year 2020 results, we expect year-over-year loan growth in the range of 5% to 7%, unchanged from the prior outlook. Year-over-year, net interest income growth in the range of 12% to 15%. Underpinning our net interest income assumptions is the forward interest rate curve as of June 30, which assumes one Fed funds rate hike of 25 basis points in October with a year-end Fed funds target rate of 5.50%. Adjusted noninterest expense growth in the range of 9% to 11%, and we expect our revenue and expense outlook to result in positive operating leverage year-over-year. In terms of credit, for the full year 2023, we currently expect to report a provision for credit losses in the range of $110 million to $130 million. Provisions 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% and based on approximately $150 million of tax rate investments, excluding light investment 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.

Thank you, Irene. In closing, we are pleased with our consistent financial performance and strong core earnings, although net interest income decreased due to deposit competition. Our revenue and pretax pre-provision profitability remain very strong. The East West business model is resilient and diversified and our balance sheet is healthy. We operate with high capital levels, and we are well positioned to deliver earnings growth and strong profitability. I would now open the call to questions. Operator?

Our first question will come from Ebrahim Poonawala with Bank of America. You may now go ahead.

First question, Irene, for you on NII. So, it was a decent step down in the second quarter. If I have it right, your guidance implies that NII stabilizes about 5.65% 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%?

Yes. Great question. First of all, when we look at where we stand today, what's positive is that although with the deposit competition, the cost of deposits did increase in the second quarter, we keep growing, right? We're bringing on new customer deposits. Through that, we have the opportunity to lay off some of these higher-cost broker deposits that we placed on the balance sheet after the mid-March disruption. I'll just share that since June 30, and we've laid off about a little over $600 million at 5.15% and have replaced that with lower-cost customer deposits. So, the momentum is here, and that is one of the underpinning drivers for why we think NII will stabilize. Of course, the expectation is that the Fed will increase rates next week. That will 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 based on how successful we are, as I mentioned, were 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. And then, of course, also a little bit as far as the range of where we'll be on the loan growth.

And where do you expect the NIB balances to stabilize, Irene?

Yes. So 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. And DDA, I'm sorry. Yes.

As of June 30, the direct deposit accounts stood at 30%. Two days ago, this figure increased to 31%. The spot rate for deposits was 2.28% on June 30 and decreased slightly to 2.27% two days ago. We have managed to keep the deposit rate fairly steady. Looking back at May and June, the deposit rate remained stable around 2.28%. The spike in April was primarily due to the Silicon Valley Bank situation in March. We took a cautious approach and did not require a significant influx of deposits since we maintained a favorable loan-to-deposit ratio. We could have allowed for some deposit outflow without concern, but we opted to actively bring in broker deposits. Once we saw stability after April, we decided to ease our stance because the momentum from new and existing customer deposits gave us confidence that things were stabilizing. By shifting from high-cost institutional funds to deposits from retail and commercial clients, we believe we are establishing a more stable situation for the future.

Got it. And 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?

Yes, I think that you just said it, kind of answered my question, but your question. The macroeconomic situation 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 thought the recession should have been here, actually, with the rate spike like that; I thought the recession had already arrived. But it didn't. It turned out to be a soft landing. That would be great, but it may not happen. The economic environment is certainly not something that we can bet on. But in the meantime, the market environment has never been as ideal as it is today. When I say market environment, I mean for decades, we've been competing with some very competitive neighborhood bankers out there. Some of them are good at venture capital, PE; some are good at making very high net worth customer mortgages and, quite frankly, for whatever reason, we decided not to be able to compete today, they go on. So, we have just so much less competition, and with our size, with our ability 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 a better position than we are today. But the macroeconomic environment is certainly not clear. So, reflecting back on another perspective, which is when we're making a 21% return on equity, why do I want to go crazy right now to try and do all kinds of stuff? So, we are watching the market. We're taking advantage of one customer at a time when there's some other customers from other banks who want to explore a relationship with us, we welcome them. But we are doing it prudently, not trying to go out there to make certain kind of earnings 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 and a very diversified deposit portfolio, and that's good. If there's any good prospect coming in, we certainly will entertain it. But we'll make sure that we stay disciplined with our East West Bank credit metrics and pricing metrics. We still feel that there is opportunity to grow. 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 going to be really good.

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

Yes, sticking on with the capital theme. As you go into year-end, if the broker deposits run down and the BTFP be paid off, and assuming cash flow soon, that capital will continue to grow. How high is too high for capital? What else can we expect the capital management payout ratio at only 22% a year?

I think how high is too high is based on, again, the macroeconomic environment. The way I see it is that we do a lot of these volatility comparison; if we have many banks out there buying stock because they can generate the kind of EPS or return that is required, and that's what they need to do, we obviously today, with a very high capital ratio, still have industry-leading ROE, so therefore this is obviously not something that we have to urgently do for our shareholders in light of, we also have dividend increases year after year. From that standpoint, we are shareholder friendly. We think that we come to a point, and if our capital ratio gets too high, if there is really not much risk in the horizon in the market in terms of the economic outlook, and for whatever reason we feel that there's so much earnings, it's just not going to be possible for enough growth, we absolutely would consider that buyback scenario. We've done that before, and we will do it again. But in this kind of uncertain economic environment, we don't know whether there will be a recession coming or how aggressive the Fed wants to keep the rate high for how long, which may cause a major downward spiral on the economic conditions that affect certain industries and so forth. This may create a much better opportunity for potential acquisitions or anything that is available out in the market, and we don't want to spend the money on buyback and not have excess capital to strike for much better opportunity. After all, we don't run our bank on a quarter-to-quarter basis; we run our bank on a long-term sustainable basis. For the last three quarters, I've been here, we've always looked at year after year of record earnings and year after year sustainable growth. We want to be able to do that. And so if you do that, we constantly have to make investments. Just like even in a challenging deposit environment like the last quarter, we're still investing in our infrastructure. We are still investing in our enterprise risk management platform to make sure that we continue to have the ability to sustain long-term growth like the way we have done for the past decade. A very simple strategy, if it makes sense, we'll do it the right way.

Okay. And I guess just one follow-up looking at the single-family residential, great growth there. What are some of the dynamics driving that? Are you still seeing strong integration coming in? Is it additional capital coming into the country? Or is this just the existing customer base, and maybe the existing potential customer base is already in the U.S. anymore?

It's a combination. There's always immigrants coming to the U.S. The fact is we have become bigger, and our brand is stronger. Our branch networks are all over the place, and people recognize our brand. So more and more of the customers in the Asian-American community from our retail banking footprint are coming to East West Bank because they know that we can make credit decisions in a timely manner. We close the loans and also fund the loans on time, and both from services and our broad outreach within the branch footprint allow us to continue to have very strong momentum so far. Again, this also surprised me a little bit. I expected that with the rate rising like that, people would not be buying homes, but I guess people are still buying homes. It's not just particularly different at East West; in fact, throughout the country, we see statistics from economic reports indicating that people are still buying homes. So we're just getting the fair share of those benefits.

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

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

That's right. That's correct. I think just to clarify our guidance is based on the forward curve as of June 30. Certainly, I think market expectations moved a little bit since then. The lift from the rate hike, let me say you that number, I don't see - I don't have it in front of you today, but certainly, it helps given the variable rate loans that we have. I also say that rate hike, given the current environment, I think we're being conservative on our deposit beta assumption with the expectation that even if rates do not increase from this point in time, they may still remain elevated for a period of time before rates decrease. So that's also underpinning our kind of NII and NIM guidance. I'd also share kind of the continuation of my comments earlier. We laid off about $600 million or so quarter-to-date. 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.

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

That's included, but we're modeling around a range around that, how about that data.

Yes. That's great. And my follow-up on the expense guide, it would just be great if you could 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?

Yes. Great question. I think when we look at the expense guidance and also the increase from our prior guidance, a couple of things. One, year-to-date, the actual results and the expenses that we've incurred so far; when we look at the remainder of the year and kind of just the sentiment around things, certainly, things are a lot different than they were at the start and mid-April. That's certainly part of the reflection on what are the expenses, what are the investments that we need to do to sustain the growth. As Dominic had talked about, we are continuing to see opportunities to grow, frontline, and back office also from a risk management perspective. So those are the real drivers around that. Nothing really unusual in the near term, but we are hiring headcount is up year-over-year. I think drivers to reduce, certainly, I think the environment changes. Now there are some levers there as well. But I think at this point in time, we don't expect that, Dave.

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

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

We are seeing some new activity. However, we are not aggressively pursuing large groups of bankers from institutions like HSBC. We are being very selective, especially given the recent challenges faced by several banks that have led many bankers to seek new opportunities. Even outside of California, we are receiving numerous inquiries. Our focus is on finding individuals who align with our culture and mindset before bringing them on board. The same applies to acquiring new customers; I’ve received multiple inquiries from clients referring friends who were with banks that have recently failed, all looking for new opportunities. We are currently engaged in discussions with many of these potential new clients, and we have successfully booked some loans. Notably, our commitments in commercial and industrial loans have risen by 15%, though the outstanding balance has only increased by 1%. While we have taken on many commitments, it will take time for them to translate into drawdowns, similar to how we operate with deposits. We’ve opened a lot of new accounts, but it will take some time to get them fully up and running. We are not rushing this process because we view our business as a long-term endeavor. Instead, we are gradually onboarding new clients and ensuring they have the right experience without overwhelming our existing customers. Additionally, we are committed to further improving our enterprise risk management practices. This is vital work that we cannot ignore just because we are experiencing an influx of customers from failed banks. We need to manage all aspects of our business effectively. We expect to gain more customers over time, not just from the failed banks, but also from other regional banks facing difficulties. Many clients are looking to East West for reassurance about their future. Banks with strong capital ratios consistently perform well and maintain solid relationships with regulators, positioning them to thrive.

And I guess related to that, in terms of investing in the business, I know you moved your expense guide up slightly. Can you talk about what's driving that revision? Is it mainly investments, and are there some opportunities you're seeing in this environment? How should we think about expenses overall, even going into next year, as you continue to invest in the business, but also 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?

Well, we are less than $100 billion, far less than $100 billion. We're $68 billion to be exact, and so therefore, this is around two-thirds, just about two-thirds of that first threshold. Looking at organic growth, it’s going to take a while to get to that $100 billion. Also, think about it; even if we're at $100 billion, we always do whatever we need to do to ensure that we are above and beyond the minimal requirements. With our capital ratio, it’s really not much issued because many banks are struggling with the potential new regulatory proposal because they have low capital ratios. Once they start adding here one item, they may not meet the threshold. We're way above it all. Getting back to the slight increase of guidance of the expenses, as Irene mentioned earlier, when we start putting in the guidance after the first quarter earnings in mid-April, we didn’t expect as much opportunity to grow at that point because we expected this would likely be a recession company. So it's going to drop rates, and all of that did happen. Not only did it happen, we saw our deposit also somewhat stabilize. Customers demanded much higher rates in March and April. By May, it somewhat subsided. There was an increase from customers of those banks in trouble who saw it coming. Once it stabilized, they started looking at the fact that some of the new parents that were acquiring those banks were not the right fit, and they started talking to us. When we start looking at all that, it’s appropriate to start hiring some of the talented bankers. We want to ensure that we continue to stay vigilant to invest whatever we need to. We do not overinvest. East West always invests incrementally in terms of technology, operations, and hiring. But we are absolutely out there looking at talent to see whether they fit into our culture, and we’ll bring them on. We do not get overly concerned about whether it will affect 1% or 2% of our expenses. Sometimes, you wait, and you miss those opportunities. We feel comfortable about doing all of that because we still have positive operating leverage today.

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

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

What we've seen is that we see nothing that's the scary part. Actually, we do regular loan-by-loan reviews. That's part of East West Bank. We've been doing this for years and years. I was concerned about the potential CRE portfolio five or six years ago. We did loan-by-loan reviews, and we continue. Even with the pandemic, I thought we were going to take a lot of losses, but we managed our credit really closely, monitoring things very closely. We have discussions with clients and ask them to do what’s right. At the end of the day, we didn't take any loss to get through that, and now it’s become a normal day-to-day business. When interest rates spike aggressively, I thought clients would struggle, but as of today, payments are being made, and they’re doing fine. I think, Brandon, it helps when we have very low loan-to-value, which gives a lot more incentive for clients to stay on the property. Our clients have a lot of liquidity, and many have personal guarantees. All these characteristics help keep our portfolio strong in the commercial real estate side. There are only 10% of our loans coming due in the next 18 months, so we will have a very stable portfolio that there's not a whole lot that we need to worry about.

That's really great color. And then, I noticed C&I utilization ticked down a bit in the quarter. I know there has been some deleveraging from new customers. But I'm wondering just what you see on the front lines there. Are you anticipating that continuing towards the back half of the year?

Second half of the year, yes. I think quite candidly, the utilization did tick down a little bit, Brandon, as you mentioned. I would share, though, as we look and to a certain extent, there's only so much we can do about that, right? As Dominic mentioned, commitments are up. I would share, though, when we look at the pipelines and when we talk to our team leaders, the expectation for the second half of the year, new client acquisition is something that is increasingly positive. That’s certainly something that we have factored in for the second half of the year. Given the current environment, we’re not necessarily expecting that utilization rate will increase substantially from this point. But I would also say no specific areas or concentrations of where that growth is coming from. It's pretty broad-based.

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

Just to close the loop on the margin, Irene, can you provide insight on where you think the cycle beta for deposit beta might end up? I believe low 60s was your previous target, but how does it look on a spot basis? Also, do you have the monthly NIM from June?

Yes. So, 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 still the same. I’m sorry, I close deposits not the NIM, right? I think the expectation for NIM is that it will decrease modestly from the second quarter, but still NII with the drivers that we're talking about, we expect that to flatten out and improve.

Our next question will come from the media 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?

Yes. From a credit risk perspective, we have no concerns. However, regarding growth volume on loan origination, we have booked a significant amount of loans for entertainment content production. If there is a strike, there may be a delay in drawing down those loans. We hope the strike will not be prolonged. If it extends for a long time, we could have some loans that do not meet our desired drawdown levels, although this will not affect credit quality. The advantage we have is a highly diversified loan portfolio, which will help offset any slowdown in entertainment content production financing. Our lending officers will focus on securing new clients and funding those loans to balance out any declines in the entertainment sector. It's worth noting that 4% of our loans are in media and entertainment, and we also have a substantial portfolio in digital media, which is not impacted by strikes. These projects include video game development and are separate from the Hollywood labor force, making the situation different. Therefore, the 4% figure is not as significant as what we’ve presented.

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

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

I wanted to revisit your comments about the planned $1.2 billion of brokered runoff back half of the year. I know you don't give kind of deposit growth guidance. But 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?

Gary, that is the plan.

Okay. And then the second part of that question is the $600 million or so that you've rolled off so far in July and replaced by customer deposits. 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 the June 30 spot rate because it doesn't sound like that's moved very much.

Yes. That's a great question. The incremental new deposits, new customers, new CI assets that have been coming in are indeed closer to the June 30 spot rate. I think the overall, we’re pleased with the movements we've seen. Some of that has been a little bit of migration that we've seen with the higher rate environment to CDs, especially on the consumer side.

The mix coming in is more CD oriented?

Well, on the consumer side, and let me clarify. I think the growth dollar-wise is commercial side. Overall, on the consumer side, especially with CDs, that is something that continues to be a pressure on the margin in total, but new customer acquisitions, generally, that has been commercial oriented and at lower rates.

Okay. I have one more question on the beta and deposit pricing. Historically, you think of there being kind of this long or multi-quarter deposit catch-up after the Fed stops raising rates. In the scenario where 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 incredibly rapid. Is your sense that in the fourth quarter, that kind of delta, assuming no additional hikes after next week, moderates pretty significantly to where the lag after the Fed's last hike is much shorter in nature? Or do you have any sense of how that might play out?

Yes. I mean, Gary, honestly, your guess is as good as mine. Realistically, as we're kind of modeling it out, our assumptions are that there will be a lag, as the deposit cost will remain somewhat elevated for a period of time. There have been different examples in the relative recent history, let's say, with the pandemic and rates changing dramatically, where we were able to go in and dramatically lower deposit costs. But as we’re modeling it out with our guidance for the rest of the year, we’re not assuming that.

I'm certainly not suggesting that deposit costs go back the other direction, but more so that the lag following the Fed height is shorter perhaps than it's been the past.

Yes. At this point, I think logically, I would expect that if you look at the rate spike and the fact that the entire banking industry, it’s because of March 8, March 9, the news of Silicon Valley Bank that caused a dramatic change in the rate environment. Then, heightening the attention of consumer retail and commercial customers, and everybody started looking at either moving deposits out or asking for a higher rate. It was a major surge in interest rates. That has subsided dramatically, so I don’t see that another 25 basis points is going to affect things much now as the banking industry stabilizes. I assume that the other banks would also be a bit more prudent in putting up high rates to attract deposits. When that's the case, the competition will ease up in terms of the rates offered.

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

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 TRIM guide. If the forward curve plays out and we get cuts next year, can you just make a comment or two about how you think the margin may react?

Yes, great question. 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 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, if the rate cuts happen, that will be something that we were fortunate to do in prior periods.

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

I wanted to ask if you have any thoughts on fee income moving forward, especially considering the approximately 77% change in core modelable items. Do you see this as a good run rate, or how do you think it will evolve?

Yes, great question. The growth rate on that has been something that has also been a great surprise for us as for transaction volume, notional amount, FX volume, consumer, and commercial; the growth we’ve seen there has been great. From the IRC SWAT teams, again, saying that volumes are increasing, even across the board, wealth management, low fees a little bit, and even the account deposit fees have all been positive. I’ll share that overall fee income also has 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, but certainly, when we look at the rest of the year, the pipeline looks great. We are acquiring new clients, and that is very positive.

Got it. Could I ask just on the fixed rate loan portfolio? I know that a good chunk of it is single-family residential. But just, I guess, when you look at the fixed rate loan book, what’s the dollar amount that’s repricing over the next 12 months? And what do the current yields look like on those loans? And if you could bifurcate it maybe between the CRE and everything else, that would be helpful?

Yes. So over the next 12 months, we have approximately $800 million of fixed and hybrid fixed loans, CRE and single-family maturing or repricing. If you break that down, it’s a little different per category. On average, we're talking about a weighted average interest rate of 4.75% that we expect to move up.

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

Yes, to clarify, some of this is maturity and some of this is hybrids that are going to step up. In the current environment, especially for the single-family, there is a cap on that. If we look at the new originations, C&I has been about flat; CRE for hybrid and variable rate blended, maybe 7.4%; and for single-family, the current originations have been about 6.5%. Many of these prices have been locked a while ago, and they started the outer concern in the process, but the current rate sheet is 7% and 8% for a 30-year fixed mortgage, no points.

Got it. And then I did want to ask, do you have 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?

Yes. The effective duration has slightly reduced quarter-over-quarter just a little bit, honestly, more of the tenure around the change. We’re probably at 3.89% right now, down modestly. The CPR, if we look at the MBS and also the CMBS, generally, I mean, the prepayments have slowed dramatically. I can get you the specifics of that later.

Okay. Great. The last question I have is about the improvement in the mix shift in June and the brokered run down. If we can stabilize the mix shift and level things out, particularly regarding the NIBs, I'm hoping you can help me understand the differences between commercial clients and retail customers at this stage. How are the mix and beta acceleration between these customer segments differing in this cycle? My initial thought was that there would have been significant commercial mix and beta catch-up earlier, and that there might be a slower catch-up on the retail side. I would appreciate your insights on that.

Yes, that's a good question. What we've observed is that you're correct; there has indeed been an earlier impact on the consumer side compared to the commercial side. There was a delay in that impact, which is partly due to the nature of our customer base. We have many clients, thousands of whom have their primary personal checking accounts with us. Currently, out of $4 billion in DDA balances, $1 billion are from consumer checking accounts. In this environment, we've faced challenges in growing that balance as clients are shifting their excess liquidity to CDs. In the second quarter, while there was a noticeable lag in consumer deposit betas, this mix shift towards CDs, combined with stable consumer balances, allowed for an increase in betas on the consumer side from where they were after March 31. Looking ahead, I believe the continued growth in commercial opportunities might lead the consumer side to moderate. If customers aren't already aware of the interest rate environment, they likely won't be at this stage. We’re not witnessing a significant migration on the consumer side, but as we onboard new clients in the commercial sector, that should provide positive momentum.

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

Well, thank you all for joining our call today, and we are all looking forward to speaking with you again in October. That concludes our call today, and thank you very much. Bye-bye.

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