East West Bancorp, Inc. (NASDAQ:EWBC)
Q1 2017 Earnings Conference Call
April 20, 2017 11:30 A.M. ET
Julianna Balicka – Director of Strategy and Corporate Development
Dominic Ng – Chairman and Chief Executive Officer
Greg Guyett – President and Chief Operating Officer
Irene Oh – Chief Financial Officer
Linda Chan – BMO Capital Markets
Ebrahim Poonawala – Bank of America
Dave Rochester – Deutsche Bank
Jared Shaw – Wells Fargo
Aaron Deer – Sandler O’Neill & Partners
Michael Young – SunTrust
Matthew Clark – Piper Jaffray
Ken Zerbe – Morgan Stanley
Chris McGratty – KBW
Gary Tenner – D.A. Davidson
Good day everyone, and welcome to the East West Bancorp’s First Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to Julianna Balicka. Please go ahead.
Thank you, William. Good morning, and thank you everyone for joining us to review the financial results of East West Bancorp for the first quarter of 2017. With me on this conference call today are Dominic Ng, our Chairman and Chief Executive Officer; Greg Guyett, our President and Chief Operating 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. 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, 2016. In addition, some of the numbers referenced in this call pertain to adjusted numbers. Please refer to our first quarter earnings release for the reconciliation of GAAP to non-GAAP 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. After the prepared remarks, we will start the Q&A and we ask that you limit your questions to two questions per analyst. Thank you.
I will now turn the call over to Dominic.
Thank you, Julianna. Good morning. Thank you everyone for joining us for our first quarter 2017 earnings call. I will begin our discussion with the summary of our first quarter results. Please go to Page 3 on the slide deck that Julianna referred to earlier.
East West delivered strong financial performance in the first quarter, which illustrated the key strength of our bank consistent loan and deposit growth, favorable asset sensitivity and disciplined expense management.
Our first quarter 2017 net income of $170 million and diluted earnings of $1.16 per share are both 53% higher than the prior quarter. Excluding the impact of the commercial property sale, our adjusted first quarter 2017 net income of $128 million and earnings per share of $0.88 are both 16% higher than the prior quarter.
Our solid core operating results this quarter were driven by strong loan and deposit growth. Loans grew 15% annualized linked quarter to a record $26.5 billion and deposits grew 9% annualized linked quarter to a record $30.5 billion. These growth rates reflect a strong start to the year.
Non-interest-bearing demand deposit grew to a record $10.7 billion as of March 31, 2017 or 35% of our total deposit mix. The balance sheet growth combined with a positive impact from rising interest rate supported solid core net interest income growth and core net margin expansion.
Through our disciplined expense oversight, we continue to deliver an industry-leading efficiency ratio, which was 43.3% in the first quarter. Finally, credit quality continues to be stable and our analyzed net charge-off ratio was 8 basis points this quarter.
Moving on to Page 4 in the slide deck, you would see that East West operating results consistently generate attractive profitability. The first quarter of 2017 return of asset and return of equity exclude the impact of the gains on the property sale is 1.49% and 14.9% respectively. Again, we are pleased with the overall financial results.
I would now turn the call over to Greg and Irene to provide more in-depth discussion of the first quarter results and on our full-year 2017 outlook.
Thank you, Dominic. Continuing on to Slide 5 and 6 to review our loan and deposit growth in more detail. Loan growth this quarter was broad-based across our portfolio with commercial real estate up by $296 million or 3% linked quarter. C&I growing by $278 million or 3%, single-family loans increasing by $190 million or 5%, and multi-family up by 9% or $147 million.
The above trend multi-family originations were largely the result of a couple of larger loans with long-standing customers, portions of which have subsequently been participated to other institutions, post the end of the quarter. Our C&I portfolio reached $9.9 billion at quarter-end, which was the result of balanced growth between the specialized industry teams, and our traditional C&I teams, which are largely focused on the Asian American customer base.
Specifically, the specialized industry verticals totaled $3.6 billion at quarter-end, up 3.6% linked quarter. These customers now represent 37% of total C&I funded loans, up 1% quarter-over-quarter. In the quarter, we saw strong growth from the entertainment, energy, and private equity fund teams. The traditional C&I portfolio increased 2.6% linked quarter. This result reflects our renewed emphasis on lending to our core commercial customer base.
Growth is likely to vary quarter-by-quarter, but we expect the overall trend to continue to be favorable in this area. And while we had success in booking new commitments in the first quarter, we also benefited from an increase in utilization of about 300 basis points in what has traditionally been a seasonally weaker quarter. The increase in utilization contributed about half of our C&I funded loan growth in the quarter.
Turning to the commercial real estate portfolio, including land and construction, it totaled $9 billion at quarter end. CRE as a percent of our total loan balances remained steady at 34%. Our CRE concentration to total capital had 265%, a 5 point increase from year-end continues to be well below the 300% threshold. CRE growth this quarter reflected higher origination activity with good long-standing customers and a slower pace of run-off than we had seen in recent quarters.
It was a strong start to the year, but we continue to be cautious in adding to our CRE book and remain committed to our historically prudent underwriting standards. For example, our construction and land loan exposures remain at low levels, increasing by only $10 million net in the quarter to $684 million. Given the focus on the future of traditional retail, I wanted to make some comments about our portfolio.
During the recent quarter, we completed a deep dive into our retail CRE loans, which comprised approximately one-third of our total CRE exposure. Similar to our overall portfolio, the average loan size is small with low loans to values and strong coverage ratios. We also generally have personal guarantees on these loans.
Specifically, our average retail CRE loan is approximately $2 million with an average loan to value of 46% and an average debt service coverage ratio of about 1.9 times. We have fewer than 50 loans over $10 million in this category and these have an average LPV and DSC that are similar to our smaller loans.
Now moving to deposits, as noted on Slide 6, our deposits reached a record $30.5 billion at quarter-end, up $652 million or 9% linked quarter annualized. Non-interest-bearing demand deposits, which are predominantly commercial operating accounts grew $475 million or 5% linked quarter to $10.7 billion or 35% of our total deposit mix. Over the past five quarters, our deposit mix has been stable with the small increase in DDAs.
Our deposit balances continue to comfortably exceed funded loan balances with a loan to deposit ratio as of March 31 of 87%. With this position and our loan and deposit mix, we believe we will continue to benefit from a rising interest rate environment, and we have ample room to support ongoing organic loan growth, while maintaining good discipline in deposit pricing.
Irene will now cover more specifics in the quarter and our updated outlook.
Thank you, Greg. I will begin with a summary income statement on Slide 7. As Dominic referenced, during the quarter, we completed the sale and leaseback of a commercial property in San Francisco for a sale price of $120.6 million and entered into a lease agreement for part of the property, including retail branch and office facilities.
The total pre-tax profit from the sale was $85.4 million, of which $71.7 million was recognized as a pre-tax gain in the first quarter and $13.7 million will be deferred over the term of the lease agreement. The after-tax gain on the sale was $41.5 million or $0.28 per diluted share. Adjusted, our net income for the first quarter was $128 million or $0.88 per diluted share, up 16% linked quarter.
Our effective tax rate for the first quarter of 2017 was $25.6 million. The adoption of the new accounting from stock-based compensation ASU 2016-09, which was effective January 1, 2017 lowered our tax expenses in the first quarter by $4.4 million or $0.03 per share.
Additionally, related to our effective tax rate, the amortization of tax credits was $14.4 million for the first quarter of 2017. Next, I will move on to Slide 8, 9, and 10 for a closer look at our earnings drivers. Our core earnings was strong in the first quarter. Our net interest income, excluding accretion increased by 12% linked quarter annualized to $269 million.
As anticipated, accretion income declined in the first quarter to $3 million and we see this as a good run rate for the remainder of the year. The remaining ASC 310-30 discount accretion on our purchase credit impaired loan portfolio is $47 million of which we expect approximately $32 million will liquidate income over the life of the loans.
As a reminder, in the fourth quarter 2017, the accretion income was $11.6 million, due to higher levels of cash activity and recoveries. Our first quarter results continued to show the benefits of our asset sensitive balance sheet. Excluding the impact of accretion, our adjusted net interest margin of 329 was a 12 basis point linked-quarter benefit from the rising rate environment.
The increase in loan yields contributed to 3 basis points of increase, higher yields on our securities portfolio, and another short-term investment contributed 4 basis points. Loans contributed a higher percentage of the earnings mix and contributed 7 basis points, and this was partially offset by 2 basis points from a higher share of borrowings in the funding mix.
Our cost of deposits was 32 basis points in the first quarter, up by 1 basis point sequentially. To illustrate the impact of higher rate on our loan yield, as of March 31, 2017, the contractual weighted average interest rate on our loan portfolio was 440, up from 394 as of September 30, 2016 before interest rates started to rise, but following the Fed Funds rate increase in March, loans still subject to flows are less than 1 million of our total portfolio or about 4%.
Additionally, fixed rate and high grade hybrid arm loans comprised of $5 billion of our total portfolio or about 19%. In Slide 9, we show the details of our fee income results this quarter. Most of the customer-related fee income categories increased quarter-over-quarter, though our total fee income decreased reflecting the impact of unrealized mark-to-market valuation changes on currency hedges and then also the derivative that we have on our books.
I would like to highlight that we have increases in branch fees, wealth management, letter of credit fees, customer driven FX income, and fees from existing customers to hedge interest rates. We see the positive growth momentum in the first quarter continuing throughout the rest of the year, as our team members win market share and expand our profit offering to our diverse customer base.
Turning to Slide 10, our total operating expense for the first quarter of 2017 was $153 million. Excluding amortization of tax credit and other investments and the amortization of the core deposit intangibles our adjusted operating expense of $137 million decreased by 1% linked-quarter, reflecting disciplined expense control. This is a good start to the year, especially in a typically seasonally higher quarter for compensation related expenses.
The decrease was supported in part by decline in consulting cost, and a decrease in other operating expenses. While we are pleased with the first quarter operating results, for the full year we continue to expect expense growth in the low single digits supporting ongoing business expansion and investments.
Our adjusted efficiency ratio was 43.3% in the first quarter, up by only 9 basis points from the fourth quarter. For the last five quarters, our efficiency ratio has raised between 45% and 43%, industry leading level relative to many of our peers. Our adjusted pre-tax, pre-provision profitability ratio was 2.09% in the first quarter, essentially stable compared to the fourth quarter. Over the past five quarters, our pre-tax pre-provision profitability has ranged from 2% to 2.10%.
Turning to Slide 11, our asset quality continues to be stable. Our allowance for loan losses totaled $263 million as of March 31, 2017 or 0.99% of loans held for investments, compared to $261 million or 1.2% of the loan held for investment as of December 31, 2016. The reduction in the allowance coverage ratio, compared to year-end, reflects a lower level specific reserves for impaired loans are ongoing low level of charge-offs, and a reduction in adversely classified loans.
Our annualized net charge-off ratio was 8 basis points for the first quarter. Nonperforming assets increased by $15 million to $145 million or 41 basis points of total assets as of March 31, 2017, compared to 37 basis points as of year-end, driven by two unrelated loans, a commercial real estate loan, and a commercial loan. Both of these loans are fully collateralized by real estate and other assets and the discounted valuations exceed the outstanding loan amount.
Moving on to capital ratios on Slide 12, East West Capital ratios are strong. Tangible equity per share of 21.20 as of March 31, 2017 grew 5% linked-quarter. The tangible equity to tangible average ratio grew by 27 basis points to 879. Common equity Tier 1 capital ratio of 11.1% was up by 20 basis points linked-quarter and the total risk-based capital ratio of 20.6% was also up by 20 basis points linked quarter.
Our strong earnings supplemented by the gains on the property sale strengthened our capital ratios. East West Board of Directors has declared second quarter 2017 dividend for the company’s common stock. The common stock cash dividend of $0.20 per share is payable on May 15, 2017 to stockholders of record on May 1, 2017. I will now review our updated outlook for 2017 on Slide 13, outlining our earnings drivers related to full year 2016 results.
We expect end of period loans to grow at a percentage rate in the low double-digit and an increase from high single digits in our last quarter’s outlook. We expect growth to be driven by C&I, which is a modest performance from CRE. We expect our adjusted net interest margin, excluding the impact of discount accretion to range between 3.35 and 3.45, an increase from 3.20 to 3.40 in our last quarter’s outlook.
Our outlook incorporates the current forward rate curve. As such, we currently assume two more fed funds rate increases in 2017 both in June and November. We expect our adjusted noninterest expense, excluding tax credit amortization and core deposit intangible amortization to increase at a percentage rate in the low single digits. This expectation remains unchanged from the previous outlook. We now expect provision for credit losses to range between $40 million and $50 million in 2017, unchanged from our previous outlook.
Based on the current pipeline current pipeline we anticipate recognizing $95 million of tax credit investments and having been associated tax credit amortization expense of $75 million in the full-year 2017, which implies and effective tax rate ranging from 26% to 29%. This compares to our previous guidance of $90 million in tax credit and $80 million of associated amortization expense.
With that, I will now turn the call over to Dominic.
Thank you, Irene. In summary, we had a strong first quarter and are optimistic in our outlook for the rest of 2017. Our robust organic loan and deposit growth continues to drive to strengthen our balance sheet and earnings growth. Our efforts to contain expenses have kept our efficiency ratio lower than 45% for 10 consecutive quarters. Even with significant investment expenses. Over 75% of loan portfolio is variable rate, which should perform favorably in the rising rate environment.
We continue to monitor credit closely and do not yet see emerging trends or certain issues. Our East West value proposition continues to be unparallel for our customers, and we are prepared to help our growing client base, navigate cross-border growth. We see strong opportunities ahead and are confident that we will continue our long track record of delivering attractive shareholder value.
I would now open the call to questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first questioner today is Linda Chan with BMO Capital Markets. Please go ahead with your question.
Just a couple of questions, one around the provision guidance, just curious, I was surprised that you didn’t raise the provision guidance in-light of the stronger loan growth outlook, can you just talk about that and you know the reserve to loans ratio being where it is right now?
Yes, I think what we kind of project for the remainder of the year Linda, certainly the reason that we have the provision that we do is really to fund the loan growth and a lot of the time people forget that even for past rated loans you have to set aside reserve. The offset of that of course is really kind of what you saw in the first quarter, because on an ongoing basis for the existing loans, loans are migrating to lower level kind of grades, you know the amount of reserve you need for the existing portfolio continues to fall. So, we ran kind of various scenarios and the range that we have for the provision is reflective of what we are seeing currently from credit quality perspective in our portfolio and factors in the growth.
Okay, thanks Irene and then my second question in terms of the expense guide, if I look at your growth rate on the adjusted basis in the first quarter is around 5% year-over-year that you are guiding to low single digits, does that assume that I guess the rate of growth slows in maybe the back half of the year as some of the potential to BSA AML costs are coming down?
Yes, I think if you look at the first quarter, a lot of the BSA related consulting costs did come down. Year-over-year when you look at the first quarter this year versus last year, I think the largest variable there, Linda is probably really compensation expense versus the other ones and so that will start averaging out because if you look at 20 – the full-year 2016 if you look at the latter half of that year, we did continue to hire to support our business. So, it is unusually high year-over-year quarter if you look at the quarter-over-quarter strength versus year-over-year.
Okay. So the expectation is that 5% should moderate a little bit as we go through the quarters?
Well I think around that 5% is probably not a bad way to look at it, but it may moderate down a little bit.
Okay. Thank you.
The next questioner today is Ebrahim Poonawala with Bank of America. Please go ahead.
Good morning guys. First question just on, if you can go back to loan growth in the first quarter, I think Greg you mentioned about line utilization increases contributed to half the loan growth on C&I in 1Q, I was wondering if you can talk about is that a new trend relative to what you observed over the last several quarters and when you are looking and talking to our clients, do you expect these utilization rates to continue to hold up or just what’s your expectation around that?
Thanks. I will say two things. One, in the second half of 2016, we actually had quite a bit of success booking new commitments, particularly in some of the new specialized industry areas. Again, I particularly call out for new ones, energy and the private equity fund business, and I think it’s a really a little bit more, just a timing issue that those commitments got funded to some degree in the first quarter of 2016. So, I guess the second point I would make is the new commitments that we booked in 2017 Q1, you know hedge utilization rates similar to where our overall portfolio migrated in the first quarter. So, I think that the increase to this level probably is sustainable, but I wouldn’t expect it to continue to grow at the same rate that it did in the first quarter.
Understood. And there if I may, I am not sure if you disclosed your China, Hong Kong portfolio at the end of the quarter and just what’s the trend you observed there in 1Q and outlook going out for the rest of the year?
What I would say in our loan book in China and Hong Kong has been relatively flat and I wouldn’t expect any dramatic change in that posture. Where we are sending spending a lot of time focusing is on trying to work with Chinese companies that have a presence in the US and so I think you see and we have had some success there in the first quarter in doing that business, but of course the loan exposures tend to show up on our US balance sheet as opposed to our China or Hong Kong balance sheet. So, I wouldn’t expect any real change in our exposure in greater China.
And is that a change in terms of how you’re approaching lending in the Mainland or Hong Kong, or it has borrower sort of demand there tempered of recently?
No I wouldn’t say it is really a change at all. I think that we continue to be open for business where we see the opportunity to serve customers, particularly US customers doing inbound business into China. For example, we have had success financing some of the growing entertainment product creation in China, but that market is awfully competitive and we stay quite disciplined in terms of the kinds of business that we pursue and pick our places where we can serve clients well, but also make a reasonable return. So, I don’t think there is any change from historic practice, and I wouldn’t see a significant growth in those two jurisdictions.
Understood. Just quickly on a separate topic, Irene I guess if you can – just wanted to touch upon the loan yields, we saw the adjusted loan yields go up 3 basis points, if you could sort of give some color on your expectations around what we should expect for 2Q as the March rate hike flows through the numbers, and given sort of any mix change within the loan portfolio.
Yes Abraham I would say, for a starter that I don’t know if we are expecting various substantial mix changes, I think what you are seeing with the growth, the drivers for that will continue so that mix shouldn’t change that much. When I look at Q2, we project out for multi-years when we do our analysis. Certainly I think with changes in the portfolio and the rising rate environment, we do expect the margin to increase largely driven by the low yields increasing and also the securities to a certain extent. And that’s reflected in the guidance that we have provided.
And our next question today is going to come from Dave Rochester with Deutsche Bank. Please go ahead with your question.
Hi, good morning guys, nice quarter.
Good morning Dave, thanks.
Just a quick question on the participated loans, what was that total amount you participated out and then was curious how the loan pipeline looked at in the 2Q versus what you had heading into the first quarter?
You’re talking about the multi-family loans that I referenced?
I think that post quarter-end it was approximately $30 million of the 190 that had been subsequently participated or has already been subsequently participated. Second question was?
Second question was just the state of the loan pipeline heading into 2Q versus 1Q?
I think that if you look at the pipeline, it’s reasonable. Again as we noted in the comments, half of the funded loan growth came from the increase in utilization in the first quarter and as I said earlier, I wouldn’t expect a similar jump in utilization over where we are today, nor would I expect to fall in utilization. So, I think it is reasonable to expect that funded loan growth won’t be quite as high in the second quarter based on what we’re seeing right now. However, there are a lot of active conversations and we have a good pipeline of business across the portfolio.
Our next questioner today is Jared Shaw with Wells Fargo. Please go ahead.
Hi good morning, thanks. Maybe just following up on the loan, what was the production yield for the loans put on this quarter, if you have that?
I think if you looked at, I think you have to distinguish between C&I and CRE and in C&I portfolio we were up a few basis points from our weighted average interest rates. I think somewhere in the 420 plus or minus range for the C&I portfolio. The CRE portfolio was relatively flat. We didn’t see much increase yet in yields on the CRE portfolio.
Okay and then when you look at the utilization rate increases was most of that, was there a big difference between the newly on boarded customers coming in and using their initial lines at the higher rate than the existing customers drawing their lines?
No, I mean as I said, we got an increase in utilization on existing lines. I would say the usage of the newly booked commitments was roughly the same as the increased utilization of our existing commitments. So, we didn’t see any substantive pickup in utilization from the newly booked commitments.
Our next questioner is Aaron Deer with Sandler O’Neill & Partners. Please go ahead with your question.
Hi, good morning everyone.
Good morning Aaron.
Greg, going back to the comments made in your opening remarks, if I hear you right, you said that you have a renewed emphasis on core customers, does that emphasis mean less emphasis or maybe some of the more recent specialty and lending areas that you pursued or how should we interpret that comment?
I certainly wouldn’t interpret as less emphasis on the specialty vertical. I think we talked in the last quarter call about some of the opportunities that we saw in the more traditional C&I business and we just started to see the flow through of some of our focus there.
Okay. And then the reduction in consulting cost seems indicative of the significant progress we have made in resolving the BSA AML order, are you hopeful that that might be lifted this year and if so how does that impact your view on potential acquisitions or other strategic decision making?
Well we always wanted to be hopeful, but this is one area that I don’t spend a lot of time thinking about it, simply because it is way beyond our control. What we do is we know exactly what we need to do to remediate the weaknesses that we had and we have been sort of like fixing all the challenges on BSA areas in the past and in percent and we continue to make really good progress and we are right on schedule in all the activities that we plan to accomplish so far, but ultimately whenever we finish we have to wait for the examiners to come and do the review and also our conversation and dialogue would be regulators has been that they are so far pleased with our progress.
On the other hand, they always would like to see some of the activities that we are conducting to be little bit more seasoned before they can actually do certain type of testing and also before they can draw a final conclusion. So, when will that be the right timing, we don’t know simply because this is the first time we ever had a consent order, and so we really don’t – this is not an area that we have a lot of experience. Ask us about M&A we can tell you exactly how fast we closed, but when it comes to written agreement this is something brand-new for us. So we are just basically doing our job, making sure that we get everything done on a timely manner and then wait for the regulators to hopefully do the final blessing at some point.
And the next questioner will be Michael Young with SunTrust. Please go ahead with your question.
Thanks. Dominic wanted to start with a big picture question, you talked on the last quarter call about the potential for China being named money manipulator and we’ve had that sort of taken off the table and then also may be a good meeting with President Trump and see any impact or change in conversations with customers that you’ve had since that point?
Well I think that obviously you just follow the news so far, I guess our expectation was right all along, and in fact it has progressed much better than the [indiscernible] and some impact in the fourth quarter of last year. So, as we looked at the next, well I guess the meeting took place about almost two weeks ago, and so there will be a 100 days of planning between both US and China. And I do know that I think from the Chinese government they already have put together a pretty solid plan about what they can offer to US, you know to help improve this bilateral trade and investment opportunity for both countries. And I think China is going to come up with a lot of these win-win idea, and I do feel that overall it will help the economy on both side.
At this stage I think from the East West Bank perspective, I think that even not counting on the next 100 days, we continue to see cross-border activities and East West continues to provide like a banking services and support to these cross-border customers coming from China and also US business who are looking at China as a viable investment opportunity. A reason that the East West Bank has a business, I think the following reasons, one is that the deals that we worked on are substantially smaller size. So when you look at the capital control from China, a huge focus is on this over billion dollar transaction, the high-profile big transaction. Those deals are way beyond our scope anyway.
So while many of these high-profile customers, we also offer banking service to them, but it is mainly on cash management or maybe sometimes FX opportunities, but when it comes to lending, you know when someone makes a $6 billion acquisition in Southern California that is not something that East West can participate because the side is way too much for us. But we still have contact in connection with many of these customers, but there are many, many smaller clients who are doing this $10 million, $20 million deals that fit right into our profile of customers that we can do business with. We continue to have good activities with these customers.
Secondly, one advantage for East West is that we know the business. We followed the regulation of what’s happening in China, as I indicated in last quarter call, and I said that I don’t see how US can call Chinese the currency manipulator, why do we say that because we know the rule. And so in that regard I think that when it comes to the capital control in China we know the rule, we know exactly why China made those call and restrict certain type of activity and I think that overall the new rules actually create less chaos and make sure that the investment coming from China is coming in a much more organized fashion and on top of that they make sure there is not going to be any kind of investment that paying way over price or maybe industry to have no business to invest in certain type of industry that these Chinese companies are not familiar with to get themselves into trouble.
So all of that actually is not healthy things. What we have seen is that, the Chinese government continues to allow oversee direct investment from Chinese company who are investing in proper industry that they are familiar with or paying a price that is reasonable. So that is something that we continue to watch and then we see that good sound investment from China to the United States continued to get the blessing from the Chinese government, but unwise, unsound, overpriced type of investment are not going to get the approval. So, if you look back a year or two ago there are some investments that are a little bit out of control and so I think the government just kind of reign in the situation it will be better.
And I think overall for the long run is positive and we will help to make the Chinese investment in the United States more sustainable. So hopefully within the next 100 days, if the US and Chinese senior leaders put the head together and get some really good ideas and we will see substantially more activities going both side. So, we are looking forward to see what will be happening and East West will always be able to hopefully find the right type of business that fit into our balance sheet and fit into our current core capability and we will take advantage of it, and we will make sure that we again capture these opportunities.
Thanks for all that color Dominic. Switching gears to the deposit side, obviously two strong quarters of good end of period deposit growth, I was just curious is the same trend sort of benefited the C&I utilization tick-up impacting deposits as well just from new customer ads or there are some other idiosyncrasies that maybe we are missing?
Well I think for the deposits what you are seeing is, sometimes we do have customers with the nature of their businesses of deposits fluctuate quite a bit, you know if you look in the fourth quarter for example for various reasons, we had customers who have large deposits that were pretty much in the entire year. This year, on average it was down compared to where it was at year-end, but we have customers where because of their businesses, taxes will have you at quarter-end of that balance is we are higher than where it was during the quarter. So, I would say those trends were not necessarily exactly the same for C&I.
And our next questioner is going to be Matthew Clark with Piper Jaffrey. Please go ahead with your question.
Hi good morning all. First question on the fee income, can you just quantify the marks on FX and derivatives and how we should think about those activities going forward, I know they are volatile, but…?
Yes, so for, maybe I will just break it down and talk about each one individually. For FX our earnings during the quarter and our results were impacted, we do from the currency hedge that we do have, we have a hedge against the R&D for our investment in the subsidiary base that we own in China. Also I’ll add during the quarter, a little bit of the impact is one the market variability what happens to currency rates, R&D versus US dollars, also during our first quarter, prior we had hedge accounting on this hedge and during the first quarter we had designated the hedge. So the difference of that is that instead of having most of it run through AOCI is ramped through P&L.
So this is something that’s going to fluctuate every quarter. For us it is the right thing to do because we have this P&L fluctuation related to our investment, but certainly you will see that variability every quarter. On the interest rate swaps, with the swaps that we help our customers enter into, we have back-to-back swaps and really there is variability every month when we book the CDA adjustment. This quarter, especially as the delta from last quarter, you saw higher impact with that. And that is something that is going to continue and I think probably on a go forward basis we talked about, maybe just breaking out a little bit more, so that is more clarity of ongoing investments in the business.
And I would say that the customer-related activity, the fee-related activity in these categories, so loan fees, FX, interest rate hedging et cetera will grow probably in the high single digits sort of around where our loan growth is may be slightly below because there is a certain element of our loan activity that doesn’t get, that isn’t as attractive from a hedging standpoint, but I would see pretty consistent growth in those customer-related categories.
Got it, makes sense. And then on BSA and kind of thinking about next year, have you guys been able to isolate may be the BSA related expenses that might go away in 2018 and then as a follow-on, when we think about the revenue growth that you guys might be able to do next year as well, how should we think about kind of the marginal growth in expenses, the marginal efficiency ratio?
So on the BSA related cost that might go away in 2018, Matthew I would say that a lot of those costs have gone away this year, we have kind of talked about as far as especially on a consulting phase when you look at 2016 versus projections for 2017, and the fact our actual results for the first quarter consulting related to BSA has come down quite a bit. When we look at 2018, certainly I think that probably that consulting line item related to BSA will come down a little bit further and also relative to 2016 and 2017 as well, you know on the comp line item particularly let’s say for temporary help that we are still, that we are still using for various reasons related to BSA and some of the work that we are doing, that may come down a little bit as well.
Please keep in mind, while the BSA overall cost will continue to decline, we continue to grow our payroll expenses because we continue – I mean as the asset grow as we continue to increase in various industry verticals and also more cross-border activities and so forth. East West Bank continues to bring in more talents. And we continue to also hire more people simply because there are more volume of business and so therefore you should continue to expect that our compensation expense continue to rise going forward.
And the next questioner today is going to be Ken Zerbe with Morgan Stanley. Please go ahead with your question.
Great, thanks. Just a quick question on the loan accretion, I think last quarter if I heard you right it was $20 million to $25 million for the entire year, now you’re on a track for sort of $3 million per quarter run rate, so obviously closer to half of that I guess. Make sure I got my numbers right, but just what led to that decline, like how does that swing around so much? Thanks.
So the total amount of accretion is the same and I think we talked about in the prepared remarks that is $47 million remaining and of that we are currently estimating $32 million will accrete over income over the life of the loan. The way this works is, is there are zero credit losses, it will be the entire $47 million. You know really kind of when we are projecting out kind of the cash flow activity, and given what happened in the first quarter, our estimate is now just really more so based on kind of the contractual cash flows and what’s happening for the remainder of this year. Right. And I think a lot of the prior quarter and then also really throughout 2016 we did have more recoveries. There may be more recoveries in 2017 and in two years as well, but certainly that number continues to diminish and I am not factoring that in as far as the guidance at this point in our estimate of when it is going to happen. Did that help clarify that?
Yes, that does help. And then just another quick question, in terms of all the tax credit investments, very broadly like, how short duration are these, because I guess my concern is just given the administration, given the political environment and given the potential changes in the tax code maybe at some point, are you guys locking in sort of the tax credit investment today that may have negative implications or effects on you if the tax flow tax credit does change down the road?
Yes I had a great question, so depending on the tax credit investments high-tech historical renewable energy, the code is different, and impact for tax years are different. We are being very cautious as far as making any investments or commitments to invest in any tax credits for years four because we also are cautious about what may happen. So that is something that we are certainly taking a look at very carefully at this point. And I also add, the last few years this has been a great investment for us, the IRRs have been tremendous, risk relative to return we thought it made a lot of sense. I think like all the investments that we make we look at what are the alternatives and what makes sense. You know rising rate environment, I think the revenues that we can generate from our securities book is much higher, so way you look at all investments in the same light, as far as risk return what makes sense and what will help our balance here on a go forward basis because I look at the tax credit the same way.
And the next questioner is going to be Chris McGratty with KBW. Please go ahead with your questions.
Hi, great, good morning. Thanks for taking the question.
Hi good morning. Maybe a question on the balance sheet, you obviously were really successful of remixing the earning assets this quarter, I am interested, I guess if you could comment on whether you think the cash is in the securities dollars or kind of stabilizing or going to grow from here. And also as it relates to your margin guidance, your deposit beta assumptions obviously is really low this quarter, I am wondering how much that could continue?
Yes, so for us, I think the cash and the investments, those balances are really a function of where we, where the deposit growth is quite honestly, especially right now where our long-term return is necessarily that high as well. So, making a big push in growing the securities, but doesn’t necessarily make a lot of sense. So, when I look at that, I don’t expect that you will see outsize growth in either of those categories. Quarter-end different times, certainly there is fluctuations based on what happened, and when you look at quarter-over-quarter you know those balances can fluctuate and they do, but overall that is our strategy.
On the deposit beta, generally speaking, we have been holding the line on raising deposit pricing. This is I think very similar to many other baits in the marketplace as well. So realistically as the Fed Fund rates continue to increase, I don’t think it’s realistic to think that we’re going to be able to hold that forever, but thus far we have and still have things that we compete with.
Great. And this is a follow-up to I think Ken’s question on the tax credits, to the extent you don’t have the amortization expense next year, I think it’s $75 million this year, assuming that goes to zero, can you just help us with where that effective tax rate offset would be, again assuming a zero amortization expense?
Yes, so our, I mean, I think one way to look at that is really kind of where our statutory tax rate is. And then you can kind of go backwards, obviously there are other items that impacted a aside from our other tax with investments that we have, but certainly that’s a big component of it.
The next questioner today is going to be Gary Tenner with D.A. Davidson. Please go ahead with your questions.
Actually Chris just took my question. Thanks very much.
Looks like we have no further questions as of now. [Operator Instructions] There look to be no further questioners, so this will conclude the question-and-answer session. I would like to turn the conference back over to Dominic Ng for any closing remarks.
Well, thank you all for joining our call today. And we are looking forward to speaking to you in July.
The conference has now concluded. Thank you all for attending today’s presentation. You may now disconnect.
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