UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2013 | |||
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||
Commission file number: 0-25141
MetroCorp Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Texas (State or other jurisdiction of incorporation or organization) | 76-0579161 (I.R.S. Employer Identification No.) |
9600 Bellaire Boulevard, Suite 252
Houston, Texas 77036
(Address of principal executive offices including zip code)
(713) 776-3876
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer £ | Accelerated Filer R | ||
Non-accelerated Filer £ (Do not check if a smaller reporting company) | Smaller Reporting Company £ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes £ No R
As of May 2, 2013, the number of outstanding shares of Common Stock was 18,725,901.
1
PART I
| Item 1. | Financial Statements. |
METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
(Unaudited)
March 31, 2013 | December 31, 2012 | |||||||
| ASSETS | ||||||||
| Cash and due from banks | $ | 25,013 | $ | 31,203 | ||||
| Federal funds sold and other short-term investments | 163,282 | 128,246 | ||||||
| Total cash and cash equivalents | 188,295 | 159,449 | ||||||
| Interest-bearing time deposits in banks | 15,354 | 15,321 | ||||||
| Securities available-for-sale, at fair value | 142,713 | 119,422 | ||||||
| Securities available-for-sale pledged with creditors’ right to repledge, at fair value | 37,959 | 44,626 | ||||||
| Total securities available-for-sale | 180,672 | 164,048 | ||||||
| Securities held-to-maturity (fair value $4,670 and $4,757 at March 31, 2013 and December 31, 2012, respectively) | 4,046 | 4,046 | ||||||
| Other investments | 5,413 | 5,592 | ||||||
| Loans, net of allowance for loan losses of $22,832 and $24,592, respectively | 1,101,884 | 1,075,745 | ||||||
| Accrued interest receivable | 3,680 | 4,120 | ||||||
| Premises and equipment, net | 3,948 | 4,046 | ||||||
| Goodwill | 14,327 | 14,327 | ||||||
| Deferred tax asset, net | 12,676 | 13,110 | ||||||
| Customers' liability on acceptances | 4,914 | 7,045 | ||||||
| Foreclosed assets, net | 12,152 | 12,555 | ||||||
| Cash value of bank owned life insurance | 33,120 | 32,794 | ||||||
| Prepaid FDIC assessment | 3,001 | 3,439 | ||||||
| Other assets | 3,754 | 4,175 | ||||||
| Total assets | $ | 1,587,236 | $ | 1,519,812 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Deposits: | ||||||||
| Noninterest-bearing | $ | 318,912 | $ | 309,696 | ||||
| Interest-bearing | 1,009,140 | 957,334 | ||||||
| Total deposits | 1,328,052 | 1,267,030 | ||||||
| Junior subordinated debentures | 36,083 | 36,083 | ||||||
| Other borrowings | 30,000 | 25,000 | ||||||
| Accrued interest payable | 274 | 233 | ||||||
| Acceptances outstanding | 4,914 | 7,045 | ||||||
| Other liabilities | 8,390 | 7,390 | ||||||
| Total liabilities | 1,407,713 | 1,342,781 | ||||||
| Commitments and contingencies | – | — | ||||||
| Shareholders' equity: | ||||||||
| Common stock, $1.00 par value, 50,000,000 shares authorized; 18,766,765 shares issued and 18,725,901 and 18,746,385 outstanding at March 31, 2013 and December 31, 2012, respectively | 18,767 | 18,767 | ||||||
| Additional paid-in-capital | 75,019 | 74,998 | ||||||
| Retained earnings | 85,908 | 82,881 | ||||||
| Accumulated other comprehensive loss | 221 | 567 | ||||||
| Treasury stock, at cost, 40,864 and 20,380 shares at March 31, 2013 and December 31, 2012, respectively | (392 | ) | (182 | ) | ||||
| Total shareholders' equity | 179,523 | 177,031 | ||||||
| Total liabilities and shareholders' equity | $ | 1,587,236 | $ | 1,519,812 | ||||
See accompanying notes to unaudited condensed consolidated financial statements.
2
METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
For the Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| Interest income: | ||||||||
| Loans | $ | 13,829 | $ | 14,999 | ||||
| Securities: | ||||||||
| Taxable | 791 | 1,027 | ||||||
| Tax-exempt | 147 | 117 | ||||||
| Other investments | 50 | 43 | ||||||
| Federal funds sold and other short-term investments (1) | 200 | 212 | ||||||
| Total interest income | 15,017 | 16,398 | ||||||
| Interest expense: | ||||||||
| Time deposits | 1,219 | 1,536 | ||||||
| Demand and savings deposits | 427 | 635 | ||||||
| Junior subordinated debentures | 316 | 336 | ||||||
| Other borrowings | 233 | 247 | ||||||
| Total interest expense | 2,195 | 2,754 | ||||||
| Net interest income | 12,822 | 13,644 | ||||||
| (Reduction in) provision for loan losses | (450 | ) | 400 | |||||
| Net interest income after provision for loan losses | 13,272 | 13,244 | ||||||
| Noninterest income: | ||||||||
| Service fees | 909 | 1,117 | ||||||
| Loan-related fees | 130 | 70 | ||||||
| Letters of credit commissions and fees | 199 | 197 | ||||||
| Gain on securities transactions, net | 14 | 12 | ||||||
| Total other-than-temporary-impairment (“OTTI”) on securities | (40 | ) | (39 | ) | ||||
| Less: Noncredit portion of OTTI | (13 | ) | – | |||||
| Net impairments on securities | (27 | ) | (39 | ) | ||||
| Other noninterest income | 425 | 446 | ||||||
| Total noninterest income | 1,650 | 1,803 | ||||||
| Noninterest expenses: | ||||||||
| Salaries and employee benefits | 6,292 | 5,921 | ||||||
| Occupancy and equipment | 1,650 | 1,689 | ||||||
| Foreclosed assets, net | (841 | ) | 1,001 | |||||
| FDIC assessment | 460 | 397 | ||||||
| Other noninterest expense | 2,741 | 1,925 | ||||||
| Total noninterest expenses | 10,302 | 10,933 | ||||||
| Income before provision for income taxes | 4,620 | 4,114 | ||||||
| Provision for income taxes | 1,593 | 1,346 | ||||||
| Net income | $ | 3,027 | $ | 2,768 | ||||
| Dividends and discount – preferred stock | – | (598 | ) | |||||
| Net income available to common shareholders | $ | 3,027 | $ | 2,170 | ||||
| Earnings per common share: | ||||||||
| Basic | $ | 0.17 | $ | 0.16 | ||||
| Diluted | $ | 0.16 | $ | 0.16 | ||||
| Weighted average common shares outstanding: | ||||||||
| Basic | 18,332 | 13,169 | ||||||
| Diluted | 18,723 | 13,309 | ||||||
| Dividends per common share | $ | – | $ | – | ||||
| (1) | Includes interest-bearing time deposits in banks |
See accompanying notes to unaudited condensed consolidated financial statements.
3
METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
For the Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| Net income | $ | 3,027 | $ | 2,768 | ||||
| Other comprehensive income, net of tax: | ||||||||
| Change in accumulated gain on effective cash flow hedging derivatives | 96 | 43 | ||||||
| Change in unrealized losses on investment securities, net of tax: | ||||||||
| Securities with OTTI charges during the period | (25 | ) | (25 | ) | ||||
| Less: OTTI charges recognized in net income | (17 | ) | (25 | ) | ||||
| Net unrealized losses on investment securities with OTTI | (8 | ) | – | |||||
| Unrealized holding (losses) gains arising during the period | (425 | ) | 21 | |||||
| Less: reclassification adjustment for losses included in net income | 9 | 8 | ||||||
| Net unrealized (losses) gains on investment securities | (434 | ) | 13 | |||||
| Other comprehensive (loss) income | (346 | ) | 56 | |||||
| Total comprehensive income | $ | 2,681 | $ | 2,824 | ||||
METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Three Months Ended March 31, 2013
(In thousands)
(Unaudited)
| Common Stock | Additional paid-in | Retained | Accumulated other comprehensive income | Treasury Stock at | ||||||||||||||||||||||||
| Shares | At par | capital | earnings | (loss) | cost | Total | ||||||||||||||||||||||
| Balance at December 31, 2012 | 18,767 | $ | 18,767 | $ | 74,998 | $ | 82,881 | $ | 567 | (182 | ) | $ | 177,031 | |||||||||||||||
| Repurchase of common stock | – | – | – | – | – | (210 | ) | (210 | ) | |||||||||||||||||||
| Stock-based compensation expense related to stock options recognized in earnings | ��� | – | 21 | – | – | – | 21 | |||||||||||||||||||||
| Net income | – | – | – | 3,027 | – | – | 3,027 | |||||||||||||||||||||
| Other comprehensive loss | – | – | – | – | (346 | ) | – | (346 | ) | |||||||||||||||||||
| Balance at March 31, 2013 | 18,767 | $ | 18,767 | $ | 75,019 | $ | 85,908 | $ | 221 | (392 | ) | $ | 179,523 | |||||||||||||||
See accompanying notes to unaudited condensed consolidated financial statements.
4
METROCORP BANCSHARES, INC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For the Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income | $ | 3,027 | $ | 2,768 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation | 234 | 284 | ||||||
| (Reduction in) provision for loan losses | (450 | ) | 400 | |||||
| Impairment on securities | 27 | 39 | ||||||
| Gain on securities transactions, net | (14 | ) | (12 | ) | ||||
| (Gain) loss on sale or writedown of foreclosed assets, net | (910 | ) | 782 | |||||
| Amortization of premiums and discounts on securities | 191 | 128 | ||||||
| Amortization of deferred loan fees and discounts | (312 | ) | (244 | ) | ||||
| Amortization of core deposit intangibles | 10 | 14 | ||||||
| Stock-based compensation | 21 | 20 | ||||||
| Change in: | ||||||||
| Accrued interest receivable | 440 | (40 | ) | |||||
| Other assets | 995 | 538 | ||||||
| Accrued interest payable | 41 | (25 | ) | |||||
| Other liabilities | 1,096 | (529 | ) | |||||
| Net cash provided by operating activities | 4,396 | 4,123 | ||||||
| Cash flows from investing activities: | ||||||||
| Net change in interest-bearing deposits in banks | (33 | ) | – | |||||
| Purchases of securities available-for-sale | (28,484 | ) | (31,565 | ) | ||||
| Purchases of other investments | – | (1 | ) | |||||
| Proceeds from maturities, calls and principal paydowns of securities available-for-sale | 10,966 | 12,603 | ||||||
| Proceeds from sales and maturities of other investments | 179 | 110 | ||||||
| Net change in loans | (32,056 | ) | (2,546 | ) | ||||
| Proceeds from sales of foreclosed assets | 7,992 | 2,800 | ||||||
| Purchases of premises and equipment | (136 | ) | (83 | ) | ||||
| Net cash used in investing activities | (41,572 | ) | (18,682 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Net change in: | ||||||||
| Deposits | 61,022 | 5,252 | ||||||
| Other borrowings | 5,000 | (315 | ) | |||||
| Repurchase of common stock | – | (112 | ) | |||||
| Cash dividends paid on preferred stock | – | (563 | ) | |||||
| Net cash provided by financing activities | 66,022 | 4,262 | ||||||
| Net increase (decrease) in cash and cash equivalents | 28,846 | (10,297 | ) | |||||
| Cash and cash equivalents at beginning of period | 159,449 | 193,609 | ||||||
| Cash and cash equivalents at end of period | $ | 188,295 | $ | 183,312 | ||||
| Supplemental information: | ||||||||
| Interest paid | $ | 2,154 | $ | 2,778 | ||||
| Income taxes paid | 250 | 1,160 | ||||||
| Noncash investing and financing activities: | ||||||||
| Issuance of common stock pursuant to incentive plan | – | 44 | ||||||
| Foreclosed assets acquired | 6,679 | 202 | ||||||
| Loans originated to finance foreclosed assets | 6,120 | – | ||||||
See accompanying notes to unaudited condensed consolidated financial statements.
5
METROCORP BANCSHARES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements include the accounts of MetroCorp Bancshares, Inc. (the “Company”) and wholly-owned subsidiaries, MetroBank, National Association (“MetroBank”) and Metro United Bank (“Metro United”), in Texas and California, respectively (collectively, the “Banks”). MetroBank is engaged in commercial banking activities through its thirteen branches in the greater Houston and Dallas, Texas metropolitan areas, and Metro United is engaged in commercial banking activities through its six branches in the San Diego, Los Angeles and San Francisco, California metropolitan areas. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain principles which significantly affect the determination of financial position, results of operations and cash flows are summarized below.
A legal entity is referred to as a Variable Interest Entity (“VIE”) if any of the following conditions exist: (1) the total equity at risk is insufficient to permit the legal entity to finance its activities without additional subordinated financial support from other parties, or (2) the entity has equity investors that cannot make significant decisions about the entity’s operations or that do not absorb their proportionate share of the expected losses or receive the expected returns of the entity. In addition, as specified in VIE accounting guidance, a VIE must be consolidated by the Company if it is deemed to be the primary beneficiary of the VIE. The primary beneficiary is the party that has both (1) the power to direct the activities of an entity that most significantly impact the VIE’s economic performance, and (2) through its interests in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. All facts and circumstances are taken into consideration when determining whether the Company has variable interest that would deem it the primary beneficiary and, therefore, require consolidation of the related VIE or otherwise rise to the level where disclosure would provide useful information to the users of the Company’s financial statements. In the case of the Company’s sole VIE, MCBI Statutory Trust I, it is qualitatively clear based on the extent of the Company’s involvement that the Company is not the primary beneficiary of the VIE. Accordingly, the accounts of this entity are not consolidated in the Company’s financial statements.
The accompanying unaudited condensed consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair statement of the Company’s financial position at March 31, 2013 and December 31, 2012, results of operations for the three months ended March 31, 2013 and 2012, and cash flows for the three months ended March 31, 2013 and 2012. Interim period results are not necessarily indicative of results for a full-year period. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles.
Certain items in prior financial statements have been reclassified to conform to the 2013 presentation, with no impact on the balance sheet, net income, shareholders’ equity or cash flows.
These unaudited financial statements and the notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
6
2. SECURITIES
The amortized cost and approximate fair value of securities is as follows:
| As of March 31, 2013 | ||||||||||||||||||||
| Amortized | Unrealized | Fair | ||||||||||||||||||
| Cost | Gains | Losses | OTTI | Value | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Securities available-for-sale | ||||||||||||||||||||
| Debt securities | ||||||||||||||||||||
| U.S. Treasury and other U.S. government sponsored enterprises and agencies | $ | 81,385 | $ | 240 | $ | (206 | ) | $ | - | $ | 81,419 | |||||||||
| Obligations of state and political subdivisions | 14,618 | 426 | (49 | ) | - | 14,995 | ||||||||||||||
| Corporate | 6,074 | 265 | - | - | 6,339 | |||||||||||||||
| Mortgage-backed securities and collateralized mortgage obligations | ||||||||||||||||||||
| Government issued or guaranteed | 61,558 | 1,225 | (51 | ) | - | 62,732 | ||||||||||||||
| Privately issued residential | 684 | 353 | (342 | ) | 695 | |||||||||||||||
| Asset backed securities | 176 | 148 | - | (167 | ) | 157 | ||||||||||||||
| Equity Securities | ||||||||||||||||||||
| CRA funds | 14,204 | 131 | - | - | 14,335 | |||||||||||||||
| Total available-for-sale securities | $ | 178,699 | $ | 2,788 | $ | (306 | ) | $ | (509 | ) | $ | 180,672 | ||||||||
| Securities held-to-maturity | ||||||||||||||||||||
| Obligations of state and political subdivisions | $ | 4,046 | $ | 624 | $ | - | $ | - | $ | 4,670 | ||||||||||
| Total held-to-maturity securities | $ | 4,046 | $ | 624 | $ | - | $ | - | $ | 4,670 | ||||||||||
| Other investments | ||||||||||||||||||||
| FHLB (1)/Federal Reserve Bank stock (2) | $ | 4,330 | $ | - | $ | - | $ | - | $ | 4,330 | ||||||||||
| Investment in subsidiary trust (3) | 1,083 | - | - | - | 1,083 | |||||||||||||||
| Total other investments | $ | 5,413 | $ | - | $ | - | $ | - | $ | 5,413 | ||||||||||
7
| As of December 31, 2012 | ||||||||||||||||||||
| Amortized | Unrealized | Fair | ||||||||||||||||||
| Cost | Gains | Losses | OTTI | Value | ||||||||||||||||
| Securities available-for-sale | ||||||||||||||||||||
| Debt securities | ||||||||||||||||||||
| U.S. Treasury and other U.S. government sponsored enterprises and agencies | $ | 70,892 | $ | 362 | $ | (73 | ) | $ | — | $ | 71,181 | |||||||||
| Obligations of state and political subdivisions | 12,810 | 579 | — | — | 13,389 | |||||||||||||||
| Corporate | 6,080 | 270 | — | — | 6,350 | |||||||||||||||
| Mortgage-backed securities and collateralized mortgage obligations: | ||||||||||||||||||||
| Government issued or guaranteed | 56,572 | 1,369 | — | — | 57,941 | |||||||||||||||
| Privately issued residential | 718 | 330 | — | (365 | ) | 683 | ||||||||||||||
| Asset backed securities | 187 | 129 | — | (173 | ) | 143 | ||||||||||||||
| Equity securities | ||||||||||||||||||||
| Investment in CRA funds | 14,128 | 233 | — | — | 14,361 | |||||||||||||||
| Total available-for-sale securities | $ | 161,387 | $ | 3,272 | $ | (73 | ) | $ | (538 | ) | $ | 164,048 | ||||||||
| Securities held-to-maturity | ||||||||||||||||||||
| Obligations of state and political subdivisions | $ | 4,046 | $ | 711 | $ | — | $ | — | $ | 4,757 | ||||||||||
| Total held-to-maturity securities | $ | 4,046 | $ | 711 | $ | — | $ | — | $ | 4,757 | ||||||||||
| Other investments | ||||||||||||||||||||
| FHLB (1)/Federal Reserve Bank (2) stock | 4,509 | — | — | — | 4,509 | |||||||||||||||
| Investment in subsidiary trust (3) | 1,083 | — | — | — | 1,083 | |||||||||||||||
| Total other investments | $ | 5,592 | $ | — | $ | — | $ | — | $ | 5,592 | ||||||||||
| (1) | FHLB stock held by the Banks is subject to certain restrictions under a credit policy of the FHLB dated May 1, 1997. Redemption of FHLB stock is dependent upon repayment of borrowings, if any, from the FHLB. |
| (2) | Federal Reserve Bank stock held by MetroBank is subject to certain restrictions under Federal Reserve Bank Policy. |
| (3) | The Company’s ownership of common securities of MCBI Trust I is carried at cost. |
The following tables display the fair value and gross unrealized losses on securities available-for-sale as of March 31, 2013 and December 31, 2012 for which OTTI has not been recognized, that were in a continuous unrealized loss position for the periods indicated. There were no securities held-to-maturity in a continuous unrealized loss position as of March 31, 2013 or December 31, 2012.
| March 31, 2013 | ||||||||||||||||||||||||
| Less Than 12 Months | Greater Than 12 Months | Total | ||||||||||||||||||||||
| Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | |||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||
| Securities available-for-sale | ||||||||||||||||||||||||
| U.S. Treasury and other U.S. government sponsored enterprises and agencies | $ | 31,078 | $ | (206 | ) | $ | — | $ | — | $ | 31,078 | $ | (206 | ) | ||||||||||
| Obligations of state and political subdivisions | 2,573 | (49 | ) | — | — | 2,573 | (49 | ) | ||||||||||||||||
| Mortgage-backed securities and collateralized mortgage obligations | ||||||||||||||||||||||||
| Government issued or guaranteed | 14,697 | (51 | ) | — | — | 14,697 | (51 | ) | ||||||||||||||||
| Privately issued residential | — | — | 71 | — | 71 | — | ||||||||||||||||||
| Total securities | $ | 48,348 | $ | (306 | ) | $ | 71 | $ | — | $ | 48,419 | $ | (306 | ) | ||||||||||
8
| As of December 31, 2012 | ||||||||||||||||||||||||
Less Than 12 Months | Greater Than 12 Months | Total | ||||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||
| Securities available-for-sale | ||||||||||||||||||||||||
| U.S. Treasury and other U.S. government sponsored enterprises and agencies | $ | 9,921 | $ | (73 | ) | $ | — | $ | — | $ | 9,921 | $ | (73 | ) | ||||||||||
| Mortgage-backed securities and collateralized mortgage obligations: | ||||||||||||||||||||||||
| Privately issued residential | — | — | 72 | — | 72 | — | ||||||||||||||||||
| Total securities | $ | 9,921 | $ | (73 | ) | $ | 72 | $ | — | $ | 9,993 | $ | (73 | ) | ||||||||||
As of March 31, 2013, management did not have the intent to sell any of the securities classified as available-for-sale in unrealized loss positions and believes it is not more likely than not that the Company will have to sell any such securities before a recovery of the cost. However, if strategic opportunities arise, the Company may consider selling selected securities. Any unrealized losses on such selected securities would be charged to earnings.
The unrealized losses are largely due to increases in the market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such securities decline. Management does not believe any of the unrealized losses above are due to credit quality. Accordingly, management believes the $306,000 of unrealized losses is temporary and the remaining $509,000 of OTTI as of March 31, 2013 represents an unrealized loss for which an impairment has been recognized in other comprehensive loss.
Other-Than-Temporary Impairments (OTTI)
The following table represents the impairment activity related to debt securities (in thousands):
| Impairment related to credit losses | Three months ended March 31, 2013 | Three months ended March 31, 2012 | ||||||
| Beginning balance at beginning of period | $ | 1,716 | $ | 1,594 | ||||
| Addition of OTTI that was not previously recognized | — | — | ||||||
| Additions to OTTI that was previously recognized when there is no intent to sell and no requirement to sell before recovery of amortized cost basis | — | 21 | ||||||
| Transfers from accumulated other comprehensive income (“AOCI”) to OTTI related to credit losses | 16 | 18 | ||||||
| Reclassifications from OTTI to realized losses | — | — | ||||||
| Ending balance at end of period | $ | 1,732 | $ | 1,633 | ||||
For the three months ended March 31, 2013, the Company recognized credit-related losses of $10,000 on one non-agency residential mortgage-backed security and $6,000 on one asset-backed security. There were no noncredit impairments included in accumulated other comprehensive income for the three months ended March 31, 2013.
To measure credit losses, external credit ratings and other relevant collateral details and performance statistics on a security-by-security basis were considered. Securities exhibiting significant deterioration are subjected to further analysis. Assumptions were developed for prepayment speed, default rate and loss severity for each security using third party sources and based on the collateral history. The resulting projections of future cash flows of the underlying collateral were then discounted by the underlying yield before any write-downs were considered to determine the net present value of the cash flows (“NPV”). The difference between the cost basis and the NPV was taken as a credit loss in the current period to the extent that these losses have not been previously recognized. The difference between the NPV and the quoted market price is considered a noncredit related loss and was included in other comprehensive income.
9
Other Securities Information
There were no sales (excluding calls and maturities) of available-for-sale securities for the three months ended March 31, 2013 or 2012. There were no sales or transfers of held-to-maturity securities for the three months ended March 31, 2013 or 2012.
At March 31, 2013, future contractual maturities of debt securities were as follows (in thousands):
Securities Available-for-sale | Securities Held-to-maturity | |||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||||
| Within one year | $ | 702 | $ | 711 | $ | — | $ | — | ||||||||
| Within two to five years | 12,569 | 12,845 | — | — | ||||||||||||
| Within six to ten years | 75,675 | 75,800 | — | — | ||||||||||||
| After ten years | 13,307 | 13,554 | 4,046 | 4,670 | ||||||||||||
| Mortgage-backed securities and collateralized mortgage obligations | 62,242 | 63,427 | — | — | ||||||||||||
| Total debt securities | $ | 164,495 | $ | 166,337 | $ | 4,046 | $ | 4,670 | ||||||||
The Company holds mortgage-backed securities which may mature at an earlier date than the contractual maturity due to prepayments. The Company also holds certain securities which may be called by the issuer at an earlier date than the contractual maturity date.
10
3. LOANS
The loan portfolio is classified by major type as follows:
| As of March 31, 2013 | As of December 31, 2012 | |||||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||||
| (Dollars in thousands) | ||||||||||||||||
| Commercial and industrial | $ | 395,640 | 35.10 | % | $ | 383,641 | 34.78 | % | ||||||||
| Real estate mortgage | ||||||||||||||||
| Residential | 37,526 | 3.33 | 36,807 | 3.34 | ||||||||||||
| Commercial | 677,061 | 60.07 | 665,244 | 60.32 | ||||||||||||
| 714,587 | 63.40 | 702,051 | 63.66 | |||||||||||||
| Real estate construction | ||||||||||||||||
| Residential | 2,753 | 0.24 | 2,420 | 0.22 | ||||||||||||
| Commercial | 7,379 | 0.66 | 7,284 | 0.66 | ||||||||||||
| 10,132 | 0.90 | 9,704 | 0.88 | |||||||||||||
| Consumer and other | 6,808 | 0.60 | 7,531 | 0.68 | ||||||||||||
| Gross loans | 1,127,167 | 100.00 | % | 1,102,927 | 100.00 | % | ||||||||||
| Unearned discounts, interest and deferred fees | (2,451 | ) | (2,590 | ) | ||||||||||||
| Total loans | 1,124,716 | 1,100,337 | ||||||||||||||
| Allowance for loan losses | (22,832 | ) | (24,592 | ) | ||||||||||||
| Loans, net | $ | 1,101,884 | $ | 1,075,745 | ||||||||||||
The recorded investment in loans is the face amount increased or decreased by applicable accrued interest and unamortized premium, discount or finance charges, and may also reflect a previous direct write-down of the loan.
The recorded investment in loans at the dates indicated is determined as follows (in thousands):
| March 31, 2013 | Gross Loan Balance | Deferred Loan Fees | Accrued Interest Receivable | Recorded Investment in Loans | ||||||||||||
| Commercial and industrial | $ | 395,640 | $ | (687 | ) | $ | 958 | $ | 395,911 | |||||||
| Real estate mortgage | 714,587 | (1,574 | ) | 2,020 | 715,033 | |||||||||||
| Real estate construction | 10,132 | (37 | ) | 17 | 10,112 | |||||||||||
| Consumer and other | 6,808 | (153 | ) | 18 | 6,673 | |||||||||||
| Total | $ | 1,127,167 | $ | (2,451 | ) | $ | 3,013 | $ | 1,127,729 | |||||||
| December 31, 2012 | Gross Loan Balance | Deferred Loan Fees | Accrued Interest Receivable | Recorded Investment in Loans | ||||||||||||
| Commercial and industrial | $ | 383,641 | $ | (814 | ) | $ | 1,078 | $ | 383,905 | |||||||
| Real estate mortgage | 702,051 | (1,595 | ) | 2,024 | 702,480 | |||||||||||
| Real estate construction | 9,704 | (30 | ) | 18 | 9,692 | |||||||||||
| Consumer and other | 7,531 | (151 | ) | 21 | 7,401 | |||||||||||
| Total | $ | 1,102,927 | $ | (2,590 | ) | $ | 3,141 | $ | 1,103,478 | |||||||
11
Loan Origination/Risk Management
The Company selectively extends credit for the purpose of establishing long-term relationships with its customers. The Company mitigates the risks inherent in lending by focusing on businesses and individuals with demonstrated payment history, historically favorable profitability trends and stable cash flows. In addition to these primary sources of repayment, the Company looks to tangible collateral and personal guarantees as secondary sources of repayment. Lending officers are provided with detailed underwriting policies covering all lending activities in which the Company is engaged and that require all lenders to obtain appropriate approvals for the extension of credit. The Company also maintains documentation requirements and extensive credit quality assurance practices in order to identify credit portfolio weaknesses as early as possible so any exposures that are discovered may be reduced.
The Company has certain lending procedures in place that are designed to maximize loan income within an acceptable level of risk. These procedures include the approval of lending policies and underwriting guidelines by the Board of Directors of each Bank, and separate policy, administrative and approval oversight by the Directors’ Loan Committee of MetroBank, and by the Directors’ Credit Committee of Metro United. Additionally, MetroBank’s loan portfolio is reviewed by its internal loan review department, and Metro United's loan portfolio is reviewed by an external third-party company. These procedures also serve to timely identify changes in asset quality and to ensure proper recording and reporting of nonperforming assets.
Inherent in all lending is the risk of nonpayment. The types of collateral required, the terms of the loans and the underwriting practices discussed under each loan category below are all designed to minimize the risk of nonpayment. In addition, as further risk protection, the Banks rarely make loans at their respective legal lending limit. MetroBank generally does not make loans larger than $13 million to one borrower and Metro United generally does not make loans larger than $8 million to one borrower. Loans greater than the Banks’ lending limits are subject to participation with other financial institutions, including with each other. Loans originated by MetroBank are approved by the Chief Lending Officer, Chief Credit Officer, MetroBank’s Loan Committee or the Director’s Loan Committee based on the size of the loan relationship and its risk rating. Loans originated by Metro United are approved by the Management Credit Committee or Director’s Credit Committee except for certain consumer loans, which are approved under individual authority. Control systems and procedures are in place to ensure all loans are approved in accordance with credit policies.
Commercial and Industrial Loans. Generally, the Company’s commercial loans are underwritten on the basis of the borrower’s ability to service such debt as reflected by cash flow projections. Commercial loans are generally collateralized by business assets, which may include real estate, accounts receivable and inventory, certificates of deposit, securities, guarantees or other collateral. The Company also generally obtains personal guarantees from the principals of the business. Working capital loans are primarily collateralized by short-term assets, whereas term loans are primarily collateralized by long-term assets. As a result, commercial loans involve additional complexities, variables and risks and require more thorough underwriting and servicing than other types of loans. Indigenous to individuals in the Asian business community is the desire to own the building and land which house their businesses. Accordingly, while a loan may be principally driven and classified by the type of business operated, real estate is frequently the primary source of collateral.
Real Estate Mortgage - Commercial and Residential Mortgage Loans. The Company makes commercial mortgage loans to finance the purchase of real property, which generally consists of developed real estate. The Company’s commercial mortgage loans are collateralized by first liens on real estate. For MetroBank, these loans typically have variable rates and amortize over a 15 to 20 year period, with balloon payments due at the end of five to seven years. For Metro United, these loans have both variable and fixed rates and amortize over a 25 to 30 year period, with balloon payments due at the end of five to ten years. Payments on loans collateralized by such properties are dependent on the successful operation or management of the properties. Accordingly, repayment of these loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than other types of loans. In underwriting commercial mortgage loans, consideration is given to the property’s historical cash flow, current and projected occupancy, location and physical condition. The underwriting analysis also includes credit checks, appraisals, environmental impact reports and a review of the financial condition of the borrower. The Company also originates two to seven year balloon residential mortgage loans with a 15 to 30-year amortization primarily collateralized by owner occupied residential properties, which are retained in the Company’s residential mortgage portfolio.
Real Estate Construction Loans. The Company makes loans to finance the construction of residential and non-residential properties. The majority of the Company’s residential construction loans in Texas are for single-family dwellings that are pre-sold or are under earnest money contracts. The Company also originates loans to finance the construction of commercial properties such as multi-family, office, industrial, warehouse and retail centers. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan to value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Company is forced to foreclose on a project prior to completion, there is no assurance that the Company will be able to recover the entire unpaid portion of the loan. In addition, the Company may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminable period of time. While the Company has underwriting procedures designed to identify what it believes to be acceptable levels of risks in construction lending, no assurance can be given that these procedures will prevent losses from the risks described above.
12
Consumer Loans. The Company, through its subsidiary Metro United, offers a variety of loan products to retail customers through its branch network. Loans to retail customers include automobile loans, lines of credit and other personal loans. The terms of these loans typically range from 12 to 60 months depending on the nature of the collateral and the size of the loan.
Loan review process. In addition to MetroBank’s loan portfolio review by its internal loan review department and Metro United's loan portfolio review by an external third-party company, other ongoing reviews are performed by loan officers and involve the grading of each loan by its respective loan officer. Depending on the grade, a loan will be aggregated with other loans of similar grade and a loss factor is applied to the total loans in each group to establish the required level of allowance for loan losses. For both Banks, grades of 1-10 are applied to each loan, with loans graded 7-10 requiring the most allowance for loan losses. Factors utilized in the grading process include but are not limited to historical performance, payment status, collateral value and financial strength of the borrower. Oversight of the loan review process is the responsibility of the Loan Review/Compliance Officer. Differences of opinion are resolved among the Loan Officer, Loan Review/Compliance Officer and the Chief Credit Officer. See “Allowance for Loan Losses and Reserve for Unfunded Lending Commitments” for additional discussion on loan grades.
MetroBank’s credit department reports credit risk grade changes on a monthly basis to its management and the Board of Directors. MetroBank performs monthly and quarterly, and Metro United performs monthly concentration analyses based on industries, collateral types and business lines. Findings are reported monthly to the Directors’ Loan Committee of MetroBank and the Directors’ Credit Committee of Metro United and quarterly to the Board of Directors of each respective Bank.
In addition, the Company reviews the real estate values, and when necessary, orders new appraisals on loans collateralized by real estate when loans are renewed, prior to foreclosure and at other times as necessary, particularly in problem loan situations. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible charge-offs or appropriate additions to the allowance for loan losses. The Company records other real estate at fair value at the time of acquisition less estimated costs to sell.
The following table presents the recorded investment in loans by credit risk profile, and which were updated as of the date indicated (in thousands):
| As of March 31, 2013 | Commercial and industrial | Real estate mortgage | Real estate construction | Consumer and other | Total | |||||||||||||||
| Grade: | ||||||||||||||||||||
| 1-6 - “Pass” | $ | 380,163 | $ | 645,678 | $ | 5,583 | $ | 6,673 | $ | 1,038,097 | ||||||||||
| 7 - “Special Mention”/ “Watch” | 3,797 | 13,268 | — | — | 17,065 | |||||||||||||||
| 8 - “Substandard�� | 11,951 | 56,087 | 4,529 | — | 72,567 | |||||||||||||||
| 9 -“Doubtful" | — | — | — | — | — | |||||||||||||||
| Total | $ | 395,911 | $ | 715,033 | $ | 10,112 | $ | 6,673 | $ | 1,127,729 | ||||||||||
| As of December 31, 2012 | Commercial and industrial | Real estate mortgage | Real estate construction | Consumer and other | Total | |||||||||||||||
| Grade: | ||||||||||||||||||||
| 1-6 - “Pass” | $ | 366,571 | $ | 611,159 | $ | 5,163 | $ | 7,401 | $ | 990,294 | ||||||||||
| 7 - “Special Mention”/ “Watch” | 4,393 | 14,593 | — | — | 18,986 | |||||||||||||||
| 8 - “Substandard” | 12,941 | 76,728 | 4,529 | — | 94,198 | |||||||||||||||
| 9 -“Doubtful" | — | — | — | — | — | |||||||||||||||
| Total | $ | 383,905 | $ | 702,480 | $ | 9,692 | $ | 7,401 | $ | 1,103,478 | ||||||||||
13
There can be no assurance, however, that the Company’s loan portfolio will not become subject to increasing pressures from deteriorating borrowers’ financial condition due to general economic and other factors. While future deterioration in the loan portfolio is possible, management is continuing its risk assessment and resolution program. In addition, management is focusing its attention on minimizing the Company’s credit risk through diversification.
Nonperforming Assets
The Company generally places a loan on nonaccrual status and ceases accruing interest when, in the opinion of management, full payment of loan principal or interest is in doubt. All loans past due 90 days are placed on nonaccrual status unless the loan is both well collateralized and in the process of collection. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction of principal as long as significant doubt exists as to collection of the principal. Loans are restored to accrual status only when interest and principal payments are brought current and, in management’s judgment, future payments are reasonably assured. In addition to nonaccrual loans, the Company evaluates on an ongoing basis other loans which are potential problem loans as to risk exposure in determining the adequacy of the allowance for loan losses.
A loan is considered impaired based on current information and events if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual basis for other loans. The measurement of impaired loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price or based on the fair value of the collateral if the loan is collateral-dependent.
Loans are classified as a troubled debt restructuring in cases where a borrower is experiencing financial difficulty and the Banks make concessionary modifications to contractual terms. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate and an extension of the maturity date(s). Generally, a nonaccrual loan that is restructured remains on nonaccrual for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. Once performance has been demonstrated, the loan may be returned to performing status after the calendar year end.
The Company requires that nonperforming assets be monitored by the special assets department or senior lenders for MetroBank, and by the special asset team consisting of internal credit personnel with the assistance of third party consultants and attorneys for Metro United. All nonperforming assets are actively managed pursuant to the Company’s loan policy. Senior management is apprised on a weekly basis of the workout endeavors and provides assistance as necessary to determine the best strategy for problem loan resolution and maximizing repayment on nonperforming assets.
In addition to the Banks’ loan review process described in the preceding paragraphs, the Office of the Comptroller of the Currency (“OCC”) periodically examines and evaluates MetroBank, while the Federal Deposit Insurance Corporation (“FDIC”) and California Department of Financial Institutions (“CDFI”) periodically examine and evaluate Metro United. Based upon such examinations, the regulators may revalue the assets of the institution and require that it charge-off certain assets, establish specific reserves to compensate for the difference between the regulators-determined value and the book value of such assets or take other regulatory action designed to lessen the risk in the asset portfolio.
14
The following table provides an analysis of the age of the recorded investment in loans by portfolio segment at the date indicated (in thousands):
| As of March 31, 2013 | 30-59 Days Past Due | 60-89 Days Past Due | Greater Than 90 Days | Total Past Due | Current | Total Recorded Investment in Loans | Recorded Investment 90 Days and Accruing | |||||||||||||||||||||
| Commercial and industrial | $ | 870 | $ | 645 | $ | 510 | $ | 2,025 | $ | 393,886 | $ | 395,911 | $ | — | ||||||||||||||
| Real estate mortgage: | ||||||||||||||||||||||||||||
| Residential | 66 | — | 142 | 208 | 37,401 | 37,609 | — | |||||||||||||||||||||
| Commercial | 2,264 | 376 | 12,053 | 14,693 | 662,731 | 677,424 | — | |||||||||||||||||||||
| Real estate construction: | ||||||||||||||||||||||||||||
| Residential | — | — | 1,426 | 1,426 | 1,322 | 2,748 | — | |||||||||||||||||||||
| Commercial | — | — | 3,103 | 3,103 | 4,261 | 7,364 | — | |||||||||||||||||||||
| Consumer and other | — | — | — | — | 6,673 | 6,673 | — | |||||||||||||||||||||
| Total | $ | 3,200 | $ | 1,021 | $ | 17,234 | $ | 21,455 | $ | 1,106,274 | $ | 1,127,729 | $ | — | ||||||||||||||
| As of December 31, 2012 | 30-59 Days Past Due | 60-89 Days Past Due | Greater Than 90 Days | Total Past Due | Current | Total Recorded Investment in Loans | Recorded Investment 90 Days and Accruing | |||||||||||||||||||||
| Commercial and industrial | $ | 2,233 | $ | 817 | $ | 1,308 | $ | 4,358 | $ | 379,547 | $ | 383,905 | $ | — | ||||||||||||||
| Real estate mortgage: | ||||||||||||||||||||||||||||
| Residential | — | — | 239 | 239 | 36,667 | 36,906 | — | |||||||||||||||||||||
| Commercial | 114 | 3,817 | 18,141 | 22,072 | 643,502 | 665,574 | — | |||||||||||||||||||||
| Real estate construction: | ||||||||||||||||||||||||||||
| Residential | — | — | 1,426 | 1,426 | 984 | 2,410 | — | |||||||||||||||||||||
| Commercial | 150 | — | 3,103 | 3,253 | 4,029 | 7,282 | — | |||||||||||||||||||||
| Consumer and other | — | — | — | — | 7,401 | 7,401 | — | |||||||||||||||||||||
| Total | $ | 2,497 | $ | 4,634 | $ | 24,217 | $ | 31,348 | $ | 1,072,130 | $ | 1,103,478 | $ | — | ||||||||||||||
The following table presents the recorded investment in nonaccrual loans, including nonaccruing troubled debt restructurings, by portfolio segment at the dates indicated (in thousands):
| Recorded investment in nonaccrual loans | March 31, 2013 | December 31, 2012 | ||||||
| Commercial and industrial | $ | 579 | $ | 1,308 | ||||
| Real estate mortgage: | ||||||||
| Residential | 142 | 239 | ||||||
| Commercial | 16,347 | 22,501 | ||||||
| Real estate construction: | ||||||||
| Residential | 1,426 | 1,426 | ||||||
| Commercial | 3,104 | 3,103 | ||||||
| Total | $ | 21,598 | $ | 28,577 | ||||
15
Information on impaired loans, which includes nonaccrual loans and troubled debt restructurings, and the related specific allowance for loan losses on such loans at March 31, 2013 and December 31, 2012, is presented below (in thousands):
| As of March 31, 2013 | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | ||||||||||||
| Impaired loans with no allowance | ||||||||||||||||
| Commercial and industrial | $ | 579 | $ | 579 | $ | — | $ | 4,394 | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Residential | 142 | 142 | — | 188 | ||||||||||||
| Commercial | 12,368 | 12,368 | — | 17,096 | ||||||||||||
| Real estate construction: | ||||||||||||||||
| Residential | 1,426 | 1,426 | — | 1,885 | ||||||||||||
| Commercial | 3,104 | 3,104 | — | 3,132 | ||||||||||||
| Impaired loans with an allowance | ||||||||||||||||
| Commercial and industrial | $ | — | $ | — | $ | — | $ | 17 | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Commercial | 3,979 | 3,980 | 252 | 4,530 | ||||||||||||
| Total: | ||||||||||||||||
| Commercial and industrial | $ | 579 | $ | 579 | $ | — | $ | 4,411 | ||||||||
| Real estate mortgage | 16,489 | 16,490 | 252 | 21,814 | ||||||||||||
| Real estate construction | 4,530 | 4,530 | — | 5,017 | ||||||||||||
| As of December 31, 2012 | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | ||||||||||||
| Impaired loans with no allowance | ||||||||||||||||
| Commercial and industrial | $ | 1,287 | $ | 1,289 | $ | — | $ | 5,162 | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Residential | 239 | 239 | — | 213 | ||||||||||||
| Commercial | 18,369 | 18,369 | — | 19,732 | ||||||||||||
| Real estate construction: | ||||||||||||||||
| Residential | 1,426 | 1,426 | — | 1,529 | ||||||||||||
| Commercial | 3,103 | 3,103 | — | 3,171 | ||||||||||||
| Impaired loans with an allowance | ||||||||||||||||
| Commercial and industrial | 21 | 21 | 21 | 1,434 | ||||||||||||
| Real estate mortgage: | ||||||||||||||||
| Commercial | 4,533 | 4,535 | 503 | 6,836 | ||||||||||||
| Total: | ||||||||||||||||
| Commercial and industrial | $ | 1,308 | $ | 1,310 | $ | 21 | $ | 6,596 | ||||||||
| Real estate mortgage | 23,141 | 23,143 | 503 | 26,781 | ||||||||||||
| Real estate construction | 4,529 | 4,529 | — | 4,700 | ||||||||||||
For the three months ended March 31, 2013 there was no interest income recognized on impaired loans. For the three months ended March 31, 2012, interest income of $89,000 was recognized on impaired loans, which consisted of nonaccrual loans that were paid in full and accruing TDRs.
16
Troubled Debt Restructurings
Loans are classified as a TDR in cases where a borrower is experiencing financial difficulty and the Banks make concessionary modifications to contractual terms. Restructured loans typically involve a modification of terms such as a reduction of the stated interest rate and/or an extension of the maturity date(s). Generally, a nonaccrual loan that is restructured remains on nonaccrual for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. Once performance has been demonstrated the loan may be returned to performing status after the calendar year end.
There were no investments in troubled debt restructurings that occurred for the three months ended March 31, 2013. As of March 31, 2013, there were no commitments to lend additional funds on loans that were modified as troubled debt restructurings. As of March 31, 2013, there were no defaults on any loans that were modified as troubled debt restructurings during the preceding twelve months.
The following table presents the recorded investment in troubled debt restructurings that occurred for the three months ended March 31, 2012 (dollars in thousands):
| Three Months Ended March 31, 2012 | ||||||||||||
| Troubled Debt Restructurings | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | |||||||||
| Real estate mortgage: | ||||||||||||
| Commercial | 1 | $ | 2,699 | $ | 2,699 | |||||||
The loan identified as a troubled debt restructuring by the Company was previously on nonaccrual status and reported as an impaired loan prior to restructuring. The borrower was under the protection of the Federal Bankruptcy Act and the court approved and imposed a reorganization plan which modified the existing payment terms. Since the loan was classified and on nonaccrual status both before and after restructuring, the modification did not impact the Company’s determination of the allowance for loan losses.
As of March 31, 2012, commitments to lend additional funds on loans that were modified as troubled debt restructurings were insignificant. As of March 31, 2012, there were no defaults on any loans that were modified as troubled debt restructurings during the preceding twelve months.
Allowance for Loan Losses and Reserve for Unfunded Lending Commitments
The allowance for loan losses provides for the risk of losses inherent in the lending process and the Company allocates the allowance for loan losses according to management’s assessments of risk inherent in the portfolio. The allowance for loan losses is increased by provisions charged against current earnings and is reduced by net charge-offs. Loans are charged off when they are deemed to be uncollectible in whole or in part. Recoveries are recorded when cash payments are received. In developing the assessment, the Company relies on estimates and exercises judgment regarding matters where the ultimate outcome is uncertain. Circumstances may change and future assessments of credit risk may yield materially different results, resulting in an increase or decrease in the allowance for credit losses.
The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments and is maintained at levels that the Company believes are adequate to absorb probable losses inherent in the loan portfolio and unfunded lending commitments as of the date of the financial statements. The Company employs a systematic methodology for determining the allowance for credit losses that consists of four components: (1) a formula-based general reserve derived from historical average losses by loan grade, (2) specific reserves on larger impaired individual credits that are based on the difference between the current loan balance and the loan’s collateral value, observable market price, or discounted present value, (3) a qualitative component that reflects current market conditions and other factors precedent to losses different from historical averages and (4) a reserve for unfunded lending commitments.
In setting the qualitative reserve portion of the allowance for loan losses, the factors the Company may consider include, but are not limited to, concentrations of credit, common characteristics of known problem loans, potential problem loans and other loans that exhibit weaknesses or deterioration, the general economic environment in the Company’s markets as well as the national economy, particularly the real estate markets, changes in value of the collateral securing loans, results of portfolio stress tests, and changes in lending processes, procedures and personnel. After the aforementioned assessment of the loan portfolio, the general economic environment and other relevant factors, management determines the appropriate allowance for loan loss level and makes the provision necessary to achieve that level. This methodology is consistently followed so that the level of the allowance for loan losses is reevaluated in response to changes in circumstances, economic conditions or other factors on an ongoing basis.
17
The Company follows a loan review program to evaluate the credit risk in the loan portfolio as discussed under “Nonperforming Assets.” The Company maintains an internally classified loan list which, along with the delinquency list of loans, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans classified as “substandard” are risk-rated as grade 8, and are those loans with well-defined weaknesses such as a highly-leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition, which may jeopardize recoverability of the debt. Loans classified as “doubtful” are risk-rated as grade 9, and are those loans which have characteristics similar to substandard loans but with an increased risk that a loss may occur, or at least a portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans include some loans that are delinquent at least 30 days or on nonaccrual status. Loans classified as “loss” are risk-rated as grade 10 and are those loans which are charged off.
In addition to the internally classified loan list and delinquency list of loans, the Company maintains a separate “watch list” for loans risk-rated as grade 7, which further aids the Company in monitoring loan portfolios. Watch list loans show potential weaknesses where the present status portrays one or more deficiencies that require attention in the short-term or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all of the characteristics of a classified loan (substandard or doubtful) but do show weakened elements compared with those of a satisfactory credit. The Company reviews these loans to assist in assessing the adequacy of the allowance for loan losses.
Policies and procedures have been developed to assess the adequacy of the allowance for loan losses and the reserve for unfunded lending commitments that include the monitoring of qualitative and quantitative trends described above. Management of both Banks review and approve their respective allowance for loan losses and the reserve for unfunded lending commitments monthly and perform a comprehensive analysis quarterly, which is also presented for approval by each Bank’s Board of Directors. The allowance for credit losses is also subject to federal and California State banking regulations. The Banks’ primary regulators conduct periodic examinations of the allowance for credit losses and make assessments regarding its adequacy and the methodology used in its determination.
The Company maintains a reserve for unfunded commitments to provide for the risk of loss inherent in its unfunded lending related commitments. The process used in determining the reserve is consistent with the process used for the allowance for loan losses discussed above.
18
The following table presents the allowance for loan losses and recorded investment in loans by portfolio segment at the date indicated (in thousands):
As of and for the three months ended March 31, 2013 | Commercial and industrial | Real estate mortgage | Real estate construction | Consumer and other | Unallocated | Total | ||||||||||||||||||
| Allowance for loan losses at beginning of period | $ | 8,255 | $ | 14,748 | $ | 216 | $ | 143 | $ | 1,230 | $ | 24,592 | ||||||||||||
| (Reduction in) provision for loan losses | (408 | ) | (1,031 | ) | (41 | ) | (43 | ) | 1,073 | (450 | ) | |||||||||||||
| Charge-offs | (884 | ) | (550 | ) | — | (25 | ) | — | (1,459 | ) | ||||||||||||||
| Recoveries | 90 | 50 | 5 | 4 | — | 149 | ||||||||||||||||||
| Allowance for loan losses at end of period | $ | 7,053 | $ | 13,217 | $ | 180 | $ | 79 | $ | 2,303 | $ | 22,832 | ||||||||||||
| Ending allowance for loan losses balance for loans individually evaluated for impairment | $ | — | $ | 289 | $ | — | $ | — | $ | 289 | ||||||||||||||
| Ending allowance for loan losses balance for loans collectively evaluated for impairment | $ | 7,053 | $ | 12,928 | $ | 180 | $ | 79 | $ | 20,240 | ||||||||||||||
| Loans: | ||||||||||||||||||||||||
| Recorded investment in loans | $ | 395,911 | $ | 715,033 | $ | 10,112 | $ | 6,673 | $ | 1,127,729 | ||||||||||||||
| Recorded investment in loans individually evaluated for impairment | $ | 579 | $ | 16,489 | $ | 4,530 | $ | — | $ | 21,598 | ||||||||||||||
| Recorded investment in loans collectively evaluated for impairment | $ | 395,332 | $ | 698,544 | $ | 5,582 | $ | 6,673 | $ | 1,106,131 | ||||||||||||||
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As of and for the three months ended March 31, 2012 | Commercial and industrial | Real estate mortgage | Real estate construction | Consumer and other | Unallocated | Total | ||||||||||||||||||
| Allowance for loan losses at beginning of period | $ | 7,966 | $ | 19,213 | $ | 320 | $ | 137 | $ | 685 | $ | 28,321 | ||||||||||||
(Reduction in) provision for loan losses | 1,923 | (2,638 | ) | (104 | ) | (6 | ) | 1,225 | 400 | |||||||||||||||
| Charge-offs | (784 | ) | (340 | ) | — | (42 | ) | — | (1,166 | ) | ||||||||||||||
| Recoveries | 118 | 363 | 19 | 11 | — | 511 | ||||||||||||||||||
| Allowance for loan losses at end of period | $ | 9,223 | $ | 16,598 | $ | 235 | $ | 100 | $ | 1,910 | $ | 28,066 | ||||||||||||
| Ending allowance for loan losses balance for loans individually evaluated for impairment | $ | 362 | $ | 655 | $ | — | $ | — | $ | 1,017 | ||||||||||||||
| Ending allowance for loan losses balance for loans collectively evaluated for impairment | $ | 8,861 | $ | 15,943 | $ | 235 | $ | 100 | $ | 25,139 | ||||||||||||||
| Loans: | ||||||||||||||||||||||||
| Recorded investment in loans | $ | 344,975 | $ | 691,071 | $ | 9,208 | $ | 4,795 | $ | 1,050,049 | ||||||||||||||
| Recorded investment in loans individually evaluated for impairment | $ | 9,315 | $ | 29,165 | $ | 3,263 | $ | 1 | $ | 41,744 | ||||||||||||||
| Recorded investment in loans collectively evaluated for impairment | $ | 335,660 | $ | 661,906 | $ | 5,945 | $ | 4,794 | $ | 1,008,305 | ||||||||||||||
4. GOODWILL
Goodwill is recorded on the acquisition date of each entity, and evaluated annually for possible impairment. Goodwill is required to be tested for impairment on an annual basis or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company’s only reporting unit with assigned goodwill is Metro United.
2012 Annual Evaluation
The Company completed its 2012 annual impairment test based on information as of August 31, 2012. The impairment analysis utilized guideline company and guideline transaction information where available, discounted cash flow analysis, and the market capitalization of the Company to estimate the fair value of Metro United.
Due to the limited number of bank transaction multiples, management allocated more weight on the income approach for the step-one analysis. The Company also performed a reconciliation of the estimated fair value of the reporting unit to the stock price of the Company. This reconciliation is performed by first determining the fair value of the reporting unit from various valuation techniques (i.e., guideline transactions, discounted cash flows, and quoted market prices). The fair value is compared to the allocated value of the reporting unit based on the Company’s market value using the stock price as of the valuation date. The Company allocates the total market value to both of its segments, MetroBank and Metro United. For each Bank, the allocation is based upon the following internal ratios:
Balance Sheet Ratios
• Total Bank assets as a percentage of total assets;
• Total Bank loans as a percentage of total loans;
• Total Bank deposits as a percentage of total deposits; and
• Total Bank shareholder's equity as a percentage of total shareholders' equity.
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Performance Ratios
• Total Bank nonperforming assets as a percentage of total assets;
• Last twelve months return on assets; and
• Last twelve months return on equity.
In allocating the market value between the two Banks, more weight was assigned to the Performance Ratios than the Balance Sheet Ratios in order to account for the differences in market valuation as a result of different financial performance. The allocated market value of Metro United is then reconciled to the weighted average fair value derived from each valuation technique (i.e., guideline transactions, discounted cash flows, and quoted market prices) by assigning an estimated control premium of 20% to the allocated market value.
Under the discounted cash flow method, the Company used an average asset growth rate of 9.8% for the next five-year period and discounted Metro United’s cash flow and terminal value using a 13.2% discount rate. The derived fair value of Metro United was lower than the carrying value of its equity; therefore Metro United failed the step-one impairment test.
The Company then performed the step-two analysis to derive the implied fair value of goodwill. The size of the implied goodwill under the step-two analysis was significantly affected by the estimated fair value of the loans pertaining to Metro United. The significant market risk adjustment, which is a consequence of the current market conditions such as the interest rate environment, risk premium requirement on performing and nonperforming loans, supply and demand of loans for sale, macroeconomic conditions and political and regulatory environment, were all substantial contributors to the valuation discounts associated with Metro United’s loan portfolio. The implied fair value of goodwill at the evaluation date exceeded the carrying value; therefore the Company determined there was no impairment of goodwill as of that date.
To the extent that market liquidity returns and the fair value of the individual assets or loans of Metro United increases at a faster rate than the fair value of Metro United as a whole, that may cause the implied goodwill to be lower than the carrying value of goodwill. Future potential changes in valuation assumptions may also impact the estimated fair value of Metro United, resulting in impairment of goodwill under the step-two analysis. The stock price performance of the Company and the fair value of Metro United's loans are factors that may impact the potential future goodwill impairment.
Goodwill impairment, if any, is a noncash adjustment to the Company’s financial statements. As goodwill and other intangible assets are not included in the calculation of regulatory capital, the Company’s well capitalized regulatory ratios are not affected. Subsequent reversal of goodwill impairment is prohibited.
Changes in the carrying amount of the Company’s goodwill for the periods indicated are as follows (in thousands):
| Balance as of January 1, 2013 | ||||
| Goodwill | 21,827 | |||
| Accumulated impairment losses | 7,500 | |||
| Net goodwill | $ | 14,327 | ||
| Impairment losses for the three months ended March 31, 2013 | — | |||
| Balance as of March 31, 2013 | ||||
| Goodwill | 21,827 | |||
| Accumulated impairment losses | 7,500 | |||
| Net goodwill | $ | 14,327 | ||
5. EARNINGS PER COMMON SHARE
Basic earnings per common share (“EPS”) is computed by dividing net income (after deducting dividends on preferred stock) by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted-average number of common shares and potentially dilutive common shares outstanding during the period. Stock options, restricted common shares and warrants can be dilutive common shares and are therefore considered in the earnings per share calculation, if dilutive. Stock options, restricted common shares and warrants that are antidilutive are excluded from earnings per share calculation. Stock options, restricted common shares and warrants are antidilutive when the exercise price is higher than the current market price of the Company’s common stock. As of March 31, 2013 and 2012, there were 258,920 and 652,750 antidilutive stock options, respectively. The number of potentially dilutive common shares is determined using the treasury stock method.
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For the Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| (In thousands, except per share amounts) | ||||||||
| Net income available to common shareholders | $ | 3,027 | $ | 2,170 | ||||
| Weighted average common shares in basic EPS | 18,332 | 13,169 | ||||||
| Effect of dilutive securities | 391 | 140 | ||||||
| Weighted average common and potentially dilutive common shares used in diluted EPS | 18,723 | 13,309 | ||||||
| Income per common share: | ||||||||
| Basic | $ | 0.17 | $ | 0.16 | ||||
| Diluted | $ | 0.16 | $ | 0.16 | ||||
6. COMMITMENTS AND CONTINGENCIES
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include various guarantees, commitments to extend credit and standby letters of credit. Additionally, these instruments may involve, to varying degrees, credit risk in excess of the amount recognized in the statement of financial condition. The Company’s maximum exposure to credit loss under such arrangements is represented by the contractual amount of those instruments. The Company applies the same credit policies and collateralization guidelines in making commitments and conditional obligations as they do for on-balance sheet instruments. Off-balance sheet financial instruments include commitments to extend credit and guarantees under standby and other letters of credit.
The contractual amount of the Company’s financial instruments with off-balance sheet risk at March 31, 2013 and December 31, 2012 is presented below:
As of March 31, 2013 | As of December 31, 2012 | |||||||
| (Dollars in thousands) | ||||||||
| Unfunded loan commitments including unfunded lines of credit | $ | 117,221 | $ | 99,474 | ||||
| Standby letters of credit | 9,821 | 10,387 | ||||||
| Commercial letters of credit | 2,660 | 1,595 | ||||||
| Operating leases | 6,750 | 7,337 | ||||||
| Total financial instruments with off-balance sheet risk | $ | 136,452 | $ | 118,793 | ||||
Litigation. The Company is involved in various litigation that arises from time to time in the normal course of business. In the opinion of management, after consultations with its legal counsel, such litigation is not expected to have a material adverse effect of the Company’s consolidated financial position, results of operations or cash flows.
7. REGULATORY MATTERS
The Banks are subject to regulations and, among others things, may be limited in their ability to pay dividends or otherwise transfer funds to the holding company. Under applicable restrictions as of March 31, 2013, no dividends could be paid by MetroBank to the Parent without regulatory approval. In addition, dividends paid by the Banks to the Parent would be prohibited if the effect thereof would cause the Banks’ capital to be reduced below applicable minimum capital requirements.
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On August 10, 2009, MetroBank entered into a written agreement (the “Agreement”) with the OCC. The Agreement is based on the findings of the OCC during the annual on-site examination of MetroBank performed in the first quarter of 2009 and is primarily focused on matters related to MetroBank’s asset quality. Pursuant to the Agreement, the Board of Directors of MetroBank has appointed a compliance committee to monitor and coordinate MetroBank’s performance under the Agreement. The Agreement provides for, among other things, the development and implementation of written programs to reduce MetroBank’s credit risks, monitor and reduce the level of criticized assets and manage commercial real estate loan concentrations in light of current adverse commercial real estate market conditions generally and in its market areas. Since the completion of the examination, management of MetroBank has proactively made adjustments to policies and procedures in an effort to alleviate the effects of the credit challenge caused by the economic deterioration and market conditions generally and in its market areas. Additionally, management and the Boards of Directors of the Company and MetroBank have aggressively taken steps to address the findings of the exam and are aggressively working to comply with the requirements of the Agreement. Failure by MetroBank to meet the requirements and conditions imposed by the Agreement could result in more severe regulatory enforcement actions such as capital directives to raise additional capital, civil money penalties, cease and desist or removal orders, injunctions, and public disclosure of such actions against MetroBank. Any such failure and resulting regulatory action could have a material adverse effect on the financial condition and results of operations of the Company and MetroBank.
As of March 31, 2013, the most recent notifications from the OCC with respect to MetroBank, and the CDFI with respect to Metro United categorized the Banks as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since the notifications that management believes have changed the Banks’ level of capital adequacy.
The Company’s and the Banks’ actual capital amounts and ratios at the dates indicated are presented in the following table (dollars in thousands):
| Actual | Minimum Required For Capital Adequacy Purposes | To be Categorized as Well Capitalized under Prompt Corrective Action Provisions | ||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| As of March 31, 2013 | ||||||||||||||||||||||||
| Total risk-based capital ratio | ||||||||||||||||||||||||
| MetroCorp Bancshares, Inc. | $ | 214,605 | 17.75 | % | $ | 96,750 | 8.00 | % | $ | N/A | N/A | % | ||||||||||||
| MetroBank, N.A. | 155,837 | 17.76 | 70,186 | 8.00 | 87,733 | 10.00 | ||||||||||||||||||
| Metro United Bank | 52,931 | 16.10 | 26,309 | 8.00 | 32,886 | 10.00 | ||||||||||||||||||
| Tier 1 risk-based capital ratio | ||||||||||||||||||||||||
| MetroCorp Bancshares, Inc. | 199,323 | 16.48 | 48,375 | 4.00 | N/A | N/A | ||||||||||||||||||
| MetroBank, N.A. | 144,743 | 16.50 | 35,093 | 4.00 | 52,640 | 6.00 | ||||||||||||||||||
| Metro United Bank | 48,782 | 14.83 | 13,154 | 4.00 | 19,732 | 6.00 | ||||||||||||||||||
| Leverage ratio | ||||||||||||||||||||||||
| MetroCorp Bancshares, Inc. | 199,323 | 13.09 | 60,923 | 4.00 | N/A | N/A | ||||||||||||||||||
| MetroBank, N.A. | 144,743 | 13.04 | 44,389 | 4.00 | 55,487 | 5.00 | ||||||||||||||||||
| Metro United Bank | 48,782 | 11.76 | 16,596 | 4.00 | 20,745 | 5.00 | ||||||||||||||||||
| As of December 31, 2012 | ||||||||||||||||||||||||
| Total risk-based capital ratio | ||||||||||||||||||||||||
| MetroCorp Bancshares, Inc. | $ | 212,083 | 17.95 | % | $ | 94,509 | 8.00 | % | $ | N/A | N/A | % | ||||||||||||
| MetroBank, N.A. | 152,613 | 17.80 | 68,587 | 8.00 | 85,734 | 10.00 | ||||||||||||||||||
| Metro United Bank | 52,714 | 16.34 | 25,814 | 8.00 | 32,267 | 10.00 | ||||||||||||||||||
| Tier 1 risk-based capital ratio | ||||||||||||||||||||||||
| MetroCorp Bancshares, Inc. | 197,077 | 16.68 | 47,255 | 4.00 | N/A | N/A | ||||||||||||||||||
| MetroBank, N.A. | 141,702 | 16.53 | 34,293 | 4.00 | 51,440 | 6.00 | ||||||||||||||||||
| Metro United Bank | 48,636 | 15.07 | 12,907 | 4.00 | 19,360 | 6.00 | ||||||||||||||||||
| Leverage ratio | ||||||||||||||||||||||||
| MetroCorp Bancshares, Inc. | 197,077 | 13.18 | 59,812 | 4.00 | N/A | N/A | ||||||||||||||||||
| MetroBank, N.A. | 141,702 | 12.70 | 44,613 | 4.00 | 55,766 | 5.00 | ||||||||||||||||||
| Metro United Bank | 48,636 | 12.76 | 15,243 | 4.00 | 19,053 | 5.00 | ||||||||||||||||||
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8. OTHER COMPREHENSIVE INCOME (LOSS)
The tax effects allocated to each component of other comprehensive income (loss) were as follows (in thousands):
| Three Months Ended March 31, 2013 | Three Months Ended March 31, 2012 | |||||||||||||||||||||||
| Before Tax Amount | Tax Expense (Benefit) | Net of Tax Amount | Before Tax Amount | Tax Expense (Benefit) | Net of Tax Amount | |||||||||||||||||||
| Change in accumulated gain on effective cash flow derivatives | $ | 151 | $ | 55 | $ | 96 | $ | 68 | $ | 25 | $ | 43 | ||||||||||||
| Unrealized loss on investment securities with OTTI: | ||||||||||||||||||||||||
| Securities with OTTI charges during the period | (40 | ) | (15 | ) | (25 | ) | (39 | ) | (14 | ) | (25 | ) | ||||||||||||
| Less: OTTI charges recognized in net income | (27 | ) | (10 | ) | (17 | ) | (39 | ) | (14 | ) | (25 | ) | ||||||||||||
| Net unrealized losses on investment securities with OTTI | (13 | ) | (5 | ) | (8 | ) | — | — | — | |||||||||||||||
| Unrealized gain (loss) on investment securities: | ||||||||||||||||||||||||
| Unrealized holding gain (loss) arising during the period | (663 | ) | (238 | ) | (425 | ) | 31 | 10 | 21 | |||||||||||||||
| Less: reclassification adjustment for gain included in net income | 14 | 5 | 9 | 12 | 4 | 8 | ||||||||||||||||||
| Net unrealized gains (losses) on investment securities | (677 | ) | (243 | ) | (434 | ) | 19 | 6 | 13 | |||||||||||||||
| Other comprehensive (loss) income | $ | (539 | ) | $ | (193 | ) | $ | (346 | ) | $ | 87 | $ | 31 | $ | 56 | |||||||||
The balance of and changes in each component of accumulated other comprehensive income (loss) as of and for the three months ended March 31, 2013 are as follows (net of taxes):
| Gains (Losses) on Effective Cash Hedging Derivatives | Net Unrealized Gains (Losses) on Investments with OTTI | Net Unrealized Investment Gains | Total Accumulated Other Comprehensive Income (Loss) | |||||||||||||
| Accumulated other comprehensive income (loss) December 31, 2012 | $ | (1,136 | ) | $ | (1,017 | ) | $ | 2,720 | $ | 567 | ||||||
| Other comprehensive income (loss)before reclassifications | 96 | (8 | ) | (425 | ) | (337 | ) | |||||||||
| Amounts reclassified from other comprehensive income (loss) (1) | — | — | (9 | ) | (9 | ) | ||||||||||
| Net current-period other comprehensive income (loss) | 96 | (8 | ) | (434 | ) | (346 | ) | |||||||||
| Accumulated other comprehensive income (loss) March 31, 2013 | $ | (1,040 | ) | $ | (1,025 | ) | $ | 2,286 | $ | 221 | ||||||
| (1) | Amounts reclassified from other comprehensive income were transferred to gain (loss) on securities, net. |
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9. DERIVATIVE FINANCIAL INSTRUMENTS
The fair value of derivative positions outstanding is included in other liabilities in the accompanying condensed consolidated balance sheets and in the net change in this financial statement line item in the accompanying condensed consolidated statements of cash flows.
Interest Rate Derivatives. During the third quarter of 2009, the Company entered into a forward-starting interest rate swap contract on its junior subordinated debentures with a notional amount of $17.5 million. The interest rate swap contract was designated as a hedging instrument in a cash flow hedge with the objective of protecting the quarterly interest payments on a portion of the Company’s $36.1 million of junior subordinated debentures issued to the Company’s unconsolidated subsidiary trust MCBI Statutory Trust I throughout the five-year period beginning in December 2010 and ending in December 2015 from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate. Under the swap contract, beginning in December 2010, the Company pays a fixed interest rate of 5.38% and receives a variable interest rate of three-month LIBOR plus a margin of 1.55% on a total notional amount of $17.5 million, with quarterly settlements, which began in March 2011.
The Company applies hedge accounting to interest rate derivatives when qualified. To qualify for hedge accounting, a derivative must be highly effective at reducing the risk associated with the exposure being hedged. In addition, for a derivative to be designated as a hedge, the risk management objective and strategy must be documented. Hedge documentation must identify the derivative hedging instrument, the asset or liability and type of risk to be hedged, and how the effectiveness of the derivative will be assessed prospectively and retrospectively. To assess effectiveness, the Company compares the dollar-value of the change in the fair value of the derivative to the change in the fair value or cash flows of the hedged item. The extent to which a derivative has been, and is expected to continue to be, effective at offsetting changes in the fair value or cash flows of the hedged item must be assessed and documented at least quarterly. Any hedge ineffectiveness (i.e., the amount by which the gain or loss on the designated derivative instrument does not exactly offset the gain or loss on the hedged item attributable to the hedged risk) must be reported in current-period earnings. If it is determined that a derivative is not highly effective at hedging the designated exposure, hedge accounting is discontinued.
At the end of the second quarter of 2011, the Company entered into an interest rate cap with a notional amount of $15.0 million with the objective of mitigating the effect of potential future interest rate increases. The interest rate cap contract is not designated nor accounted for as a hedging instrument. The interest rate cap contract was effective July 1, 2011 for a five-year term. Under the interest rate cap contract, beginning October 3, 2011 and ending July 1, 2016, the Company will receive quarterly settlements for the difference between the three-month LIBOR interest rate and the cap rate of 2.0%, if the three-month LIBOR interest rate exceeds the cap rate on the settlement date.
The Company obtains dealer quotations to value its interest rate derivative contract designated as a hedge of cash flows and its non-hedging interest rate derivative. The notional amounts and estimated fair values of interest rate derivative contracts outstanding at March 31, 2013 and December 31, 2012 are presented in the following table (in thousands).
| March 31, 2013 | December 31, 2012 | |||||||||||||||
| Notional Amount | Estimated Fair Value | Notional Amount | Estimated Fair Value | |||||||||||||
| Interest rate derivative contract designated as a hedge of cash flows | $ | 17,500 | $ | (1,624 | ) | $ | 17,500 | $ | (1,775 | ) | ||||||
| Interest rate derivative contract not designated as a hedge of cash flows | $ | 15,000 | $ | 49 | $ | 15,000 | $ | 41 | ||||||||
Gains, Losses and Derivative Cash Flows. For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to offset the cumulative change in expected future cash flows on the hedge transaction) is included in other non-interest income or other non-interest expense. Net cash flows from the interest rate swap on junior subordinated debentures designated as a hedging instrument in an effective hedge of cash flows are included in interest expense on junior subordinated debentures.
25
Amounts included in the condensed consolidated statements of income and in other comprehensive income for the period related to interest rate derivatives designated as hedges of cash flows were as follows:
Gains recorded in income and other comprehensive income, net of tax (in thousands) | ||||||||||||||||||||
| Derivatives – effective portion reclassified from AOCI into income | Hedge ineffectiveness recorded directly in income | Total income statement impact | Derivatives – effective portion recorded in OCI | Total change in OCI for period | ||||||||||||||||
| Three months ended March 31, 2013 | ||||||||||||||||||||
| Interest rate swap | $ | — | $ | — | $ | — | $ | 96 | $ | 96 | ||||||||||
| Three months ended March 31, 2012 | ||||||||||||||||||||
| Interest rate swap | $ | — | $ | — | $ | — | $ | 43 | $ | 43 | ||||||||||
Amounts included in the consolidated statements of operations for the period related to non-hedging interest rate derivatives for the year ended March 31, 2013 and 2012 were as follows (in thousands).
| Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| Non-hedging interest rate derivative: | ||||||||
| Other non-interest income | $ | 7 | $ | (34) | ||||
Counterparty Credit Risk. Derivative contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Derivative contracts are executed with a Credit Support Annex, or CSA, which is a bilateral ratings-sensitive agreement that requires collateral postings at established credit threshold levels. These agreements protect the interests of the Company and its counterparties, should either party suffer a credit rating deterioration. Institutional counterparties must have an investment grade credit rating. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. There are no credit-risk-related contingent features associated with any of the Company’s derivative contracts. The Company had no credit exposure relating to the interest rate swap at March 31, 2013. The amount of cash collateral posted by the Company related to derivative contracts was $2.3 million at March 31, 2013.
10. OPERATING SEGMENT INFORMATION
The Company operates two community banks in distinct geographical areas, and manages its operations and prepares management reports and other information with a primary focus on these geographical areas. Performance assessment and resource allocation are based upon this geographical structure. The operating segment identified as “Other” includes the parent company and eliminations of transactions between segments. The accounting policies of the individual operating segments are the same as those of the Company as described in Note 1. Transactions between operating segments are primarily conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations. Operating segments pay for centrally provided services based upon estimated or actual usage of those services.
26
The following is a summary of selected operating segment information as of and for the three months ended March 31, 2013 and 2012:
| For the Three Months Ended March 31, 2013 | For the Three Months Ended March 31, 2012 | |||||||||||||||||||||||||||||||
| MetroBank | Metro United | Other | Consolidated Company | MetroBank | Metro United | Other | Consolidated Company | |||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||
| Total interest income | $ | 10,849 | $ | 4,166 | $ | 2 | $ | 15,017 | $ | 12,410 | $ | 3,981 | $ | 7 | $ | 16,398 | ||||||||||||||||
| Total interest expense | 1,309 | 574 | 312 | 2,195 | 1,737 | 669 | 348 | 2,754 | ||||||||||||||||||||||||
| Net interest income | 9,540 | 3,592 | (310 | ) | 12,822 | 10,673 | 3,312 | (341 | ) | 13,644 | ||||||||||||||||||||||
| (Reduction in) provision for loan losses | (450 | ) | ─ | ─ | (450 | ) | 400 | ─ | ─ | 400 | ||||||||||||||||||||||
| Net interest income after provision for loan losses | 9,990 | 3,592 | (310 | ) | 13,272 | 10,273 | 3,312 | (341 | ) | 13,244 | ||||||||||||||||||||||
| Noninterest income | 1,905 | 106 | (361 | ) | 1,650 | 2,057 | 84 | (338 | ) | 1,803 | ||||||||||||||||||||||
| Noninterest expenses | 7,418 | 2,411 | 473 | 10,302 | 8,513 | 2,391 | 29 | 10,933 | ||||||||||||||||||||||||
| Income (loss) before income tax provision | 4,477 | 1,287 | (1,144 | ) | 4,620 | 3,817 | 1,005 | (708 | ) | 4,114 | ||||||||||||||||||||||
| Provision (benefit) for income taxes | 1,435 | 548 | (390 | ) | 1,593 | 1,160 | 423 | (237 | ) | 1,346 | ||||||||||||||||||||||
| Net income (loss) | $ | 3,042 | $ | 739 | $ | (754 | ) | $ | 3,027 | $ | 2,657 | $ | 582 | $ | (471 | ) | $ | 2,768 | ||||||||||||||
| As of March 31, 2013 | As of March 31, 2012 | |||||||||||||||||||||||||||||||
| MetroBank | Metro United | Other | Consolidated Company | MetroBank | Metro United | Other | Consolidated Company | |||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||
| Net loans | $ | 767,618 | $ | 334,266 | $ | ─ | $ | 1,101,884 | $ | 724,511 | $ | 293,972 | $ | ─ | $ | 1,018,483 | ||||||||||||||||
| Total assets | 1,146,420 | 440,418 | 398 | 1,587,236 | 1,106,658 | 395,975 | (1,626 | ) | 1,501,007 | |||||||||||||||||||||||
| Deposits | 964,232 | 370,574 | (6,754 | ) | 1,328,052 | 933,396 | 333,992 | (10,561 | ) | 1,256,827 | ||||||||||||||||||||||
11. FAIR VALUE
Fair value is the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is reported based on a hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are:
· | Level 1 – Quoted prices in active markets for identical assets or liabilities. |
· | Level 2 – Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
· | Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. |
Financial assets measured at fair value on a recurring basis are as follows:
Securities. Where quoted prices are available in an active market, securities are reported at fair value utilizing Level 1 inputs. Level 1 securities are comprised of bond funds. If quoted market prices are not available, the Company obtains fair values from an independent pricing service. The fair value measurements consider data that may include proprietary pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities are comprised of highly liquid government bonds, and collateralized mortgage and debt obligations. Market values provided by the pricing service are compared to prices from other sources for reasonableness. The Company has not adjusted the values from the pricing service.
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Interest Rate Derivatives. The Company’s derivative positions are classified within Level 2 in the fair value hierarchy and is valued using models generally accepted in the financial services industry that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives aredetermined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract, along with significant observable inputs, including interest rates, yield curves, non-performance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral ratings-sensitive agreement that requires collateral postings at established credit threshold levels. These agreements protect the interests of the Company and its counterparties, should either party suffer a credit rating deterioration.
The following table presents the financial instruments carried at fair value on a recurring basis by caption on the consolidated balance sheets and by valuation hierarchy (as described above) at March 31, 2013 and December 31, 2012:
| Fair Value Measurements, using | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Fair Value Measurements | |||||||||||||
| Securities available-for-sale at March 31, 2013 | ||||||||||||||||
| U.S. Treasury and other U.S. government sponsored enterprises and agencies | $ | — | $ | 81,419 | $ | — | $ | 81,419 | ||||||||
| Obligations of state and political subdivisions | — | 14,995 | — | 14,995 | ||||||||||||
| Corporate | — | 6,339 | — | 6,339 | ||||||||||||
| Mortgage-backed securities and collateralized mortgage obligations: | — | |||||||||||||||
| Government issued or guaranteed | — | 62,732 | — | 62,732 | ||||||||||||
| Privately issued residential | — | 695 | — | 695 | ||||||||||||
| Asset backed securities | — | 157 | — | 157 | ||||||||||||
| Investment in CRA funds | 14,335 | — | — | 14,335 | ||||||||||||
| Total available-for-sale securities | 14,335 | 166,337 | — | 180,672 | ||||||||||||
| Derivative assets | ||||||||||||||||
| Interest rate cap | — | 49 | — | 49 | ||||||||||||
| Total assets measured at fair value on a recurring basis | $ | 14,335 | $ | 166,386 | $ | — | $ | 180,721 | ||||||||
| Derivative liabilities at March 31, 2013 | ||||||||||||||||
| Interest rate swap | $ | — | $ | (1,624 | ) | $ | — | $ | (1,624 | ) | ||||||
| Securities available-for-sale at December 31, 2012 | ||||||||||||||||
| U.S. Treasury and other U.S. government sponsored enterprises and agencies | $ | — | $ | 71,181 | $ | — | $ | 71,181 | ||||||||
| Obligations of state and political subdivisions | — | 13,389 | — | 13,389 | ||||||||||||
| Corporate | — | 6,350 | — | 6,350 | ||||||||||||
| Mortgage-backed securities and collateralized mortgage obligations: | — | |||||||||||||||
| Government issued or guaranteed | — | 57,941 | — | 57,941 | ||||||||||||
| Privately issued residential | — | 683 | — | 683 | ||||||||||||
| Asset backed securities | — | 143 | — | 143 | ||||||||||||
| Investment in CRA funds | 14,361 | — | — | 14,361 | ||||||||||||
| Total available-for-sale securities | 14,361 | 149,687 | — | 164,048 | ||||||||||||
| Derivative assets | ||||||||||||||||
| Interest rate cap | — | 41 | — | 41 | ||||||||||||
| Total assets measured at fair value on a recurring basis | $ | 14,361 | $ | 149,728 | $ | — | $ | 164,089 | ||||||||
| Derivative liabilities at December 31, 2012 | ||||||||||||||||
| Interest rate swap | $ | — | $ | (1,775) | $ | — | $ | (1,775) | ||||||||
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Certain non-financial assets measured at fair value on a non-recurring basis include non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets measured at fair value for impairment assessment, as well as foreclosed assets. Certain financial assets are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
Non-financial and financial assets measured at fair value on a non-recurring basis include the following:
Goodwill. Goodwill is measured at fair value on a non-recurring basis using Level 3 inputs. In the first step of a goodwill impairment test, the Company primarily uses a review of the valuation of recent guideline bank acquisitions, if available, as well as discounted cash flow analysis and the market capitalization of the Company. If the second step of a goodwill impairment test is required, the implied fair value of goodwill is determined in the same manner as goodwill is recognized in a business combination. See Note 4 “Goodwill” for additional information.
Foreclosed Assets. Foreclosed assets are carried at fair value less costs to sell. The fair value measurements of foreclosed assets can include Level 2 measurement inputs such as real estate appraisals and comparable real estate sales information, in conjunction with Level 3 measurement inputs such as cash flow projections, qualitative adjustments, sales cost estimates, etc. As a result, the categorization of foreclosed assets is Level 3 of the fair value hierarchy. In connection with the measurement and initial recognition of certain foreclosed assets, the Company may recognize charge-offs through the allowance for loan losses.
Impaired Loans. Certain impaired loans with a valuation reserve are measured for impairment using the practical expedient, whereby fair value of the loan is based on the fair value of the loan’s collateral, provided the loan is collateral dependent. The fair value measurements of loan collateral can include real estate appraisals, comparable real estate sales information, cash flow projections, realization estimates, etc., all of which can include observable and unobservable inputs. As a result, the categorization of impaired loans can be either Level 2 or Level 3 of the fair value hierarchy, depending on the nature of the inputs used for measuring the related collateral’s fair value. As of March 31, 2013 and December 31, 2012, certain impaired loans were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon the fair value of the underlying collateral.
The following presents assets carried at fair value on a nonrecurring basis by caption on the condensed consolidated balance sheets and by valuation hierarchy (as described above) as of March 31, 2013 and December 13, 2012 (in thousands):
| As of March 31, 2013 | ||||||||
| Level 2 | Level 3 | |||||||
| Assets | ||||||||
| Goodwill | $ | — | $ | 14,327 | ||||
| Foreclosed assets | — | 12,152 | ||||||
| Impaired loans (1) | 3,728 | — | ||||||
| As of December 31, 2012 | ||||||||
| Level 2 | Level 3 | |||||||
| Assets | ||||||||
| Goodwill | $ | — | $ | 14,327 | ||||
| Foreclosed assets | — | 12,555 | ||||||
| Impaired loans (1) | 4,646 | — | ||||||
(1) Impaired loans represent collateral dependent impaired loans with a specific valuation allowance.
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The following presents losses related to fair value adjustments that are included in the Consolidated Statements of Operations for the three months ended March 31, 2013 and 2012 related to assets held at those dates (in thousands):
Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| Losses related to: | ||||||||
| Goodwill | $ | — | $ | — | ||||
| Foreclosed assets (1) | 64 | 77 | ||||||
| Impaired loans (2) | — | — | ||||||
(1) Losses represent related losses on foreclosed properties that were written down subsequent to their initial classification as foreclosed properties.
(2) Losses on impaired loans represent charge-offs which are netted against the allowance for loan losses.
FASB ASC Topic 825 requires disclosure of the fair value of financial assets and liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.
The estimated fair values of financial instruments that are reported at amortized cost in the Company’s Consolidated Balance Sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, were as follows:
| As of March 31, 2013 | As of December 31, 2012 | |||||||||||||||
| Carrying or Contract Amount | Estimated Fair Value | Carrying or Contract Amount | Estimated Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Financial Assets | ||||||||||||||||
| Level 2 inputs: | ||||||||||||||||
| Cash and cash equivalents | $ | 188,295 | $ | 188,295 | $ | 159,449 | $ | 159,449 | ||||||||
| Interest-bearing time deposits in banks | 15,354 | 15,354 | 15,321 | 15,321 | ||||||||||||
| Investment securities held-to-maturity | 4,046 | 4,670 | 4,046 | 4,757 | ||||||||||||
| Other investments | 5,413 | 5,413 | 5,592 | 5,592 | ||||||||||||
| Cash value of bank owned life insurance | 33,120 | 33,120 | 32,794 | 32,794 | ||||||||||||
| Accrued interest receivable | 3,680 | 3,680 | 4,120 | 4,120 | ||||||||||||
| Level 3 inputs: | ||||||||||||||||
| Loans held-for-investment, net | 1,101,884 | 1,091,892 | 1,075,745 | 1,062,432 | ||||||||||||
| Financial Liabilities | ||||||||||||||||
| Level 2 inputs: | ||||||||||||||||
| Deposit transaction accounts | 810,247 | 810,247 | 808,377 | 808,377 | ||||||||||||
| Junior subordinated debentures | 36,083 | 36,083 | 36,083 | 36,083 | ||||||||||||
| Accrued interest payable | 274 | 274 | 233 | 233 | ||||||||||||
| Level 3 inputs: | ||||||||||||||||
| Time deposits | 517,804 | 520,982 | 458,653 | 461,672 | ||||||||||||
| Other borrowings | 30,000 | 29,976 | 25,000 | 25,008 | ||||||||||||
| Off-balance sheet financial instruments | ||||||||||||||||
| Unfunded loan commitments, including unfunded lines of credit | — | 226 | — | 251 | ||||||||||||
| Standby letters of credit | — | 13 | — | 24 | ||||||||||||
The following methodologies and assumptions were used to estimate the fair value of the Company’s financial instruments as disclosed in the table:
Assets for Which Fair Value Approximates Carrying Value. The fair values of certain financial assets and liabilities carried at cost, including cash and due from banks, deposits with banks, federal funds sold, cash value of bank owned life insurance, certificates of deposit with banks denominated in a foreign currency, other investments, due from customers on acceptances and accrued interest receivable, are considered to approximate their respective carrying values due to their short-term nature and/or negligible credit risks.
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Investment Securities. Fair values are based primarily upon quoted market prices obtained from an independent pricing service.
Loans. The fair value of loans originated by the Banks is estimated by discounting the expected future cash flows using the current interest rates at which similar loans with similar terms would be made. The presence of floors on a large portion of the variable rate loans has supported the yields above current market levels and is the key factor causing the fair value of the variable rate loans with floors to exceed the book value. The fair value of the remainder of the variable rate loans approximates the carrying value while fixed rate loans are generally above the carrying values. Using these results, valuation adjustments are made for specific credit risks as well as general portfolio credit and market risks to arrive at the fair value. The valuation methods described above are not based on the exit price concept of fair value.
Liabilities for Which Fair Value Approximates Carrying Value. The estimated fair value for transactional deposit liabilities with no stated maturity (i.e., demand, savings, and money market deposits) approximates the carrying value. The estimated fair value of deposits does not take into account the value of the Company’s long-term relationships with depositors, commonly known as core deposit intangibles, which are separate intangible assets, and not considered financial instruments. Nonetheless, the Company would likely realize a core deposit premium if its deposit portfolio were sold in the principal market for such deposits.
The fair value of acceptances outstanding, accounts payable and accrued liabilities are considered to approximate their respective carrying values due to their short-term nature.
Time Deposits. Fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregated expected monthly maturities on time deposits.
Other Borrowings. The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other borrowings maturing within fourteen days approximate their fair values. Fair values of other borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Junior Subordinated Debentures. The fair value of the junior subordinated debentures approximates the carrying value as the debentures reprice quarterly.
Commitments to Extend Credit and Letters of Credit. The fair value of such instruments is estimated using the unamortized portion of fees collected for execution of such credit facility.
12. INCOME TAXES
The Company’s effective tax rate was 34.5% for three months ended March 31, 2013 compared with 32.7% for the three months ended March 31, 2012. The increase in the effective income tax rate in 2013 as compared to 2012 was partially the result of state income taxes, bank owned life insurance investment income and foreign taxes. Additionally, the effective income tax rates for the three months ended March 31, 2013 and 2012 were impacted by the amount of other non-deductible expense and non-taxable income in each respective period, and also relative to the pre-tax accounting income/loss upon which the effective income tax rate was calculated. The Texas state tax is based on the Company’s gross margin with limited deductions. Because the Texas state tax allows only limited deductions the tax may not correlate, from year to year, with pre-tax income. The California state tax is based on the unitary income of the consolidated group which can vary disproportionately from pre-tax income depending on the apportionment of income among members of the unitary group.
As of March 31, 2013, the Company had approximately $12.7 million in deferred tax assets. Deferred tax assets are subject to an evaluation of whether it is more likely than not that they will be realized. The Company has not provided a valuation allowance for the deferred tax assets at March 31, 2013 and December 31, 2012 due primarily to its ability to offset reversals of net deductible temporary differences against income taxes paid in previous years and expected to be paid in future years. In making such judgments, significant weight is given to evidence that can be objectively verified. Because of historical losses that were recorded by the Company for the years ended December 31, 2010 and 2009, and if the Company is unable to generate sufficient taxable income in the future, then the Company may not be able to conclude it is more likely than not that the benefits of the deferred tax assets will be fully realized and may be required to recognize a valuation allowance and a corresponding income tax expense equal to the portion of the deferred tax asset that may not be realized.
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The U.S. Federal and California State net operating loss carryforward period of 20 years provides sufficient time to utilize the deferred tax assets pertaining to the existing net operating loss carryforwards and any net operating losses that would be created by the reversal of the future net deductions which have not yet been taken.
13. NEW AUTHORITATIVE ACCOUNTING GUIDANCE
Accounting Standards Update (“ASU”) ASU No. 2013-02–“Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. ASU No. 2013-02 does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts ASU No. 2013-02 was effective for the Company for annual and interim periods beginning on January 1, 2013 and did not have a material impact on the Company's financial condition, results of operations or cash flows.
ASU No. 2013-01 – “Balance Sheet (Topic 210) – Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities”. ASU No. 2013-01 addresses implementation issues about the scope of ASU No. 2011-11 “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities” and clarifies that ASU No. 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement . ASU No. 2013-01 was effective for the Company for annual and interim periods beginning on January 1, 2013 and did not have a material impact on the Company's financial condition, results of operations or cash flows.
ASU No. 2012-06 – “Business Combinations (Topic 805) - Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution”. ASU No. 2012-06 states that when a reporting entity recognizes an indemnification asset (in accordance with Subtopic 805-20) as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement (that is, the lesser of the term of the indemnification agreement and the remaining life of the indemnified assets). ASU No. 2012-06 was effective for the Company for annual and interim periods beginning on January 1, 2013 and did not have a material impact on the Company's financial condition, results of operations or cash flows.
ASU No. 2012-04 – “Technical Corrections and Improvements”. The amendments in ASU No. 2012-04 represent changes to clarify the FASB Accounting Standards Codification (“Codification”), correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments are categorized as (1) source literature amendments (2) guidance clarification and reference corrections and (3) relocated guidance. Additionally, the amendments are intended to make the Codification easier to understand and the fair value measurement guidance easier to apply by eliminating inconsistencies and providing needed clarifications. The amendments in ASU No. 2012-04 that do not have transition guidance were effective October 1, 2012. The amendments that are subject to the transition guidance were effective for fiscal periods beginning on January 1, 2013. ASU No. 2012-04 did not have a material impact on the Company's financial condition, results of operations or cash flows.
ASU No. 2012-02 "Intangibles – Goodwill and Other (Topic 350) – Testing Indefinite-Lived Intangible Assets for Impairment". ASU No. 2012-02 gives entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that an indefinite-lived intangible asset is impaired. If, after assessing the totality of events or circumstances, an entity determines it is more likely than not that an indefinite-lived intangible asset is impaired, then the entity must perform the quantitative impairment test. If, under the quantitative impairment test, the carrying amount of the intangible asset exceeds its fair value, an entity should recognize an impairment loss in the amount of that excess. Permitting an entity to assess qualitative factors when testing indefinite-lived intangible assets for impairment results in guidance that is similar to the goodwill impairment testing guidance in ASU No. 2011-08. ASU No. 2012-02 was effective for the Company beginning January 1, 2013 and did not have a significant impact on the Company's financial condition, results of operations or cash flows.
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ASU No. 2011-11, "Balance Sheet (Topic 210) - "Disclosures about Offsetting Assets and Liabilities". ASU No. 2011-11 amends Topic 210, "Balance Sheet," to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU No. 2011-11 was effective for the Company for annual and interim periods beginning on January 1, 2013 and did not have a material impact on the Company's financial condition, results of operations or cash flows.
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Special Cautionary Notice Regarding Forward-looking Statements
Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of invoking these safe harbor provisions. These forward-looking statements include information about possible or assumed future results of the Company’s operations or performance. Words such as “believe”, “expect”, “anticipate”, “estimate”, “continue”, “intend”, “may”, “will”, “should”, the negatives of such words or similar expressions, identify these forward-looking statements. Many possible factors or events could affect the future financial results and performance of the Company and could cause those financial results or performance to differ materially from those expressed in the forward-looking statement. These possible events or factors include, without limitation:
| • | changes in the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on the Company's loan portfolio and allowance for loan losses; |
| • | changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations; |
| • | changes in the levels of loan prepayments and the resulting effects on the value of the Company’s loan portfolio; |
| • | changes in local economic and business conditions which adversely affect the ability of the Company’s customers to transact profitable business with the Company, including the ability of borrowers to repay their loans according to their terms or a change in the value of the related collateral; |
| • | increased competition for deposits and loans adversely affecting rates and terms; |
| • | the concentration of the Company’s loan portfolio in loans collateralized by real estate; |
| • | the Company’s ability to raise additional capital; |
| • | the effect of MetroBank’s compliance, or failure to comply within stated deadlines, of the provisions of the Agreement with the OCC; |
| • | the Company’s ability to identify suitable acquisition candidates; |
| • | the timing, impact and other uncertainties of the Company’s ability to enter new markets successfully and capitalize on growth opportunities; |
| • | increased credit risk in the Company’s assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio; |
| • | incorrect assumptions underlying the establishment of and provisions made to the allowance for loan losses; |
| • | increases in the level of nonperforming assets; | |
| • | the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on the results of operations; | |
| • | changes in the availability of funds resulting in increased costs or reduced liquidity; |
| • | an inability to fully realize the Company’s net deferred tax asset; | |
| • | a deterioration or downgrade in the credit quality and credit agency ratings of the securities in the Company’s securities portfolio; | |
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| • | increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios; |
| • | potential environmental risk and associated cost on the Company's foreclosed real estate assets; | |
| • | the Company’s ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; | |
| • | increases in FDIC deposit insurance assessments; |
| • | government intervention in the U.S. financial system; |
| • | the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; |
| • | changes in statutes and government regulations or their interpretations applicable to bank holding companies and our present and future banking and other subsidiaries, including changes in tax requirements and tax rates; |
| • | the potential payment of interest on demand deposit accounts in order to effectively compete for clients; |
| • | adverse conditions in Asia; |
| • | potential interruptions or breaches in security of the Company’s information systems; and | |
| • | possible noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statues and regulations. |
All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company analyzes the major elements of the Company’s balance sheets and statements of income. This section should be read in conjunction with the Company’s Unaudited Condensed Consolidated Financial Statements and accompanying notes and other detailed information appearing elsewhere in this document.
Overview
The Company recorded net income of $3.0 million for the three months ended March 31, 2013, compared with $2.8 million for the same quarter in 2012. The Company’s diluted earnings per common share for the three months ended March 31, 2013 were $0.16 (based on 18.7 million diluted shares), compared with $0.16 (based on 13.3 million diluted shares) for the same quarter in 2012. Diluted earnings per share is computed by dividing net income (after deducting dividends on preferred stock) by the weighted-average number of common shares and potentially dilutive common shares outstanding at the end of the period.
Total assets were $1.59 billion at March 31, 2013, an increase of $67.4 million or 4.4% from $1.52 billion at December 31, 2012. Available-for-sale investment securities at March 31, 2013 were $180.7 million, an increase of $16.6 million or 10.1% from $164.0 million at December 31, 2012. Net loans at March 31, 2013 were $1.10 billion, an increase of $26.1 million or 2.4% from $1.08 billion at December 31, 2012. Total deposits at March 31, 2013 were $1.33 billion, an increase of $61.0 million or 4.8% from $1.27 billion at December 31, 2012. Other borrowings at March 31, 2013 were $30.0 million, an increase of $5.0 million or 20.0% from $25.0 million at December 31, 2012. The Company’s return on average assets (“ROAA”) for the three months ended March 31, 2013 and 2012 was 0.80% and 0.75%, respectively. The Company’s return on average equity (“ROAE”) for the three months ended March 31, 2013 and 2012 was 6.88% and 6.67%, respectively. Shareholders’ equity at March 31, 2013 was $179.5 million compared to $177.0 million at December 31, 2012, an increase of $2.5 million or 1.4%. Details of the changes in the various components of net income are further discussed below.
Results of Operations
Net Interest Income and Net Interest Margin. For the three months ended March 31, 2013, net interest income, before the provision for loan losses, was $12.8 million, a decrease of $822,000 or 6.0% compared with $13.6 million for the same period in 2012. The decrease was due primarily to a decline in the yield on average total loans, partially offset by lower cost of deposits. Average interest-earning assets for the three months ended March 31, 2013 were $1.44 billion, an increase of $44.5 million or 3.2% compared with $1.40 billion for the same period in 2012. The weighted average yield on interest-earning assets for the first quarter of 2013 was 4.23%, a decrease of 50 basis points compared with 4.73% for the same quarter in 2012. Average interest-bearing liabilities for the three months ended March 31, 2013 were $1.04 billion, a decrease of $23.6 million or 2.2% compared with $1.06 billion for the same period in 2012. The weighted average interest rate paid on interest-bearing liabilities for the first quarter 2013 was 0.86%, a decrease of 18 basis points compared with 1.04% for the same quarter in 2012. The average interest rate decreased primarily as higher cost time deposits matured and were replaced with lower cost deposits. Additionally, market rates paid on savings and money market accounts declined.
The net interest margin for the three months ended March 31, 2013 was 3.61%, a decrease of 32 basis points compared with 3.93% for the same period in 2012. The decrease was primarily the result of lower yields on loans and a lower volume of taxable securities, partially offset by lower rates paid on deposits.
Total Interest Income. Total interest income for the three months ended March 31, 2013 was $15.0 million, a decrease of $1.4 million or 8.4% compared with $16.4 million for the same period in 2012. The decrease was primarily due to lower yield on loans and securities, partially offset by an increase in the volume of loans.
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Interest Income from Loans. Interest income from loans for the three months ended March 31, 2013 was $13.8 million, a decrease of $1.2 million or 7.8% compared with $15.0 million for the same quarter in 2012. The decrease was the result of lower loan yield compared with the same quarter in 2012. Average total loans for the three months ended March 31, 2013 were $1.10 billion compared to $1.05 billion for the same period in 2012, an increase of approximately $46.7 million or 4.5%. For the first quarter of 2013, the average yield on loans was 5.12% compared to 5.75% for the same quarter in 2012, a decrease of 63 basis points.
Approximately $750.7 million or 66.6% of the total loan portfolio are variable rate loans that periodically reprice and are sensitive to changes in market interest rates. To lessen interest rate sensitivity in the event of a falling interest rate environment, the Company originates variable rate loans with interest rate floors. At March 31, 2013, approximately $601.3 million in loans or 53.3% of the total loan portfolio were variable rate loans with interest rate floors that carried a weighted average interest rate of 5.46%. For the three months ended March 31, 2013, the average yield on total loans was approximately 187 basis points above the prime rate. At March 31, 2012, variable rate loans with interest rate floors comprised 59.3% of the total loan portfolio and carried a weighted average interest rate of 6.00%.
Interest Income from Investments. Interest income from investments (which includes investment securities, federal funds sold and other investments) for the three months ended March 31, 2013 was $1.2 million, a decrease of $211,000 or 15.1% compared to $1.4 million for the same period in 2012. The decrease was primarily the result of a decrease in the volume of average taxable securities, lower reinvestment rates on taxable securities and a redeployment of funds to federal funds sold and other short-term investments. Average total investments for the three months ended March 31, 2013 were $344.5 million compared to average total investments for the same period in 2012 of $346.6 million, a decrease of approximately $2.1 million or 0.6%. The decrease in average total investments was primarily due to the redeployment of funds as a result of greater loan volume. For the first quarter of 2013, the average yield on total investments was 1.39% compared to 1.62% for the same quarter in 2012, a decrease of 23 basis points.
Total Interest Expense. Total interest expense for the three months ended March 31, 2013 was $2.2 million, a decrease of $559,000 or 20.3% compared to $2.8 million for the same period in 2012. The decrease primarily reflected lower costs on deposits.
Interest Expense on Deposits. Interest expense on interest-bearing deposits for the three months ended March 31, 2013 was $1.6 million, a decrease of $525,000 or 24.2% compared to $2.2 million for the same period in 2012. Average interest-bearing deposits for the three months ended March 31, 2013 were $974.5 million compared to average interest-bearing deposits for the same period in 2012 of $1.00 billion, a decrease of $26.4 million or 2.6%. The average interest rate paid on interest-bearing deposits for the first quarter of 2013 was 0.68% compared to 0.87% for the same quarter in 2012, a decrease of 19 basis points. The decline in interest expense was primarily due to lower volume and cost of interest-bearing deposits and the replacement of higher cost time deposits with lower cost deposits as they matured.
Interest Expense on Junior Subordinated Debentures and Other Borrowings. Interest expense on junior subordinated debentures for the three months ended March 31, 2013 was $316,000, a decrease of $20,000 compared to $336,000 for the same period in 2012. The average interest rate paid on junior subordinated debentures for the first quarter of 2013 was 3.50% compared to 3.68% for the same quarter in 2012. Average junior subordinated debentures for the three months ended March 31, 2013 and 2012 were $36.1 million.
Interest expense on other borrowings for the three months ended March 31, 2013 was $233,000, a decrease of $14,000 compared to $247,000 for the same period in 2012. Average borrowed funds for the three months ended March 31, 2013 was $28.8 million, an increase of $2.8 million or 10.9% compared to $26.0 million for the same period in 2012, primarily due to FHLB San Francisco advances. The average interest rate paid on borrowed funds for the first quarter of 2013 was 3.28% compared to 3.82% for the same quarter in 2012. The cost decreased due primarily to the lower market rates on FHLB advances.
37
The following table presents, for each major category of interest-earning assets and interest-bearing liabilities, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates for the periods indicated. No tax-equivalent adjustments were made and all average balances are daily average balances. Nonaccruing loans have been included in the table as loans having a zero yield, with income, if any, recognized at the end of the loan term.
| For The Three Months Ended March 31, | ||||||||||||||||||||||||
| 2013 | 2012 | |||||||||||||||||||||||
| Average | Interest | Average | Average | Interest | Average | |||||||||||||||||||
| Outstanding | Earned/ | Yield/ | Outstanding | Earned/ | Yield/ | |||||||||||||||||||
| Balance | Paid | Rate(1) | Balance | Paid | Rate(1) | |||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||
| Loans | $ | 1,095,386 | $ | 13,829 | 5.12 | % | $ | 1,048,717 | $ | 14,999 | 5.75 | % | ||||||||||||
| Taxable securities | 149,913 | 791 | 2.14 | 172,909 | 1,027 | 2.39 | ||||||||||||||||||
| Tax-exempt securities | 17,111 | 147 | 3.48 | 11,622 | 117 | 4.05 | ||||||||||||||||||
| Other investments (2) | 5,580 | 50 | 3.63 | 6,464 | 43 | 2.68 | ||||||||||||||||||
| Federal funds sold and other short-term investments | 171,880 | 200 | 0.47 | 155,617 | 212 | 0.55 | ||||||||||||||||||
| Total interest-earning assets | 1,439,870 | 15,017 | 4.23 | 1,395,329 | 16,398 | 4.73 | ||||||||||||||||||
| Allowance for loan losses | (24,262 | ) | (28,707 | ) | ||||||||||||||||||||
| Total interest-earning assets, net of allowance for loan losses | 1,415,608 | 1,366,622 | ||||||||||||||||||||||
| Noninterest-earning assets | 121,471 | 126,791 | ||||||||||||||||||||||
| Total assets | $ | 1,537,079 | $ | 1,493,413 | ||||||||||||||||||||
| Liabilities and shareholders' equity | ||||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||
| Interest-bearing demand deposits | $ | 70,776 | $ | 21 | 0.12 | % | $ | 63,839 | $ | 21 | 0.13 | % | ||||||||||||
| Savings and money market accounts | 412,248 | 406 | 0.40 | 438,445 | 614 | 0.56 | ||||||||||||||||||
| Time deposits | 491,428 | 1,219 | 1.01 | 498,564 | 1,536 | 1.24 | ||||||||||||||||||
| Junior subordinated debentures | 36,083 | 316 | 3.50 | 36,083 | 336 | 3.68 | ||||||||||||||||||
| Other borrowings | 28,833 | 233 | 3.28 | 26,007 | 247 | 3.82 | ||||||||||||||||||
| Total interest-bearing liabilities | 1,039,368 | 2,195 | 0.86 | 1,062,938 | 2,754 | 1.04 | ||||||||||||||||||
| Noninterest-bearing liabilities: | ||||||||||||||||||||||||
| Noninterest-bearing demand deposits | 306,101 | 247,030 | ||||||||||||||||||||||
| Other liabilities | 13,087 | 16,416 | ||||||||||||||||||||||
| Total liabilities | 1,358,556 | 1,326,384 | ||||||||||||||||||||||
| Shareholders' equity | 178,523 | 167,029 | ||||||||||||||||||||||
| Total liabilities and shareholders' equity | $ | 1,537,079 | $ | 1,493,413 | ||||||||||||||||||||
| Net interest income | $ | 12,822 | $ | 13,644 | ||||||||||||||||||||
| Net interest spread | 3.37 | % | 3.68 | % | ||||||||||||||||||||
| Net interest margin | 3.61 | % | 3.93 | % | ||||||||||||||||||||
| (1) | Annualized. | |
| (2) | Other investments include Federal Reserve Bank stock, Federal Home Loan Bank stock and investment in subsidiary trust. |
38
The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between changes in outstanding balances and changes in interest rates for the three months ended March 31, 2013 compared with the three months ended March 31, 2012. For purposes of this table, changes attributable to both rate and volume have been allocated to each accordingly.
| Three Months Ended March 31, | ||||||||||||
| 2013 vs 2012 | ||||||||||||
| Increase (Decrease) | ||||||||||||
| Due to | ||||||||||||
| Volume | Rate | Total | ||||||||||
| (Dollars in thousands) | ||||||||||||
| Interest-earning assets: | ||||||||||||
| Loans | $ | 538 | $ | (1,708 | ) | $ | (1,170 | ) | ||||
| Taxable securities | (144 | ) | (92 | ) | (236 | ) | ||||||
| Tax-exempt securities | 54 | (24 | ) | 30 | ||||||||
| Other investments | (6 | ) | 13 | 7 | ||||||||
| Federal funds sold and other short-term investments | 20 | (32 | ) | (12 | ) | |||||||
| Total decrease in interest income | 462 | (1,843 | ) | (1,381 | ) | |||||||
| Interest-bearing liabilities: | ||||||||||||
| Interest-bearing demand deposits | 2 | (2 | ) | — | ||||||||
| Savings and money market accounts | (41 | ) | (167 | ) | (208 | ) | ||||||
| Time deposits | (35 | ) | (282 | ) | (317 | ) | ||||||
| Junior subordinated debentures | (8 | ) | (12 | ) | (20 | ) | ||||||
| Other borrowings | 25 | (39 | ) | (14 | ) | |||||||
| Total decrease in interest expense | (57 | ) | (502 | ) | (559 | ) | ||||||
| (Decrease) increase in net interest income | $ | 519 | $ | (1,341 | ) | $ | (822 | ) | ||||
Provision for Loan Losses. Provisions for loan losses are charged to income to bring the Company’s allowance for loan losses to a level which management considers adequate to absorb probable losses inherent in the loan portfolio. The (reduction in ) provision for loan losses for the three months ended March 31, 2013 was a reversal of ($450,000), a decrease of $850,000 compared with a provision of $400,000 for the same period in 2012, primarily as a result of a reduction in nonperforming and classified loans. The allowance for loan losses as a percent of total loans was 2.03%, 2.23% and 2.68% at March 31, 2013, December 31, 2012 and March 31, 2012, respectively.
Noninterest Income. Noninterest income for the three months ended March 31, 2013 was $1.7 million, a decrease of $153,000 or 8.5% compared with $1.8 million for the same period in 2012. The decrease for the three months ended March 31, 2013 was primarily due to a decline in service fees.
Noninterest Expense. Noninterest expense for the three months ended March 31, 2013 was $10.3 million, a decrease of $631,000 or 5.8% compared with $10.9 million for the same period in 2012. The decrease was mainly the result of $974,000 in net gains on sales of ORE properties as well as a decline in ORE expenses, but partially offset by increases in other noninterest expense and salaries and employee benefits.
Salaries and employee benefits expense for the three months ended March 31, 2013 was $6.3 million, an increase of $371,000 or 6.3% compared with $5.9 million for the same period in 2012. The increase was primarily due to increased headcount and share-based compensation costs.
Other noninterest expense for the three months ended March 31, 2013 was $2.7 million, an increase of $816,000 or 42.4% compared to $1.9 million for the same period in 2012, primarily due to an increase in data processing expenses as a result of a core processing system conversion, and increases in the provision for unfunded commitments and in operational losses.
The Company’s efficiency ratio is calculated by dividing total noninterest expense, excluding loan loss provisions, goodwill impairment, provisions for unfunded commitments, writedowns on foreclosed assets and gains and losses on sales of foreclosed assets, by net interest income plus noninterest income, excluding impairment on securities and gains and losses on securities transactions. The efficiency ratio for the three months ended March 31, 2013 was 77.49%, an increase from 66.96% for the same quarter in 2012, primarily due to decreased net interest income combined with increases in other noninterest expense and salaries and employee benefits expense.
39
Income Taxes. Income tax expense for the three months ended March 31, 2013 was $1.6 million, compared with $1.3 million for the same period in 2012. The Company’s effective tax rate was 34.5% for three months ended March 31, 2013 compared with 32.7% for the three months ended March 31, 2012. The increase in the effective income tax rate in 2013 as compared to 2012 was partially the result of state income taxes, bank owned life insurance investment income and foreign taxes. Additionally, the effective income tax rates for the three months ended March 31, 2013 and 2012 were impacted by the amount of other non-deductible expense and non-taxable income in each respective period, and also relative to the pre-tax accounting income/loss upon which the effective income tax rate was calculated. The Texas state tax is based on the Company’s gross margin with limited deductions. Because the Texas state tax allows only limited deductions the tax may not correlate, from year to year, with pre-tax income. The California state tax is based on the unitary income of the consolidated group which can vary disproportionately from pre-tax income depending on the apportionment of income among members of the unitary group.
As of March 31, 2013, the Company had approximately $12.7 million in deferred tax assets compared with $13.1 million at December 31, 2012 and $14.8 million at March 31, 2012. Deferred tax assets are subject to an evaluation of whether it is more likely than not that they will be realized. The Company has not provided a valuation allowance for the deferred tax assets at March 31, 2013 and December 31, 2012 due primarily to its ability to offset reversals of net deductible temporary differences against income taxes paid in previous years and expected to be paid in future years. In making such judgments, significant weight is given to evidence that can be objectively verified. Because of historical losses that were recorded by the Company for the years ended December 31, 2010 and 2009, and if the Company is unable to generate sufficient taxable income in the future, then the Company may not be able to conclude it is more likely than not that the benefits of the deferred tax assets will be fully realized and may be required to recognize a valuation allowance and a corresponding income tax expense equal to the portion of the deferred tax asset that may not be realized.
The U.S. Federal and California State net operating loss carryforward period of 20 years provides sufficient time to utilize the deferred tax assets pertaining to the existing net operating loss carryforwards and any net operating losses that would be created by the reversal of the future net deductions which have not yet been taken.
Financial Condition
Loan Portfolio. Total loans at March 31, 2013 were $1.12 billion, an increase of $24.4 million or 2.2% compared with $1.10 billion at December 31, 2012, mainly due to increases in real estate mortgage loans and commercial and industrial loans. At March 31, 2013 and December 31, 2012, the ratio of total loans to total deposits was 84.69% and 86.84%, respectively. Total loans represented 70.9% and72.4% of total assets at March 31, 2013 and December 31, 2012, respectively.
The following table summarizes the loan portfolio by type of loan at the dates indicated:
| As of March 31, 2013 | As of December 31, 2012 | |||||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||||
| (Dollars in thousands) | ||||||||||||||||
| Commercial and industrial | $ | 395,640 | 35.10 | % | $ | 383,641 | 34.78 | % | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Residential | 37,526 | 3.33 | 36,807 | 3.34 | ||||||||||||
| Commercial | 677,061 | 60.07 | 665,244 | 60.32 | ||||||||||||
| 714,587 | 63.40 | 702,051 | 63.66 | |||||||||||||
| Real estate construction: | ||||||||||||||||
| Residential | 2,753 | 0.24 | 2,420 | 0.22 | ||||||||||||
| Commercial | 7,379 | 0.66 | 7,284 | 0.66 | ||||||||||||
| 10,132 | 0.90 | 9,704 | 0.88 | |||||||||||||
| Consumer and other | 6,808 | 0.60 | 7,531 | 0.68 | ||||||||||||
| Gross loans | 1,127,167 | 100.00 | % | 1,102,927 | 100.00 | % | ||||||||||
| Unearned discounts, interest and deferred fees | (2,451 | ) | (2,590 | ) | ||||||||||||
| Total loans | 1,124,716 | 1,100,337 | ||||||||||||||
| Allowance for loan losses | (22,832 | ) | (24,592 | ) | ||||||||||||
| Loans, net | $ | 1,101,884 | $ | 1,075,745 | ||||||||||||
40
Nonperforming Assets. At March 31, 2013, total nonperforming assets consisted of $17.5 million in nonaccrual loans, $4.1 million in nonaccruing troubled debt restructurings (“TDRs”) and $12.2 million in other real estate (“ORE”). Total nonperforming assets at March 31, 2013 were $33.8 million compared with $41.5 million at December 31, 2012, a decrease of $7.8 million or 18.7%. The ratio of total nonperforming assets to total assets decreased to 2.13% at March 31, 2013 from 2.73% at December 31, 2012.
The $7.8 million decrease in total nonperforming assets consisted of declines of $6.1 million in nonaccrual loans, $916,000 in TDRs, $400,000 in accruing TDRs and a net reduction of $403,000 in ORE. In Texas, nonaccrual loans including nonaccrual TDRs decreased primarily due to a $6.7 million loan transfer to ORE and $1.0 million in charge-offs, but partially offset by the addition of three loans totaling approximately $878,000. The decrease in nonperforming assets in California primarily consisted of decreases of $354,000 in nonaccrual loans, $400,000 in accruing TDRs, $45,000 in nonaccrual TDRs and $340,000 in ORE.
ORE at March 31, 2013 decreased $403,000 compared with December 31, 2012, which included a net reduction of $64,000 in Texas and $340,000 in California. The decrease in Texas was primarily the result of a $6.7 million loan transferred to ORE but was subsequently sold during first quarter 2013, and writedowns of two other properties. The decrease in California was primarily the result of the sale of two properties.
The Company is occasionally involved in the sale of certain federally guaranteed loans into the secondary market with servicing retained. Under the terms of the Small Business Administration (“SBA”) program, the Company at its option may repurchase any loan that may become classified as nonperforming. Any repurchased loans may increase the Company’s nonperforming loans until the time at which the loan repurchased is either restored to an accrual status or the Company files a claim with the SBA for the guaranteed portion of the loan. There were no sales of SBA loans for the three months ended March 31, 2013 or 2012.
The following table presents information regarding nonperforming assets as of the dates indicated:
| As of | As of | |||||||
| March 31, 2013 | December 31, 2012 | |||||||
| (Dollars in thousands) | ||||||||
| Nonaccrual loans (1) | $ | 17,501 | $ | 23,568 | ||||
| Accruing loans 90 days or more past due (1) | — | — | ||||||
| Troubled debt restructurings – accruing (1) | — | 400 | ||||||
| Troubled debt restructurings – nonaccruing (1) | 4,098 | 5,014 | ||||||
| Other real estate (“ORE”) | 12,152 | 12,555 | ||||||
| Total nonperforming assets | 33,751 | 41,537 | ||||||
| Total nonperforming assets to total assets | 2.13 | % | 2.73 | % | ||||
| Total nonperforming assets to total loans and ORE | 2.97 | % | 3.73 | % | ||||
(1) Represents unpaid principal balance.
A loan is considered impaired, based on current information and events, if management believes that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. An insignificant delay or insignificant shortfall in the amount of payment does not require a loan to be considered impaired. If the measure of the impaired loan is less than the recorded investment in the loan, a specific reserve is established for the shortfall as a component of the Company’s allowance for loan loss methodology. The Company considers all nonaccrual loans to be impaired.
41
Information on impaired loans, which includes nonaccrual loans and troubled debt restructurings, and the related specific allowance for loan losses on such loans at March 31, 2013 and December 31, 2012, is presented below (in thousands):
| As of March 31, 2013 | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | ||||||||||||
| Impaired loans with no allowance | ||||||||||||||||
| Commercial and industrial | $ | 579 | $ | 579 | $ | — | $ | 4,394 | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Residential | 142 | 142 | — | 188 | ||||||||||||
| Commercial | 12,368 | 12,368 | — | 17,096 | ||||||||||||
| Real estate construction: | ||||||||||||||||
| Residential | 1,426 | 1,426 | — | 1,885 | ||||||||||||
| Commercial | 3,104 | 3,104 | — | 3,132 | ||||||||||||
| Impaired loans with an allowance | ||||||||||||||||
| Commercial and industrial | $ | — | $ | — | $ | — | $ | 17 | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Commercial | 3,979 | 3,980 | 252 | 4,530 | ||||||||||||
| Total: | ||||||||||||||||
| Commercial and industrial | $ | 579 | $ | 579 | $ | — | $ | 4,411 | ||||||||
| Real estate mortgage | 16,489 | 16,490 | 252 | 21,814 | ||||||||||||
| Real estate construction | 4,530 | 4,530 | — | 5,017 | ||||||||||||
| As of December 31, 2012 | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | ||||||||||||
| Impaired loans with no allowance | ||||||||||||||||
| Commercial and industrial | $ | 1,287 | $ | 1,289 | $ | — | $ | 5,162 | ||||||||
| Real estate mortgage: | ||||||||||||||||
| Residential | 239 | 239 | — | 213 | ||||||||||||
| Commercial | 18,369 | 18,369 | — | 19,732 | ||||||||||||
| Real estate construction: | ||||||||||||||||
| Residential | 1,426 | 1,426 | — | 1,529 | ||||||||||||
| Commercial | 3,103 | 3,103 | — | 3,171 | ||||||||||||
| Impaired loans with an allowance | ||||||||||||||||
| Commercial and industrial | 21 | 21 | 21 | 1,434 | ||||||||||||
| Real estate mortgage: | ||||||||||||||||
| Commercial | 4,533 | 4,535 | 503 | 6,836 | ||||||||||||
| Total: | ||||||||||||||||
| Commercial and industrial | $ | 1,308 | $ | 1,310 | $ | 21 | $ | 6,596 | ||||||||
| Real estate mortgage | 23,141 | 23,143 | 503 | 26,781 | ||||||||||||
| Real estate construction | 4,529 | 4,529 | — | 4,700 | ||||||||||||
For the three months ended March 31, 2013 there was no interest income recognized on impaired loans. For the three months ended March 31, 2012, interest income of $89,000 was recognized on impaired loans, which consisted of nonaccrual loans that were paid in full and accruing TDRs.
Allowance for Loan Losses and Reserve for Unfunded Lending Commitments. At March 31, 2013 and 2012, the allowance for loan losses was $22.8 million and $28.1 million, respectively, or 2.03% and 2.68% of total loans, respectively. At December 31, 2012, the allowance for loan losses was $24.6 million, or 2.23% of total loans. Net charge-offs for the three months ended March 31, 2013 were $1.3 million or 0.12% of total loans compared with net charge-offs of $655,000 or 0.06% of total loans for the same period in 2012. The net charge-offs for the first quarter of 2013 primarily consisted of $921,000 in loans from Texas and $389,000 in loans from California.
42
The allowance for loan losses provides for the risk of losses inherent in the lending process and the Company allocates the allowance for loan losses according to management’s assessments of risk inherent in the portfolio. The allowance for loan losses is increased by provisions charged against current earnings and is reduced by net charge-offs. Loans are charged off when they are deemed to be uncollectible in whole or in part. Recoveries are recorded when cash payments are received. In developing the assessment, the Company relies on estimates and exercises judgment regarding matters where the ultimate outcome is uncertain. Circumstances may change and future assessments of credit risk may yield materially different results, resulting in an increase or decrease in the allowance for credit losses.
The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments and is maintained at levels that the Company believes are adequate to absorb probable losses inherent in the loan portfolio and unfunded lending commitments as of the date of the financial statements. The Company employs a systematic methodology for determining the allowance for credit losses that consists of four components: (1) a formula-based general reserve based on historical average losses by loan grade, (2) specific reserves on larger impaired individual credits that are based on the difference between the current loan balance and the loan’s collateral value, observable market price, or discounted present value, (3) a qualitative component that reflects current market conditions and other factors precedent to losses different from historical averages and (4) a reserve for unfunded lending commitments.
In setting the qualitative reserve portion of the allowance for loan losses, the factors the Company may consider include, but are not limited to, concentrations of credit, common characteristics of known problem loans, potential problem loans and other loans that exhibit weaknesses or deterioration, the general economic environment in the Company’s markets as well as the national economy, particularly the real estate markets, changes in value of the collateral securing loans, results of portfolio stress tests and changes in lending processes, procedures and personnel. After the aforementioned assessment of the loan portfolio, the general economic environment and other relevant factors, management determines the appropriate allowance for loan loss level and makes the provision necessary to achieve that level. This methodology is consistently followed so that the level of the allowance for loan losses is reevaluated in response to changes in circumstances, economic conditions or other factors on an ongoing basis.
43
The Company maintains a reserve for unfunded commitments to provide for the risk of loss inherent in its unfunded lending related commitments. The process used in determining the reserve is consistent with the process used for the allowance for loan losses discussed above.
The following table presents an analysis of the allowance for credit losses and other related data for the periods indicated:
As of and for the Three Months Ended March 31, | ||||||||
| 2013 | 2012 | |||||||
| (Dollars in thousands) | ||||||||
| Average total loans outstanding for the period | $ | 1,095,386 | $ | 1,048,717 | ||||
| Total loans outstanding at end of period | $ | 1,124,716 | $ | 1,046,549 | ||||
| Allowance for loan losses at beginning of period | $ | 24,592 | $ | 28,321 | ||||
| (Reduction in) provision for loan losses | (450 | ) | 400 | |||||
| Charge-offs: | ||||||||
| Commercial and industrial | (884 | ) | (784 | ) | ||||
| Real estate mortgage | (550 | ) | (340 | ) | ||||
| Real estate construction | – | – | ||||||
| Consumer and other | (25 | ) | (42 | ) | ||||
| Total charge-offs | (1,459 | ) | (1,166 | ) | ||||
| Recoveries: | ||||||||
| Commercial and industrial | 90 | 118 | ||||||
| Real estate mortgage | 50 | 363 | ||||||
| Real estate construction | 5 | 19 | ||||||
| Consumer and other | 4 | 11 | ||||||
| Total recoveries | 149 | 511 | ||||||
| Net charge-offs | (1,310 | ) | (655 | ) | ||||
| Allowance for loan losses at end of period | 22,832 | 28,066 | ||||||
| Reserve for unfunded lending commitments at beginning of period | 961 | 1,012 | ||||||
| Provision (reversal) for unfunded lending commitments | (12 | ) | (212 | ) | ||||
| Reserve for unfunded lending commitments at end of period | 949 | 800 | ||||||
| Allowance for credit losses | $ | 23,781 | $ | 28,866 | ||||
| Ratio of allowance for loan losses to end of period total loans | 2.03 | % | 2.68 | % | ||||
| Ratio of net (charge-offs) recoveries to average total loans | (0.12 | )% | (0.06 | )% | ||||
| Ratio of allowance for loan losses to end of period total nonperforming loans (1) | 105.71 | % | 67.18 | % | ||||
| (1) | Total nonperforming loans are nonaccrual loans, accruing and nonaccruing TDRs, plus loans over 90 days past due. |
44
Securities. At March 31, 2013, the available-for-sale securities portfolio was $180.7 million, an increase of $16.6 million or 10.1% compared with $164.0 million at December 31, 2012. The increase was primarily due to purchases of U.S. government agency securities and U.S. government sponsored mortgage-backed securities. At March 31, 2013 and December 31, 2012, the held-to-maturity portfolio was $4.0 million. The securities portfolio is primarily comprised of obligations of U.S. government sponsored enterprises, mortgage-backed securities and municipal securities. The securities portfolio has been funded primarily by the liquidity created from deposit growth and loan repayments in excess of loan funding requirements. Other investments, which include Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stock, and the investment in subsidiary trust, were $5.4 million at March 31, 2013, a decrease of $179,000 or 3.2% compared with $5.6 million at December 31, 2012.
Deposits. At March 31, 2013, total deposits were $1.33 billion, an increase of $61.0 million or 4.8% compared with $1.27 billion at December 31, 2012, primarily due to an increase in interest-bearing accounts. The Company’s ratio of noninterest-bearing demand deposits to total deposits at March 31, 2013 and December 31, 2012 was 24.0% and 24.4%, respectively. Interest-bearing deposits at March 31, 2013 were $1.01 billion, an increase of $51.8 million or 4.8% compared with $957.3 million at December 31, 2012.
Junior Subordinated Debentures. Junior subordinated debentures at March 31, 2013 and December 31, 2012 were $36.1 million. The debentures mature on December 15, 2035, but are redeemable at the Company’s option at par plus accrued and unpaid interest. The debentures, issued to the Company’s unconsolidated subsidiary trust MCBI Statutory Trust I, were used to fund the Company’s acquisition of Metro United. The junior subordinated debentures accrued interest at a fixed rate of 5.76% until December 15, 2010, at which time the debentures began accruing interest at a floating rate equal to the 3-month LIBOR plus 1.55%. Related to these debentures, the Company entered into a forward-starting interest rate swap contract during the third quarter of 2009. Under the swap, the Company pays a fixed interest rate of 5.38% and receives a variable interest rate of three-month LIBOR plus a margin of 1.55% on a total notional amount of $17.5 million, with quarterly settlements which began in March 2011. See Note 10, “Derivative Financial Instruments,” to the Condensed Consolidated Financial Statements for additional information related to this interest rate swap.
Other Borrowings. Other borrowings at March 31, 2013 were $30.0 million, an increase of $5.0 million or 20.0% compared to other borrowings of $25.0 million at December 31, 2012. Other borrowings at March 31, 2013 primarily include $5.0 million in advances from the FHLB of San Francisco and $25.0 million in security repurchase agreements. The advances from the FHLB of San Francisco bear interest at an average rate of 0.91% and have maturities ranging from four years to five years. The security repurchase agreements bear an average rate of 3.71% and mature on December 31, 2014. Securities sold under securities repurchase agreements are currently puttable by the counterparty at a fixed repurchase price at the end of each calendar quarter. In addition, securities under one repurchase agreement are puttable by either the counterparty or the Company at the replacement cost of the repurchase transaction at the end of each calendar year.
In February 2010, the Company issued an unsecured debenture to one of the Company's Co-Chairmen of the Board and an affiliate of one of the Company's 5.0% or more shareholders. Each debenture was issued for a principal amount of $500,000. The notes, as amended in February 2012 were to mature February 10, 2013 and bore interest on the principal amount at a fixed rate per annum equal to 5.0% due quarterly and began March 31, 2010; however, the promissory notes were repaid in the fourth quarter of 2012.
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The following table provides an analysis of the Company’s other borrowings as of the dates and for the periods indicated:
As of and for the Three Months Ended March 31, 2013 | As of and for the Year Ended December 31, 2012 | |||||||
| (Dollars in thousands) | ||||||||
| FHLB Notes and Advances: | ||||||||
| at end of period | $ | 5,000 | $ | — | ||||
| average during the period | 3,833 | — | ||||||
| maximum month-end balance during the period | 5,000 | 3 | ||||||
| Interest rate at end of period | 0.91 | % | — | % | ||||
| Interest rate during the period | 0.89 | 0.02 | ||||||
| Security Repurchase Agreements: | ||||||||
| at end of period | $ | 25,000 | $ | 25,000 | ||||
| average during the period | 25,000 | 25,000 | ||||||
| maximum month-end balance during the period | 25,000 | 25,000 | ||||||
| Interest rate at end of period | 3.71 | % | 3.71 | % | ||||
| Interest rate during the period | 3.71 | 3.71 | ||||||
| Unsecured debentures: | ||||||||
| at end of period | $ | — | $ | — | ||||
| average during the period | — | 926 | ||||||
| maximum month-end balance during the period | — | 1,000 | ||||||
| Interest rate at end of period | — | % | 5.00 | % | ||||
| Interest rate during the period | — | 5.00 | ||||||
| Federal Reserve TT&L: | ||||||||
| at end of period | $ | — | $ | — | ||||
| average during the period | — | 2 | ||||||
| maximum month-end balance during the period | — | — | ||||||
Liquidity. The Company’s loan to deposit ratio at March 31, 2013 and December 31, 2012 was 84.69% and 86.84%, respectively. As of March 31, 2013, the Company had commitments to fund loans in the amount of $117.2 million. At this same date, the Company had stand-by letters of credit of $12.5 million. Available sources to fund these commitments and other cash demands of the Company come from loan and investment securities repayments, deposit inflows and lines of credit from the FHLBs of Dallas and San Francisco as well as the FRB discount window. With its current level of collateral, the Company has the ability to borrow an additional $458.2 million from the FHLBs, $10.2 million from the FRB discount window and $5.0 million from other correspondent banks.
Capital Resources. Shareholders’ equity at March 31, 2013 was $179.5 million compared to $177.0 million at December 31, 2012, an increase of $2.5 million. The increase was primarily the result of net income for the three months ending March 31, 2013.
The Company’s Board of Directors elected to suspend its common stock dividend indefinitely in April 2009. The payment of future dividends by the Company will be made at the discretion of the Company's Board of Directors. Additionally, future determination of dividends will depend on a number of factors, including but not limited to current and prospective earnings, capital requirements, financial condition, and other factors that the Board of Directors may deem relevant to the Company and the Banks.
The Company paid no dividends on common stock for the three months ended March 31, 2013 and 2012. There were no preferred dividends paid for the three months ended March 31, 2013 due to the repurchase of Troubled Asset Relief Program (“TARP”) preferred stock in 2012. Preferred dividends paid for the three months ended March 31, 2012 were $563,000.
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The following table provides a comparison of the Company’s and each of the Bank’s leverage and risk-weighted capital ratios as of March 31, 2013 to the minimum and well-capitalized regulatory standards:
Minimum Required For Capital Adequacy Purposes | To Be Categorized as Well Capitalized Under Prompt Corrective Action Provisions | Actual Ratio At March 31, 2013 | ||||||||||
| The Company | ||||||||||||
| Leverage ratio | 4.00 | %(1) | N/A | 13.09 | % | |||||||
| Tier 1 risk-based capital ratio | 4.00 | N/A | 16.48 | |||||||||
| Risk-based capital ratio | 8.00 | N/A | 17.75 | |||||||||
| MetroBank | ||||||||||||
| Leverage ratio | 4.00 | %(2) | 5.00 | % | 13.04 | % | ||||||
| Tier 1 risk-based capital ratio | 4.00 | 6.00 | 16.50 | |||||||||
| Risk-based capital ratio | 8.00 | 10.00 | 17.76 | |||||||||
| Metro United | ||||||||||||
| Leverage ratio | 4.00 | %(3) | 5.00 | % | 11.76 | % | ||||||
| Tier 1 risk-based capital ratio | 4.00 | 6.00 | 14.83 | |||||||||
| Risk-based capital ratio | 8.00 | 10.00 | 16.10 | |||||||||
| (1) | The Federal Reserve Board may require the Company to maintain a leverage ratio above the required minimum. | ||
| (2) | The OCC may require MetroBank to maintain a leverage ratio above the required minimum. | ||
| (3) | The FDIC may require Metro United to maintain a leverage ratio above the required minimum. | ||
Critical Accounting Estimates
The Company has established various accounting estimates which govern the application of accounting principles generally accepted in the United States in the preparation of the Company’s consolidated financial statements. Certain accounting estimates involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting estimates to be critical accounting estimates. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.
Allowance for loan losses. The Company believes the allowance for loan losses is a critical accounting estimate that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. The allowance for loan losses is increased by provisions charged against current earnings and is reduced by net charge-offs. Loans are charged off when they are deemed to be uncollectible in whole or in part. Recoveries are recorded when cash payments are received. In developing the assessment, the Company relies on estimates and exercises judgment regarding matters where the ultimate outcome is uncertain. Circumstances may change and future assessments of credit risk may yield materially different results, resulting in an increase or decrease in the allowance for credit losses.
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The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments and is maintained at levels that the Company believes are adequate to absorb probable losses inherent in the loan portfolio and unfunded lending commitments as of the date of the financial statements. The Company employs a systematic methodology for determining the allowance for credit losses that consists of four components: (i) a formula-based general reserve based on historical average losses by loan grade and grade migration, (ii) specific reserves on larger individual impaired credits that are based on the difference between the current loan balance and the loan’s collateral value, observable market price or discounted present value, (iii) a qualitative component that reflects current market conditions and other factors precedent to losses different from historical averages and (iv) a reserve for unfunded lending commitments.
In estimating the allowance for loan losses, management reviews the effect of changes in the local real estate market on collateral values, the effect of current economic indicators on the loan portfolio and their probable impact on borrowers and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management’s estimate of the allowance to increase or decrease and result in adjustments to the Company’s provision for loan losses. See—“Financial Condition—Allowance for Loan Losses and the Reserve for Unfunded Lending Commitments.”
Impairment of goodwill. The Company believes impairment of goodwill is a critical accounting estimate that requires significant judgment and estimates to be used in the preparation of its consolidated financial statements. The Company reviews goodwill for impairment on an annual basis, or more often, if events or circumstances indicate that it is more likely than not that the fair value of Metro United, the Company’s only reporting unit with assigned goodwill, is below the carrying value of its equity. The Company’s annual evaluation is performed as of August 31 of each year.
In determining the fair value of Metro United, the Company uses a review of the valuation of recent guideline bank acquisitions, if available, pricing of publicly traded comparables, as well as a discounted cash flow analysis and the market capitalization of the Company. The guideline bank transactions are selected from a similar geographic footprint as Metro United or having a similar market focus, based on publicly available information. Valuation multiples such as price-to-book, price-to-tangible book, price-to-deposits and price-to-earnings from the guideline transactions are compared with Metro United’s operating results to derive its estimated fair value as of the valuation date. For discounted cash flow analyses, financial forecasts are developed by projecting operations for the next five years and discounting the cash flows and the terminal values. The financial forecasts consider several key business drivers such as anticipated loan and deposit growth, forward interest rates, historical performance, and industry and economic trends, among other considerations. In addition, as a third method of determining fair value, quoted stock prices as of the valuation date for the Company and its peer guideline banks are used. The fair values of the reporting unit separately derived from each valuation technique (i.e., guideline transactions, discounted cash flows, and quoted market prices) are used to assess whether there is any goodwill impairment.
The Company also considers the fair value of Metro United in relationship to the Company’s stock price by performing a reconciliation to the Company’s market value. This reconciliation is performed by first determining the fair value of the reporting unit from the valuation technique mentioned previously (i.e. guideline transactions, discounted cash flows and quoted market prices). The fair value is compared to the allocated value of the reporting unit based on the Company’s market value using the stock price as of the valuation date. The Company allocates the total market value to both of its segments, MetroBank and Metro United. For each Bank, the allocation is based upon the following internal ratios:
Balance Sheet Ratios
• Total Bank assets as a percentage of total assets;
• Total Bank loans as a percentage of total loans;
• Total Bank deposits as a percentage of total deposits; and
• Total Bank shareholder's equity as a percentage of total shareholders' equity.
Performance Ratios
• Total Bank nonperforming assets as a percentage of total assets;
• Last twelve months return on assets; and
• Last twelve months return on equity.
In allocating the market value between the two Banks, more weight was assigned to the Performance Ratios than the Balance Sheet Ratios in order to account for the differences in market valuation as a result of different financial performance. The allocated market value of Metro United is then reconciled to the weighted average fair value derived from each valuation technique (i.e. guideline transactions, discounted cash flows and quoted market prices) by assigning an estimated control premium of 20% to the allocated market value.
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The derived fair value of Metro United is then compared with the carrying value of its equity. If the carrying value of its equity exceeds the fair value at the evaluation date, then the step-one impairment test would have failed, and the Company would perform the step-two analysis to derive the implied fair value of goodwill.
Under the step-two analysis, the implied fair value of goodwill is determined in the same manner as goodwill is recognized in a business combination. The fair value of Metro United’s assets and liabilities, including previously unrecognized intangible assets, is individually determined. The excess between the fair value of Metro United over the fair value of its net assets is the implied goodwill.
Impairment of investment securities. The Company believes impairment of investment securities is a critical accounting estimate that requires significant judgment and estimates to be used in the preparation of its consolidated financial statements. Investments classified as available-for-sale are carried at fair value and the impact of changes in fair value are recorded on the consolidated balance sheet as an unrealized gain or loss in accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Securities classified as available-for-sale or held-to-maturity are subject to review to identify when a decline in value is other-than-temporary. Factors considered in determining whether a decline in value is other-than-temporary include: the extent and the duration of the decline; the reasons for the decline in value (credit event, and interest-rate related including general credit spread widening); the financial condition of and near-term prospects of the issuer, and the Company’s intent to sell and whether or not it is more likely than not that the Company would be required to sell the security before the anticipated recovery of its amortized cost basis. When it is determined that an other-than-temporary impairment exists and the Company does not intend to sell the security or if it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the impairment is separated into the amount that is credit-related and the amount due to all other factors. The credit-related impairment is recognized in earnings.
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For debt securities, determining credit-related impairment is driven principally by assumptions regarding the amount and timing of projected cash flows. For mortgage-backed and asset-backed securities, cash flow estimates are determined based on prepayment assumptions, default rates and loss severity rates derived from widely accepted third-party data sources. The Company has developed these estimates using information based on historical experience as well as using market observable data, such as industry analyst reports and forecasts, sector credit ratings and other data relevant to the collectability of a security. See Note 2 “Securities” for additional discussion on other-than-temporary impairment.
Stock-based compensation. The Company believes stock-based compensation is a critical accounting estimate that requires significant judgment and estimates used in the preparation of its consolidated financial statements. The Company accounts for stock-based compensation in accordance with generally accepted accounting principles. The Company uses the Black-Scholes option-pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of the Company’s common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized on the consolidated statements of income.
Fair Value. The Company believes that the determination of fair value of certain assets is a critical accounting estimate that requires significant judgment used in the preparation of its consolidated financial statements. Certain portions of the Company’s assets are reported on a fair value basis. Fair value is used on a recurring basis for certain assets in which fair value is the primary basis of accounting. An example of this recurring use of fair value includes available-for-sale securities. Additionally, fair value is used on a non-recurring basis to evaluate assets for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include goodwill and intangible assets. Depending on the nature of the asset various valuation techniques and assumptions are used when estimating fair value.
Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Fair value determination requires that a number of significant judgments are made. First, where prices for identical assets and liabilities are not available, application of the three-level hierarchy would require that similar assets are identified. If observable market prices are unavailable or impracticable to obtain, then fair value is estimated using modeling techniques such as discounted cash flow analyses. These modeling techniques incorporate the Company’s assessments regarding assumptions that market participants would use in pricing the asset or the liability, including assumptions about the risks inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance. Assessments with respect to assumptions that market participants would make are inherently difficult to determine and use of different assumptions could result in material changes to these fair value measurements. The use of significant, unobservable inputs is described in Note 12 “Fair Value” to the consolidated financial statements.
In estimating the fair values for investment securities the Company believes that independent, third-party market prices are the best evidence of exit price and where available, estimates are based on such prices. If such third-party market prices are not available on the exact securities owned, fair values are based on the market prices of similar instruments, independent pricing service estimates or are estimated using industry-standard or proprietary models whose inputs may be unobservable. When market observable data is not available, the valuation of financial instruments becomes more subjective and involves substantial judgment. The need to use unobservable inputs generally results from the lack of market liquidity for certain types of loans and securities, which results in diminished observability of both actual trades and assumptions that would otherwise be available to value these instruments.
Income taxes. The Company believes that the determination of income taxes is a critical accounting estimate that requires significant judgment used in the preparation of its consolidated financial statements. The estimates and judgments occur in the calculation of tax credits, benefits, and deductions, in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes in these estimates may result in an increase or decrease to the Company’s tax provision in a subsequent period.
The Company must assess the likelihood that it will be able to recover its deferred tax assets. If recovery is not likely, it must increase the provision for taxes by recording a valuation allowance against the deferred tax assets that it estimates will not ultimately be recoverable. The Company believes that it will ultimately recover the deferred tax assets recorded in its consolidated balance sheets. However, should there be a change in the Company’s ability to recover its deferred tax assets, the tax provision would increase in the period in which it has determined that the recovery was not likely.
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| Item 3. | Quantitative and Qualitative Disclosures about Market Risk. |
There have been no material changes in the market risk information previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. See Form 10-K, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition — Interest Rate Sensitivity and Liquidity.”
| Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting. There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II
OTHER INFORMATION
| Item 1. | Legal Proceedings. |
The Company is involved in various litigation that arises from time to time in the normal course of business. In the opinion of management, after consultations with its legal counsel, such litigation is not expected to have a material adverse effect of the Company’s consolidated financial position, results of operations or cash flows.
| Item 1A. | Risk Factors. |
There have been no material changes to the risk factors previously disclosed under "Item 1A. Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission on March 21, 2013.
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| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
The following table provides information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Company’s common stock during the three months ended March 31, 2013:
| Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plan (2) | Maximum Number of Shares That May Yet Be Purchased Under the Plan (2) | ||||||||||||
| February 1, 2013 to February 28, 2013 | 20,210 | $ | 10.27 | N/A | N/A | |||||||||||
| March 1, 2013 to March 31, 2013 | 274 | 10.61 | N/A | N/A | ||||||||||||
| Total | 20,484 | $ | 10.27 | N/A | N/A | |||||||||||
| (1) | All shares of common stock reported in the table above were repurchased by the Company at the fair market value of the Company’s common stock in connection with the satisfaction of tax withholding obligations under restricted stock agreements between us and certain key employees and directors. | |
| (2) | The Company has no publicly announced plans or programs. |
| Item 3. | Defaults Upon Senior Securities. |
| Not applicable |
| Item 4. | Mine Safety Disclosures. Not applicable |
| Item 5. | Other Information. |
| Not applicable |
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| Item 6. | Exhibits. |
| Exhibit | ||
| Number | Identification of Exhibit | |
| 3.1 | Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (Registration No. 333-62667) (the "Registration Statement")). | |
| 3.2 | Articles of Amendment to Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008). | |
| 3.3 | Statement of Designations establishing the terms of the Series A Preferred Stock of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on January 21, 2009). | |
| 3.4 | Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on November 19, 2007). | |
| 4.1 | Specimen form of certificate evidencing the Common Stock (incorporated herein by reference to Exhibit 4 to the Registration Statement). | |
| 4.2 | Warrant, dated January 16, 2009, to purchase 771,429 shares of the Company's Common Stock (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on January 21, 2009). | |
| 11 | Computation of Earnings Per Common Share, included as Note 5 to the unaudited Condensed Consolidated Financial Statements of this Form 10-Q. | |
| 31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 32.1** | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2** | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 101* | Interactive Data File. | |
| * Filed herewith. |
| ** Furnished herewith. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| METROCORP BANCSHARES, INC. | |||
| By: | /s/ George M. Lee | ||
| Date: May 9, 2013 | George M. Lee Co-Chairman, President and | ||
| Chief Executive Officer (principal executive officer) | |||
| Date: May 9, 2013 | By: | /s/ David C. Choi | |
| David C. Choi | |||
| Chief Financial Officer (principal financial officer/ principal accounting officer) | |||
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EXHIBIT INDEX
| Exhibit | ||
| Number | Identification of Exhibit | |
| 3.1 | Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (Registration No. 333-62667) (the "Registration Statement")). | |
| 3.2 | Articles of Amendment to Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008). | |
| 3.3 | Statement of Designations establishing the terms of the Series A Preferred Stock of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on January 21, 2009). | |
| 3.4 | Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on November 19, 2007). | |
| 4.1 | Specimen form of certificate evidencing the Common Stock (incorporated herein by reference to Exhibit 4 to the Registration Statement). | |
| 4.2 | Warrant, dated January 16, 2009, to purchase 771,429 shares of the Company's Common Stock (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on January 21, 2009). | |
| 11 | Computation of Earnings Per Common Share, included as Note 5 to the unaudited Condensed Consolidated Financial Statements of this Form 10-Q. | |
| 31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
| 32.1** | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2** | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 101* | Interactive Data File. | |
| * Filed herewith. |
| ** Furnished herewith. |
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