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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
Commission file number: 000-50050
Center Financial Corporation
(Exact name of Registrant as specified in its charter)
California | 52-2380548 | |
(State of Incorporation) | (IRS Employer Identification No.) | |
3435 Wilshire Boulevard, Suite 700 Los Angeles, California | 90010 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code—(213) 251-2222
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
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. x Yes ¨ 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 ¨ 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 definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | x | |||
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 x
As of November 1, 2010, there were 39,902,811 outstanding shares of the issuer’s Common Stock with no par value.
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Index
3 | ||||
ITEM 1: INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) | 3 | |||
6 | ||||
31 | ||||
31 | ||||
37 | ||||
38 | ||||
44 | ||||
57 | ||||
60 | ||||
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 60 | |||
61 | ||||
62 | ||||
62 | ||||
62 | ||||
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | 62 | |||
62 | ||||
62 | ||||
62 | ||||
63 | ||||
65 |
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Item 1: | INTERIM CONSOLIDATED FINANCIAL STATEMENTS |
CENTER FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
AS OF SEPTEMBER 30 AND DECEMBER 31
09/30/2010 | 12/31/2009 | |||||||
(Dollars in thousands) | ||||||||
ASSETS | ||||||||
Cash and due from banks | $ | 33,491 | $ | 34,294 | ||||
Federal funds sold | 198,285 | 145,810 | ||||||
Interest-bearing deposits in other banks | 89,236 | 52,698 | ||||||
Cash and cash equivalents | 321,012 | 232,802 | ||||||
Securities available for sale, at fair value | 290,803 | 370,427 | ||||||
Non-covered loans held for sale, at the lower of cost or fair value | 50,723 | 23,318 | ||||||
Federal Home Loan Bank and Pacific Coast Bankers Bank stock, at cost | 15,642 | 15,673 | ||||||
Non-covered loans, net of allowance for loan losses of $54,460 as of September 30, 2010 and $58,543 as of December 31, 2009 | 1,361,051 | 1,455,824 | ||||||
Covered loans | 112,674 | — | ||||||
Premises and equipment, net | 13,698 | 13,368 | ||||||
FDIC loss share receivable | 23,652 | — | ||||||
Core deposit intangibles, net | 474 | — | ||||||
Customers’ liability on acceptances | 1,412 | 2,341 | ||||||
Non-covered other real estate owned | 4,548 | 4,278 | ||||||
Covered other real estate owned | 1,459 | — | ||||||
Accrued interest receivable | 5,487 | 6,879 | ||||||
Deferred income taxes, net | 10,095 | 11,551 | ||||||
Investments in affordable housing partnerships | 10,314 | 11,522 | ||||||
Cash surrender value of life insurance | 12,691 | 12,392 | ||||||
Income tax receivable | 16,354 | 16,140 | ||||||
Prepaid regulatory assessment fees | 8,808 | 11,483 | ||||||
Other assets | 6,542 | 4,802 | ||||||
Total | $ | 2,267,439 | $ | 2,192,800 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Liabilities | ||||||||
Deposits: | ||||||||
Noninterest-bearing | $ | 383,508 | $ | 352,395 | ||||
Interest-bearing | 1,408,773 | 1,395,276 | ||||||
Total deposits | 1,792,281 | 1,747,671 | ||||||
Acceptances outstanding | 1,412 | 2,341 | ||||||
Accrued interest payable | 5,558 | 5,803 | ||||||
Other borrowed funds | 168,538 | 148,443 | ||||||
Long-term subordinated debentures | 18,557 | 18,557 | ||||||
Accrued expenses and other liabilities | 10,403 | 13,927 | ||||||
Total liabilities | 1,996,749 | 1,936,742 | ||||||
Commitments and Contingencies | — | — | ||||||
Shareholders’ Equity | ||||||||
Preferred stock, no par value; 10,000,000 shares authorized; issued and outstanding, 55,000 shares and 128,500 shares as of September 30, 2010 and December 31, 2009, respectively | ||||||||
Series A, cumulative, issued and outstanding, 55,000 shares as of September 30, 2010 and December 31, 2009 | 53,347 | 53,171 | ||||||
Series B, non-cumulative, convertible, issued and outstanding, none and 73,500 shares as of September 30, 2010 and December 31, 2009, respectively | — | 70,000 | ||||||
Common stock, no par value; 100,000,000 and 40,000,000 shares authorized; issued and outstanding, 39,902,811 and 20,160,726 shares (including 65,784 shares and 10,050 of unvested restricted stock) as of September 30, 2010 and December 31, 2009, respectively | 187,621 | 88,060 | ||||||
Retained earnings | 26,300 | 41,314 | ||||||
Accumulated other comprehensive income, net of tax | 3,422 | 3,513 | ||||||
Total shareholders’ equity | 270,690 | 256,058 | ||||||
Total | $ | 2,267,439 | $ | 2,192,800 | ||||
See accompanying notes to interim consolidated financial statements.
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CENTER FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||
Interest and Dividend Income: | ||||||||||||||||
Interest and fees on loans | $ | 22,513 | $ | 23,128 | $ | 64,529 | $ | 72,181 | ||||||||
Interest on federal funds sold | 127 | 162 | 289 | 310 | ||||||||||||
Interest on taxable investment securities | 1,481 | 2,380 | 7,252 | 6,955 | ||||||||||||
Interest on tax-advantaged investment securities | — | 2 | — | 12 | ||||||||||||
Dividends on equity stock | 18 | 33 | 39 | 37 | ||||||||||||
Money market funds and interest-earning deposits | — | 11 | 11 | 56 | ||||||||||||
Total interest and dividend income | 24,139 | 25,716 | 72,120 | 79,551 | ||||||||||||
Interest Expense: | ||||||||||||||||
Interest on deposits | 5,137 | 9,031 | 15,658 | 27,668 | ||||||||||||
Interest on borrowed funds | 1,747 | 1,736 | 5,021 | 5,336 | ||||||||||||
Interest expense on trust preferred securities | 155 | 156 | 438 | 529 | ||||||||||||
Total interest expense | 7,039 | 10,923 | 21,117 | 33,533 | ||||||||||||
Net interest income before provision for loan losses | 17,100 | 14,793 | 51,003 | 46,018 | ||||||||||||
Provision for loan losses | 4,000 | 10,561 | 16,000 | 54,847 | ||||||||||||
Net interest income (loss) after provision for loan losses | 13,100 | 4,232 | 35,003 | (8,829 | ) | |||||||||||
Noninterest Income: | ||||||||||||||||
Customer service fees | 2,043 | 2,008 | 6,161 | 6,004 | ||||||||||||
Fee income from trade finance transactions | 684 | 543 | 2,062 | 1,679 | ||||||||||||
Wire transfer fees | 321 | 275 | 933 | 820 | ||||||||||||
Gain on business acquisition | — | — | 5,900 | — | ||||||||||||
Gain on sale of loans | 257 | — | 1,460 | — | ||||||||||||
Net gain (loss) on sale of securities available for sale | — | (7 | ) | 2,209 | (55 | ) | ||||||||||
Loan service fees | 565 | 167 | 1,153 | 626 | ||||||||||||
Other income | 539 | 356 | 1,279 | 1,480 | ||||||||||||
Total noninterest income | 4,409 | 3,342 | 21,157 | 10,554 | ||||||||||||
Noninterest Expense: | ||||||||||||||||
Salaries and employee benefits | 4,653 | 4,671 | 13,640 | 13,645 | ||||||||||||
Occupancy | 1,388 | 1,214 | 4,020 | 3,644 | ||||||||||||
Furniture, fixtures, and equipment | 756 | 713 | 1,903 | 1,757 | ||||||||||||
Data processing | 832 | 591 | 1,950 | 1,708 | ||||||||||||
Legal fees | 567 | 174 | 1,152 | 824 | ||||||||||||
Accounting and other professional fees | 309 | 425 | 1,170 | 1,187 | ||||||||||||
Business promotion and advertising | 376 | 289 | 1,048 | 971 | ||||||||||||
Supplies and communications | 440 | 368 | 1,100 | 1,096 | ||||||||||||
Security service | 320 | 269 | 840 | 775 | ||||||||||||
Regulatory assessment | 1,073 | 642 | 3,096 | 2,876 | ||||||||||||
Merger related expenses | — | — | 129 | — | ||||||||||||
OREO related expenses | 170 | 1,152 | 1,529 | 1,305 | ||||||||||||
Other operating expenses | 1,508 | 1,195 | 3,950 | 3,807 | ||||||||||||
Total noninterest expense | 12,392 | 11,703 | 35,527 | 33,595 | ||||||||||||
Income (loss) before income tax provision (benefit) | 5,117 | (4,129 | ) | 20,633 | (31,870 | ) | ||||||||||
Income tax provision (benefit) | (846 | ) | (1,605 | ) | 4,400 | (13,834 | ) | |||||||||
Net income (loss) | 5,963 | (2,524 | ) | 16,233 | (18,036 | ) | ||||||||||
Preferred stock dividends and accretion of preferred stock discount | (748 | ) | (742 | ) | (31,246 | ) | (2,211 | ) | ||||||||
Net income (loss) available to common shareholders | 5,215 | (3,266 | ) | (15,013 | ) | (20,247 | ) | |||||||||
Comprehensive income (loss): | ||||||||||||||||
Net income (loss) | $ | 5,963 | $ | (2,524 | ) | $ | 16,233 | $ | (18,036 | ) | ||||||
Other comprehensive income (loss) - unrealized gain (loss) on available-for-sale securities, net of income tax benefit (expense) of $78, $991, ($49), and $2,167, respectively | 144 | 1,365 | (91 | ) | 2,991 | |||||||||||
Comprehensive income (loss) | $ | 6,107 | $ | (1,159 | ) | $ | 16,142 | $ | (15,045 | ) | ||||||
Earnings (loss) per common share: | ||||||||||||||||
Basic | $ | 0.13 | $ | (0.19 | ) | $ | (0.44 | ) | $ | (1.21 | ) | |||||
Diluted | $ | 0.13 | $ | (0.19 | ) | $ | (0.44 | ) | $ | (1.21 | ) | |||||
Average common shares outstanding: | ||||||||||||||||
Basic | 39,902,114 | 16,788,950 | 33,762,755 | 16,787,986 | ||||||||||||
Diluted | 39,912,160 | 16,788,950 | 33,762,755 | 16,787,986 | ||||||||||||
See accompanying notes to interim consolidated financial statements.
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CENTER FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30
2010 | 2009 | |||||||
(Dollars in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | 16,233 | $ | (18,036 | ) | |||
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: | ||||||||
Compensation expenses related to stock options and restricted stock | 553 | 726 | ||||||
Depreciation and amortization | 3,264 | 2,931 | ||||||
Amortization of deferred fees | (190 | ) | (589 | ) | ||||
Amortization of premium, net of accretion of discount, on securities available for sale and held to maturity | (59 | ) | 425 | |||||
Provision for loan losses | 16,000 | 54,847 | ||||||
Net (gain) loss on sale of securities available for sale | (2,209 | ) | 55 | |||||
Gain on Innovative acquisition | (5,900 | ) | — | |||||
Accretion of FDIC loss share receivable | (105 | ) | — | |||||
Net increase of loans held for sale | (45,750 | ) | (7,925 | ) | ||||
Gain on sale of loans | (1,460 | ) | — | |||||
Proceeds from sale of loans held for sale | 19,805 | 12,066 | ||||||
Loss on sale of non-covered OREO | 15 | — | ||||||
Valuation adjustment on non-covered OREO | 994 | — | ||||||
Valuation adjustment on covered OREO | 29 | — | ||||||
Deferred tax expense (benefit) provision | 1,505 | (7,981 | ) | |||||
Decrease (increase) in accrued interest receivable | 1,392 | (202 | ) | |||||
Net increase in cash surrender value of life insurance policy | (299 | ) | — | |||||
Increase in income tax receivable | (214 | ) | — | |||||
Decrease in prepaid assessment | 2,675 | — | ||||||
Increase in other assets | (1,035 | ) | (18,988 | ) | ||||
Decrease in accrued interest payable | (2,037 | ) | (160 | ) | ||||
(Decrease) increase in accrued expenses and other liabilities | (4,454 | ) | 1,403 | |||||
Net cash (used in) provided by operating activities | (1,247 | ) | 18,572 | |||||
Cash flows from investing activities: | ||||||||
Purchase of securities available for sale | (88,390 | ) | (124,166 | ) | ||||
Proceeds from principal repayment, matured, or called securities available for sale | 122,304 | 35,713 | ||||||
Proceeds from sale of securities available for sale | 59,745 | 22,250 | ||||||
Net decrease in investment in Federal Home Loan Bank and other equity stock | 1,249 | — | ||||||
Net decrease in non-covered loans | 32,888 | 91,989 | ||||||
Net decrease in covered loans | 11,821 | — | ||||||
Proceeds from sale of loans acquired for investment | 36,971 | — | ||||||
Proceeds from recoveries of loans previously charged off | 4,544 | 599 | ||||||
Proceeds from FDIC loss share receivable | 1,753 | |||||||
Purchases of premises and equipment | (1,889 | ) | (454 | ) | ||||
Proceeds from sale of non-covered OREO | 3,180 | 6,000 | ||||||
Proceeds from sale of covered OREO | 2,126 | — | ||||||
Net cash acquired from business combination inclusive of settlement received from FDIC | 71,505 | — | ||||||
Net decrease in investments in affordable housing partnerships | 131 | — | ||||||
Net cash provided by investing activities | 257,938 | 31,931 | ||||||
Cash flows from financing activities: | ||||||||
Net (decrease) increase in deposits | (164,697 | ) | 206,696 | |||||
Net decrease in other borrowed funds | (1,720 | ) | (45,216 | ) | ||||
Proceeds from stock options exercised | — | 46 | ||||||
Write-off of previously recognized tax benefit related to compensation expenses | — | (522 | ) | |||||
Payment of cash dividend | (2,064 | ) | (2,695 | ) | ||||
Net cash (used in) provided by financing activities | (168,481 | ) | 158,309 | |||||
Net increase in cash and cash equivalents | 88,210 | 208,812 | ||||||
Cash and cash equivalents, beginning of the period | 232,802 | 98,211 | ||||||
Cash and cash equivalents, end of the period | $ | 321,012 | $ | 307,023 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Interest paid | $ | 23,585 | $ | 33,693 | ||||
Income taxes paid | $ | 826 | $ | 2,300 | ||||
Supplemental schedule of noncash investing, operating, and financing activities: | ||||||||
Cash dividend accrual for preferred stock | $ | 344 | $ | 344 | ||||
Cash dividend accrual for common stock | $ | — | $ | — | ||||
Accretion of preferred stock discount | $ | 175 | $ | 156 | ||||
Transfer of non-covered loans to non-covered loans held for sale | $ | 12,784 | $ | — | ||||
Transfer of non-covered loans to non-covered OREO | $ | 4,560 | $ | 12,028 | ||||
Transfer of covered loans to covered OREO | $ | 1,672 | $ | — | ||||
Acquisition: | ||||||||
Assets acquired | $ | 219,797 | $ | — | ||||
Liabilities assumed | $ | 232,485 | $ | — |
See accompanying notes to interim consolidated financial statements.
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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. THE BUSINESS OF CENTER FINANCIAL CORPORATION
Center Financial Corporation (“Center Financial”) is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is headquartered in Los Angeles, California. Center Financial Corporation (“Center Financial”) was incorporated on April 19, 2000 and acquired all of the issued and outstanding shares of Center Bank (the “Bank”) in October 2002. Currently, Center Financial’s direct subsidiaries include the Bank and Center Capital Trust I. Center Financial exists primarily for the purpose of holding the stock of the Bank and of the other subsidiary and for providing access to capital and funding for the Bank. Center Financial, the Bank, and Center Capital Trust I are collectively referred to herein as the “Company.”
The Bank is a California state-chartered and FDIC-insured financial institution, which was incorporated in 1985 and commenced operations in March 1986. The Bank’s headquarters are located at 3435 Wilshire Boulevard, Suite 700, Los Angeles, California 90010. The Bank provides comprehensive financial services for small to medium sized business owners, primarily in California. The Bank specializes in commercial loans, which are mostly secured by real property, to multi-ethnic and small business customers. In addition, the Bank is a Preferred Lender of Small Business Administration (“SBA”) loans and provides trade finance loans and other international banking products.
On April 16, 2010, the California Department of Financial Institutions closed Innovative Bank, Oakland, California, and appointed the Federal Deposit Insurance Corporation (“FDIC”) as its receiver. On the same date, Center Bank assumed the banking operations of Innovative Bank from the FDIC under a purchase and assumption agreement with loss sharing. After this acquisition, the Bank has 22 full-service branch offices.
2. BASIS OF PRESENTATION
The interim consolidated financial statements include the accounts of Center Financial and the Bank. Center Capital Trust I is not consolidated as disclosed in Note 12.
The interim consolidated financial statements are presented in accordance with U.S. generally accepted accounting principles (“GAAP”) for unaudited financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for the fair statement of results for the periods presented. All adjustments are of a normal and recurring nature. Results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. The interim consolidated financial statements should be read in conjunction with the audited financial statements and notes included in the Company’s annual report on Form 10-K, as amended, for the year ended December 31, 2009.
Use of estimates
Management has made a number of estimates and assumptions related to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in accordance with GAAP. Actual results could differ from those estimates. Material estimates subject to change in the near term include, among other items, the allowance for credit losses, the carrying value of other real estate owned, the carrying value of intangible assets, the carrying value of the FDIC loss share receivable and the realization of deferred tax assets. As discussion in Note 5 below, the acquired assets and assumed liabilities of Innovative Bank in an FDIC-assisted transaction were measured at estimated fair value. Management made significant estimates and exercised significant judgment in estimating fair value and accounting for the acquisition of Innovative Bank.
Reclassifications
Reclassifications have been made to the prior year financial statements to conform to the current presentation.
3. SIGNIFICANT ACCOUNTING POLICIES
Accounting policies are fully described in Note 2 to the consolidated financial statements in Center Financial’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2009 and there have been no material changes noted.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
4. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2009, the FASB issuedFASB Accounting Standards Update (“ASU”) 2009-16, Accounting for Transfers of Financial Assets (Statement 166), which amends ASC Topic 860 (FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities). These eliminate the Qualified Special Purpose Entity (“QSPE”) concept, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies the derecognition criteria, revises how retained interests are initially measured, and removes the guaranteed mortgage securitization recharacterization provisions. This ASU requires additional disclosures for non-public companies that are similar to the disclosures previously required for public companies by FASB Staff Position FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” This ASU is effective as of the beginning of a company’s first fiscal year that begins after November 15, 2009 (January 1, 2010 for calendar year-end companies), and for subsequent interim and annual reporting periods. The disclosure requirements must be applied to transfers that occurred before and after its effective date. Early adoption is prohibited. The Company adopted this new accounting pronouncement as of January 1, 2010 and the impact of adoption was not material on the consolidated financial statements.
In January 2010, the FASB issuedFASB ASU 2010-06, Improving Disclosures about Fair Value Measurements, which amends ASC 820 to require additional disclosures regarding fair value measurements. Specifically, the ASU requires disclosure of the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfers in or out of Level 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. In addition to these new disclosure requirements, the ASU also amends ASC 820 to clarify certain existing disclosure requirements. For example, the ASU clarifies that reporting entities are required to provide fair value measurement disclosures for each class of assets and liabilities. Previously separate fair value disclosures were required for each major category of assets and liabilities. ASU 2010-06 also clarifies the requirement to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. Except for the requirement to disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis, these disclosures are effective for the quarter ended March 31, 2010. The requirement to separately disclose purchases, sales, issuances, and settlements of recurring Level 3 measurements becomes effective for the Corporation for the quarter ended March 31, 2011. The Company adopted this new accounting pronouncement as of January 1, 2010 and the impact of adoption was not material on the consolidated financial statements.
The FASB issuedFASB ASU 2010-18, Effect of a Loan Modification When The Loan Is Part of a Pool That Is Accounted for as a Single Asset, a consensus of the FASB Emerging Issues Task Force (Issue No. 09-I), which amends This ASU amends FASB ASC Subtopic 310-30,Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality, so that modifications of loans that are accounted for within a pool under that Subtopic do not result in the removal of the loans from the pool even if the modifications of the loans would otherwise be considered a troubled debt restructuring. A one-time election to terminate accounting for loans in a pool, which may be made on a pool-by-pool basis, is provided upon adoption of the new guidance. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. The amendments in this ASU are effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The Company adopted this new accounting pronouncement as of July 1, 2010 and the impact of adoption was not material on the consolidated financial statements.
In July 2010, the FASB issued FASB ASU 2010-20,Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which will required more information about credit quality. The ASU introduces the term “financing receivables”, which includes loans, trade accounts receivable, notes receivable, credit cards, leveraged leases, direct financing leases, and sales-type leases. The term does not include receivables measured at fair value or the lower of cost of fair value and debt securities among others. It also defines two levels of disaggregation for disclosure: portfolio segment and class of financing receivables. A portfolio segment is defined as the level at which an entity determines its allowance for credit losses. A class of financing receivable is defined as a group of finance receivables determined on the basis of their initial measurement attribute (i.e., amortized cost of purchased credit impaired), risk characteristics, and an entity’s method for monitoring and assessing credit risk. The ASU requires an entity to provide additional disclosures including, but not limited to, a rollforward schedule of the allowance for credit losses (with the ending allowance balance further disaggregated based on impairment methodology) and the related ending balance of the finance receivable presented by portfolio segment, and the aging of past due financing receivables at the end of the period, the nature and extent of troubled debt restructurings that occurred during the period and their impact on the allowance for credit losses, the nature and extend of troubled debt restructurings that occurred within the last year, that have defaulted in the current reporting period, and their impact on the allowance for credit losses, the nonaccrual status of financing receivables, and impaired financing receivables, presented by class. The extensive new disclosures of information as of the end of a reporting
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
period will become effective for both interim and annual reporting periods ending after December 15, 2010 for public companies. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures will be required for periods beginning after December 15, 2010 for public companies. The Company is currently in the process of assessing the impact of this pronouncement on the consolidated financial statements.
5. ACCOUNTING FOR BENEFICIAL CONVERSION FEATURE OF PREFERRED STOCK
On August 11, 2010, while completing its second quarter Form 10-Q, the Company identified an omission in its accounting for the issuance and conversion of its Series B Preferred Stock in that it did not quantify the value of the beneficial conversion feature of the Series B Preferred Stock. The revised calculations relate to the intrinsic value of the beneficial conversion feature of the Series B Preferred Stock. The Company has “no par” common and preferred stock and all additional paid-in capital transactions are recorded in the respective preferred and common stock category. As further discussed in Note 17, Preferred Stock and Common Stock Warrants, the Company issued 73,500 shares of Series B Preferred Stock for a gross purchase price of $73.5 million on December 31, 2009 with an earliest potential redemption date of December 31, 2014 and, upon receiving shareholder approval, a beneficial mandatory conversion into common stock at a conversion price of $3.75. The market value of the Company’s common stock on December 29, 2009, the commitment date for the preferred stock issuance, was $5.23 per share. The beneficial conversion feature of the preferred stock had an intrinsic value on December 29, 2009 of $29,007,972, based on the difference between the conversion price of $3.75 per share and the market value of the Company’s common stock at the commitment date. The accretion of the beneficial conversion feature was recognized upon shareholder approval, and was recognized on the actual date of conversion of March 29, 2010. The calculation of net income available for common shareholders and basic earnings per share was restated for the quarter ended March 31, 2010 to properly reflect the accretion of beneficial conversion discount on the preferred stock. The Company adjusted the balances of its common stock and retained earnings accounts as of March 31, 2010 to reflect the discount accretion of $29,007,973.
6. BUSINESS COMBINATION
On April 16, 2010, the California Department of Financial Institutions closed Innovative Bank, Oakland, California, and appointed the Federal Deposit Insurance Corporation (“FDIC”) as its receiver. On the same date, Center Bank acquired assets and assumed liabilities related to the banking operations of Innovative Bank from the FDIC under a purchase and assumption agreement with loss sharing.
Center Bank assumed both the insured and non-insured deposits balance, at a premium of 0.5 percent. The loss sharing agreement between the FDIC and Center Bank, which covers all loans and other real estate owned that have been assumed, and the business combination fair value adjustments, significantly mitigates the risk of future loss on the loan portfolio acquired. Under the terms of the loss sharing agreement, the FDIC will absorb 80% of losses and share in 80% of loss recoveries. The reimbursed losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the assumption. New loans made after that date are not covered by the loss sharing agreement.
Upon closing of the transaction, Center Bank was entitled to receive approximately $20.0 million, of which $18.9 million was received in April 2010, in cash for asset discount and negative transaction equity net of deposit premium paid. As part of the transaction, the FDIC received one million Equity Appreciation Instruments (“EAI”) based on Center Financial’s stock price and exercised all EAI’s realizing a gain of approximately $1.4 million on April 26, 2010. The value of the EAI in the amount of $1.4 million was included as additional acquisition cost in the calculation of the bargain purchase gain.
The acquired loan portfolio and other real estate owned are referred to as “covered loans” and “covered other real estate owned”, respectively, and these are presented as separate line items in the consolidated statements of financial condition. Collectively these balances are referred to as “covered assets”.
The assets acquired and liabilities assumed for Innovative Bank have been accounted for under the acquisition method of accounting (formerly referred to as the purchase method) in accordance with FASB ASC 805,Business Combinations. The assets and liabilities were recorded at their estimated fair values as of the acquisition date. The foregoing fair value amounts are subject to change for up to one year after the closing date of the acquisition as additional information relating to closing date fair values becomes available. The amounts are also subject to adjustments based upon final settlement with the FDIC. In addition, the tax treatment of FDIC assisted acquisitions is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date. The terms of the agreements provide for the FDIC to indemnify the Bank against claims with respect to liabilities of Innovative Bank not assumed by the Bank and certain other types of claims identified in the agreement.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
In FDIC-assisted transactions, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer’s bid, the FDIC may be required to make a cash payment to the acquirer. In the Innovative Bank acquisition, cost basis net assets (liabilities) of $(1.5) million were transferred to the Bank. The bargain purchase gain represents the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed.
The Bank did not immediately acquire all the real estate, banking facilities, furniture or equipment as part of the purchase and assumption agreement. However, pursuant to an option to purchase or lease the real estate and furniture and equipment from the FDIC, which expired 90 days from the acquisition date, the Company acquired certain furniture and equipment from the FDIC in July 2010. Acquisition costs of the furniture and equipment were based on current appraisals and determined at the purchase date.
A summary of the net assets (liabilities) received from the FDIC and the estimated fair value adjustments resulting in the bargain purchase gain are presented below:
Received from FDIC | Fair Value Adjustments | Recorded by Center | ||||||||||
(Dollars in thousands) | ||||||||||||
Assets acquired: | ||||||||||||
Cash and due from banks | $ | 49,905 | $ | — | $ | 49,905 | ||||||
Investment securities | 11,907 | — | 11,907 | |||||||||
FHLB stock | 1,218 | — | 1,218 | |||||||||
Fed Fund Sold | 2,700 | — | 2,700 | |||||||||
Loans, net | 162,248 | (36,081 | ) | 126,167 | ||||||||
OREO | 2,132 | (190 | ) | 1,942 | ||||||||
FDIC loss share receivable | — | 25,300 | 25,300 | |||||||||
Core deposit intangible | — | 510 | 510 | |||||||||
Other assets | (467 | ) | 615 | 148 | ||||||||
Total assets acquired | 229,643 | (9,846 | ) | 219,797 | ||||||||
Liabilities assumed: | ||||||||||||
Deposits | 209,309 | — | 209,309 | |||||||||
FHLB borrowings | 20,045 | 1,384 | 21,429 | |||||||||
Deferred tax liability | — | — | 2,481 | |||||||||
Other liabilities | 1,747 | — | 1,747 | |||||||||
Total liabilities assumed | 231,101 | 1,384 | 234,966 | |||||||||
Net assets (liabilities) acquired | $ | (1,458 | ) | $ | (11,230 | ) | $ | (15,169 | ) | |||
Aggregate fair value adjustments | $ | (11,230 | ) | |||||||||
Net assets (liabilities) acquired | $ | (15,169 | ) | |||||||||
Net settlement from FDIC | 20,024 | |||||||||||
Value of equity appreciation instrument to FDIC | (1,436 | ) | ||||||||||
Bargain purchase gain on Innovative acquisition, net of deferred tax |
| $ | 3,419 | |||||||||
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
7. INVESTMENT SECURITIES
The following table summarizes the amortized cost, fair value and distribution of the Company’s investment securities as of the dates indicated:
As of September 30, 2010 | ||||||||||||||||
(Dollars in thousands) | Amortized Cost | Gross Unrealized Gain | Gross Unrealized Loss | Fair Value | ||||||||||||
Available for Sale: | ||||||||||||||||
U.S. Treasury | $ | 300 | $ | — | $ | — | $ | 300 | ||||||||
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities | 53,037 | 203 | — | 53,240 | ||||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 152,585 | 4,916 | — | 157,501 | ||||||||||||
Corporate trust preferred security | 2,730 | — | (1,017 | ) | 1,713 | |||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,500 | 187 | — | 4,687 | ||||||||||||
Collateralized mortgage obligations | 72,386 | 1,051 | (75 | ) | 73,362 | |||||||||||
Total securities available for sale | $ | 285,538 | $ | 6,357 | $ | (1,092 | ) | $ | 290,803 | |||||||
Total investment securities | $ | 285,538 | $ | 6,357 | $ | (1,092 | ) | $ | 290,803 | |||||||
As of December 31, 2009 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gain | Gross Unrealized Loss | Fair Value | |||||||||||||
Available for Sale: | ||||||||||||||||
U.S. Treasury | $ | 300 | $ | — | $ | — | $ | 300 | ||||||||
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities | 74,001 | 274 | (5 | ) | 74,270 | |||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 206,975 | 5,358 | (158 | ) | 212,175 | |||||||||||
Corporate trust preferred security | 2,713 | — | (309 | ) | 2,404 | |||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,500 | 33 | — | 4,533 | ||||||||||||
Collateralized mortgage obligations | 76,533 | 728 | (516 | ) | 76,745 | |||||||||||
Total securities available for sale | $ | 365,022 | $ | 6,393 | $ | (988 | ) | $ | 370,427 | |||||||
Total investment securities | $ | 365,022 | $ | 6,393 | $ | (988 | ) | $ | 370,427 | |||||||
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table shows the Company’s investments with gross unrealized losses and related fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2010 and December 31, 2009.
As of September 30, 2010 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities | $ | 29 | $ | — | $ | — | $ | — | $ | 29 | $ | — | ||||||||||||
Corporate trust preferred security | 1,713 | (1,017 | ) | — | — | 1,713 | (1,017 | ) | ||||||||||||||||
Collateralized mortgage obligations | 11,614 | (75 | ) | — | — | 11,614 | (75 | ) | ||||||||||||||||
Total | $ | 13,356 | $ | (1,092 | ) | — | — | $ | 13,356 | $ | (1,092 | ) | ||||||||||||
As of December 31, 2009 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise securities | $ | 7,988 | $ | (5 | ) | $ | — | $ | — | $ | 7,988 | $ | (5 | ) | ||||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities | 30,070 | (144 | ) | 937 | (14 | ) | 31,007 | (158 | ) | |||||||||||||||
Corporate trust preferred security | 2,404 | (309 | ) | — | — | 2,404 | (309 | ) | ||||||||||||||||
Collateralized mortgage obligations | 41,880 | (516 | ) | — | — | 41,880 | (516 | ) | ||||||||||||||||
Total | $ | 82,342 | $ | (974 | ) | $ | 937 | $ | (14 | ) | $ | 83,279 | $ | (988 | ) | |||||||||
The Company does not consider the securities included in the table above to be other than temporarily impaired as of September 30, 2010.
The following table summarizes, as of September 30, 2010, the maturity characteristics of the investment portfolio, by investment category. Expected remaining maturities may differ from remaining contractual maturities because obligors may have the right to prepay certain obligations with or without penalties.
After One But Within Five Years | After Five But Within Ten Years | |||||||||||||||||||||||||||||||||||||||
Within one Year | After Ten Years | Total | ||||||||||||||||||||||||||||||||||||||
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||
Available for Sale (Fair Value): | ||||||||||||||||||||||||||||||||||||||||
U.S. Treasury | $ | 300 | 0.22 | % | $ | — | — | % | $ | — | 0 | % | $ | — | 0 | % | $ | 300 | 0.22 | % | ||||||||||||||||||||
U.S. Governmental agencies securities and U.S Government sponsored enterprise securities | — | — | 51,237 | 1.46 | 2,003 | 1.07 | — | — | 53,240 | 1.45 | ||||||||||||||||||||||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 6 | 5.77 | 1,808 | 4.62 | 41,878 | 3.00 | 113,809 | 3.47 | 157,501 | 3.36 | ||||||||||||||||||||||||||||||
Corporate trust preferred securities | — | — | — | — | — | — | 1,713 | 12.24 | 1,713 | 12.24 | ||||||||||||||||||||||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,687 | 3.52 | — | — | — | — | — | — | 4,687 | 3.52 | ||||||||||||||||||||||||||||||
Collateralized mortgage obligations | — | — | — | — | 13,354 | 1.92 | 60,008 | 2.81 | 73,362 | 2.65 | ||||||||||||||||||||||||||||||
Total available for sale | $ | 4,993 | 3.32 | $ | 53,045 | 1.57 | $ | 57,235 | 2.68 | $ | 175,530 | 3.33 | $ | 290,803 | 2.88 | |||||||||||||||||||||||||
8. NON-COVERED LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Non-covered loans refer to loans not covered by the FDIC loss sharing agreement. Loans acquired in a FDIC assisted acquisition that are subject to a loss sharing agreement are referred to as “covered loans” and reported separately in the consolidated statements of financial condition.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table sets forth the composition of the allowance for loan losses on non-covered loans as of September 30, 2010 and December 31, 2009:
September 30, 2010 | December 31, 2009 | |||||||
(Dollars in thousands) | ||||||||
Specific (Impaired loans) | $ | 8,282 | $ | 2,656 | ||||
Formula (non-homogeneous) | 45,694 | 55,539 | ||||||
Homogeneous | 484 | 348 | ||||||
Total allowance for loan losses | $ | 54,460 | $ | 58,543 | ||||
The table below summarizes the activity in the Company’s allowance for loan losses on non-covered loans for the periods and as of dates indicated:
Nine Months | Nine Months | |||||||||||
Ended | Year Ended | Ended | ||||||||||
September 30, | December 31, | September 30, | ||||||||||
2010 | 2009 | 2009 | ||||||||||
(Dollars in thousands) | ||||||||||||
Allowance for Loan Losses: | ||||||||||||
Balance at beginning of period | $ | 58,543 | $ | 38,172 | $ | 38,172 | ||||||
Charge-offs | 24,627 | 57,832 | 29,640 | |||||||||
Recoveries | 4,544 | 731 | 599 | |||||||||
Net loan charge-offs | 20,083 | 57,101 | 29,041 | |||||||||
Provision for loan losses | 16,000 | 77,472 | 54,847 | |||||||||
Balance at end of period | $ | 54,460 | $ | 58,543 | $ | 63,978 | ||||||
Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due as scheduled according to the contractual terms of the loan agreement, including contractual interest and principal payments. Impaired loans are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, alternatively, at the loan’s observable market price or the fair value of the collateral if the loan is collateralized, less costs to sell. Loans are identified for specific allowances from information provided by several sources including asset classification, third party reviews, delinquency reports, periodic updates to financial statements, public records, and industry reports. All loan types are subject to impairment evaluation for a specific allowance once identified as impaired.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table provides information on non-covered impaired loans:
Impaired Loans | ||||||||||||||||||||
At September 30, 2010 | ||||||||||||||||||||
Allowance as a | Cumulative | Cumulative Charge-off as a % of | ||||||||||||||||||
Balance | Allowance | % of Balance | Charge-off | Original Balance | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
With no allocated allowance | ||||||||||||||||||||
Without charge-off | $ | 44,961 | $ | — | — | % | $ | — | — | % | ||||||||||
With charge-off | 9,150 | — | — | 7,778 | 45.9 | |||||||||||||||
With allocated allowance | ||||||||||||||||||||
Without charge-off | 39,645 | 7,992 | 20.2 | — | 0.0 | |||||||||||||||
With charge-off | 5,199 | 290 | 5.6 | 2,317 | 30.8 | |||||||||||||||
Total | $ | 98,955 | $ | 8,282 | 8.4 | % | $ | 10,095 | 9.3 | % | ||||||||||
Allowance allocated to impaired loans as a percentage of impaired loans with allowance allocated | 18.5 | % | ||||||||||||||||||
Impaired Loans | ||||||||||||||||||||
At December 31, 2009 | ||||||||||||||||||||
Allowance as a | Cumulative | Cumulative Charge-off as a % of | ||||||||||||||||||
Balance | Allowance | % of Balance | Charge-off | Original Balance | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
With no allocated allowance | ||||||||||||||||||||
Without charge-off | $ | 32,768 | $ | — | — | % | $ | — | — | % | ||||||||||
With charge-off | 22,290 | — | — | 11,864 | 34.7 | |||||||||||||||
With allocated allowance | ||||||||||||||||||||
Without charge-off | 17,579 | 2,071 | 11.8 | — | 0.0 | |||||||||||||||
With charge-off | 4,466 | 579 | 13.0 | 2,072 | 31.7 | |||||||||||||||
Total | $ | 77,103 | $ | 2,650 | 3.4 | % | $ | 13,936 | 15.3 | % | ||||||||||
Allowance allocated to impaired loans as a percentage of impaired loans with allowance allocated | 12.0 | % |
9. COVERED ASSETS AND FDIC LOSS SHARE RECEIVABLE
Covered Loans
Loans acquired in an FDIC-assisted acquisition that are subject to a loss sharing agreement are referred to as “covered loans” and reported separately in the consolidated statements of financial condition. Covered loans are reported exclusive of the expected cash flow reimbursements expected from the FDIC.
Acquired loans are valued as of acquisition date in accordance with FASB ASC 805,Business Combinations. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB ASC 310-30,Loans and Debt Securities Acquired with Deteriorated Credit Quality. In addition, because of the significant discounts associated with the acquired portfolios, the Company elected to account for all of the acquired loans, with the exception of a small population of loans, under ASC 310-30 (formerly known as SOP 03-3) in the amount of $125.2 million at acquisition. Certain cash secured loans and overdrafts in the amount of $923,000 were not accounted for under ASC 310-30. Under ASC 805 and ASC 310-30, loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date.
If credit deterioration is experienced subsequent to the initial acquisition fair value amount, such deterioration will be measured, and a provision for credit losses will be charged to earnings. The effect of the provision for credit losses on covered loans will be offset, to the extent of the 80% loss share, by an increase to the FDIC loss share receivable. Any increase in the FDIC loss share receivable will be recognized in non-interest income. Through September 30, 2010, no additional provision for credit losses has been required related to the covered loan portfolio.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table reflects the estimated fair value of the acquired loans at the acquisition date:
April 16, 2010 | ||||
(Dollars in thousands) | ||||
Gross loans acquired | $ | 162,248 | ||
Discount | (36,081 | ) | ||
Covered loans, net | $ | 126,167 | ||
The outstanding principal balance of covered loans, excluding purchase accounting adjustments, at September 30, 2010 was $146.5 million. The following table represents the major types of covered loans as of September 30, 2010:
September 30, 2010 | ||||
(Dollars in thousands) | ||||
Commercial real estate | $ | 73,043 | ||
Commercial | 9,698 | |||
SBA | 29,022 | |||
Other | 911 | |||
Total loans | $ | 112,674 | ||
At September 30, 2010, the covered loan amounted to $112.7 million.
In estimating the fair value of the covered loans at the acquisition date, the Company (i) calculated the contractual amount and timing of undiscounted principal and interest payments and (ii) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference.
On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans.
Changes in the carrying amount of covered loans and the accretable yield were as follows for the three and nine months ended September 30, 2010:
Three months ended September 30, 2010 | Nine months ended September 30, 2010 | |||||||||||||||
Carrying amount | Accretable | Carrying amount | Accretable | |||||||||||||
of Loans | Yield | of Loans | Yield | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Balance at beginning of period | $ | 122,362 | $ | 18,503 | $ | — | $ | — | ||||||||
Acquisition | — | — | 126,167 | 20,412 | ||||||||||||
Accretion | 2,207 | (2,207 | ) | 4,116 | (4,116 | ) | ||||||||||
Payments received | (11,783 | ) | — | (15,937 | ) | — | ||||||||||
Transfer to OREO | (112 | ) | — | (1,672 | ) | — | ||||||||||
Balance at end of period | $ | 112,674 | $ | 16,296 | $ | 112,674 | $ | 16,296 | ||||||||
Covered OREO
All OREO acquired in FDIC-assisted acquisitions that are subject to a FDIC loss sharing agreement are referred to as “covered OREO” and reported separately in the consolidated statements of financial condition. Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered OREO at the loan’s fair value, inclusive of the acquisition date fair value discount.
Covered OREO was initially recorded at its estimated fair value on the acquisition date based on similar market comparable valuations less estimated selling costs. Any subsequent valuation adjustments due to declines in fair value will be charged to non-interest expense, and will be offset, in part, by non-interest income representing the corresponding increase to the FDIC loss share receivable. Any recoveries of previous valuation adjustments will be credited to non-interest expense with a corresponding charge to non-interest income for the portion of the recovery that is due to the FDIC.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The activities related to the covered OREO for the three months ended and since the acquisition date through September 30, 2010 are as follows:
Three months ended | Nine months ended | |||||||
September 30, 2010 | September 30, 2010 | |||||||
(Dollars in thousands) | ||||||||
Balance at beginning of period | $ | 1,560 | $ | — | ||||
Acquisition | — | 1,942 | ||||||
Additions to covered OREO | 112 | 1,672 | ||||||
Fair value adjustment during the period | (29 | ) | (29 | ) | ||||
Dispositions of covered OREO | (184 | ) | (2,126 | ) | ||||
Balance at end of period | $ | 1,459 | $ | 1,459 | ||||
FDIC Loss Share Receivable
The Company has elected to account for amounts receivable under the loss sharing agreement with the FDIC as FDIC loss share receivable in accordance with FASB ASC 805,Business Combinations. The FDIC loss share receivable was initially recorded at fair value, based on the discounted value of expected future cash flows under the loss sharing agreement. The difference between the present value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into non-interest income over the life of the FDIC loss share receivable.
The FDIC loss share receivable is reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered portfolio. These adjustments are measured on the same basis as the related covered loans and covered other real estate owned. Any increases in the cash flows of the covered assets over those expected will reduce the FDIC loss share receivable and any decreases in cash flows of the covered assets under those expected will increase the FDIC loss share receivable. Increases and decreases to the FDIC loss share receivable are recorded as adjustments to non-interest income.
The FDIC loss share receivable was determined to be $25.3 million at the acquisition date. Changes in the FDIC loss share receivable for the three and nine months ended September 30, 2010 are as follows:
Three months ended September 30, 2010 | Nine months ended September 30, 2010 | |||||||
(Dollars in thousands) | ||||||||
Balance at beginning of period | $ | 25,300 | $ | — | ||||
Acquisition | — | 25,300 | ||||||
Payment received from FDIC | (1,753 | ) | (1,753 | ) | ||||
Accretion | 105 | 105 | ||||||
Balance at end of period | $ | 23,652 | $ | 23,652 | ||||
10. NON-COVERED OTHER REAL ESTATE OWNED (OREO)
The Company had four non-covered OREO properties comprised of three commercial properties totaling $3.4 million and one residential property of $1.2 million as of September 30, 2010. The changes in non-covered other real estate owned for the three and nine months ended September 30, 2010 and 2009 are as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Balance, beginning of period | $ | 2,778 | $ | 4,567 | $ | 4,278 | $ | — | ||||||||
Addition | 3,300 | 1,440 | 4,560 | 6,007 | ||||||||||||
Disposition | (1,530 | ) | (854 | ) | (3,195 | ) | (854 | ) | ||||||||
Valuation adjustments | — | (340 | ) | (994 | ) | (340 | ) | |||||||||
Transfer to other receivable | — | — | (101 | ) | — | |||||||||||
Balance, end of period | $ | 4,548 | $ | 4,813 | $ | 4,548 | $ | 4,813 | ||||||||
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
11. OTHER INTANGIBLE ASSETS
In April 2010, the Company recorded a core deposit intangible of $510,000 for the acquisition of Innovative Bank. The Company amortizes premiums on acquired deposits using the straight-line method over 7 to 9 years. The Company’s amortization expense for core deposit intangible was $16,000 and $36,000 for the three and nine months ended September 30, 2010 resulting in a core deposit intangible net of amortization of $474,000 at September 30, 2010. Estimated amortization expense for five succeeding fiscal years is as follows:
(Dollars in thousands) | ||||
2010 (remaining three months) | $ | 10 | ||
2011 | 62 | |||
2012 | 62 | |||
2013 | 62 | |||
2014 | 62 | |||
2015 | 62 | |||
Thereafter | 154 | |||
$ | 474 | |||
12. OTHER BORROWED FUNDS
The Company borrows funds from the Federal Home Loan Bank of San Francisco (“FHLB”) and the Treasury, Tax, and Loan Investment Program. Other borrowed funds totaled $168.5 million and $148.4 million at September 30, 2010 and December 31, 2009, respectively. Interest expense on other borrowed funds was $1.7 million and $5.0 million for the three and nine months ended September 30, 2010, respectively, reflecting average interest rates of 4.08% and 4.02% compared to 4.31% and 4.24% for the same periods in 2009, respectively.
As of September 30, 2010, the Company had outstanding borrowing of $166.6 million from the FHLB with original maturity terms ranging from 4 years to 15 years. Advances of 10-year and 15-year terms are amortizing at predetermined schedules over the life of the advances. Of the $166.6 million outstanding, $145.0 million is composed of six fixed rate term advances, each with an option to be called by the FHLB after the original lockout dates varying from 6 months to 2 years. If market interest rates are higher than the advances’ stated rates at that time, the advances will be called by the FHLB and the Bank will be required to repay the FHLB. If market interest rates are lower after the lockout period, then the advances will not be called by the FHLB. If the fixed rate term advances are not called by the FHLB, they will mature at maturity dates ranging from 4 years to 10 years. The Company may repay the advances with a prepayment penalty at any time. If the advances are called by the FHLB, there is no prepayment penalty.
The Company has pledged, under a blanket lien, all qualifying commercial and residential loans as collateral under the borrowing agreement with the FHLB, with a total carrying value of $732.9 million at September 30, 2010 as compared to $812.9 million at December 31, 2009.
Subject to the right of the FHLB to require early repayment of the borrowings discussed above, FHLB advances outstanding, with an average interest rate of 4.46%, as of September 30, 2010, mature as follows:
(Dollars in thousands) | ||||
2010 | $ | 92 | ||
2011 | 40,381 | |||
2012 | 105,295 | |||
2013 | 157 | |||
2014 | 167 | |||
Thereafter | 20,477 | |||
$ | 166,569 | |||
Borrowings obtained from the Treasury Tax and Loan Investment Program mature within a month from the transaction date. Under the program, the Company receives funds from the U.S. Treasury Department in the form of open-ended notes, up to a total of $2.2 million. The Company has pledged U.S. government agencies and/or mortgage-backed securities with a total carrying value of $1.7 million at September 30, 2010, as collateral to participate in the program. The total borrowed amount under the program, outstanding at September 30, 2010 and December 31, 2009 was $1.0 million and $1.6 million, respectively.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
13. LONG-TERM SUBORDINATED DEBENTURES
Center Capital Trust I is a Delaware business trust formed by the Company for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by the Company. During the fourth quarter of 2003, Center Capital Trust I issued 18,000 Capital Trust Preferred Securities (“TP Securities”), with liquidation value of $1,000 per security, for gross proceeds of $18,000,000. The entire proceeds of the issuance were invested by Center Capital Trust I in $18,000,000 of Junior Long-term Subordinated Debentures (the “Subordinated Debentures”) issued by the Company, with identical maturity, repricing and payment terms as the TP Securities. The Subordinated Debentures represent the sole assets of Center Capital Trust I. The Subordinated Debentures mature on January 7, 2034, with interest based on 3-month LIBOR plus 2.85%, with repricing and payments due quarterly in arrears on January 7, April 7, July 7, and October 7 of each year commencing April 7, 2004. The Subordinated Debentures are redeemable by the Company, subject to receipt by the Company of prior approval from the Federal Reserve Bank, on any January 7th, April 7th, July 7th, and October 7th on or after April 7, 2009 at the Redemption Price. Redemption Price means 100% of the principal amount of Subordinated Debentures being redeemed plus accrued and unpaid interest on such Subordinated Debentures to the Redemption Date, or in case of redemption due to the occurrence of a Special Event, to the Special Redemption Date if such Redemption Date is on or after April 7, 2009. The TP Securities are subject to mandatory redemption to the extent of any early redemption of the Subordinated Debentures and upon maturity of the Subordinated Debentures on January 7, 2034.
Holders of the TP Securities are entitled to a cumulative cash distribution on the liquidation amount of $1,000 per security at a current rate per annum of 3.38%. Interest rate defined as per annum rate of interest, resets quarterly, equal to LIBOR immediately preceding each interest payment date (January 7, April 7, July 7, and October 7 of each year) plus 2.85%.
The distributions on the TP Securities are treated as interest expense in the consolidated statements of operations. The Company has the option to defer payment of the distributions for a period of up to five years, as long as the Company is not in default on the payment of interest on the Subordinated Debentures. The TP Securities issued in the offering were sold in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TP Securities.
On March 1, 2005, the FRB adopted a final rule that allows the continued inclusion of trust-preferred securities in the Tier I capital of bank holding companies. However, under the final rule, after a five-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier I capital elements, net of goodwill. As of September 30, 2010, trust preferred securities comprised 6.52% of the Company’s Tier I capital.
Center Capital Trust I is not reported on a consolidated basis. Therefore, the capital securities of $18,000,000 do not appear on the consolidated statement of financial condition. Instead, the long-term subordinated debentures of $18,557,000 payable by Center Financial to the Center Capital Trust I and the investment in the Center Capital Trust I’s common stock of $557,000 (included in other assets) are separately reported.
14. COMMITMENTS AND CONTINGENCIES
Off-Balance-Sheet Risk
The Company is a 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 commitments to extend credit, commercial letters of credit, standby letters of credit and performance bonds. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.
The Company’s exposure to credit loss is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Commercial letters of credit, standby letters of credit, and performance bonds are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in making loans to customers. The Company generally holds collateral supporting those commitments if deemed necessary.
A summary of the notional amounts of the Company’s financial instruments relating to extension of credit with off-balance-sheet risk at September 30, 2010 and December 31, 2009 follows:
September 30, 2010 | December 31, 2009 | |||||||
(Dollars in thousands) | ||||||||
Loans | $ | 171,201 | $ | 187,148 | ||||
Standby letters of credit | 28,151 | 21,284 | ||||||
Commercial letters of credit | 27,160 | 22,190 | ||||||
Performance bonds | 249 | 651 |
Liabilities for losses on outstanding commitments of $248,000 and $246,000, respectively, were reported separately in other liabilities at September 30, 2010 and December 31, 2009.
Litigation
From time to time, the Company is a party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel as to the current status of these claims and proceedings, management does not believe that the aggregate potential liability resulting from such proceedings would have a material adverse effect on the Company’s financial condition or results of operations.
15. STOCK-BASED COMPENSATION
The Company has a Stock Incentive Plan which was adopted by the Board of Directors in April 2006, approved by the shareholders in May 2006, and amended by the Board in June 2007 (the “2006 Plan”). The 2006 Plan provides for the granting of incentive stock options to officers and employees, and non-qualified stock options and restricted stock awards to employees (including officers) and non-employee directors. The 2006 Plan replaced the Company’s former stock option plan (the “1996 Plan”) which expired in February 2006, and all options under the 1996 Plan which were outstanding on April 12, 2006 were transferred to and made part of the 2006 Plan. The option prices of all options granted under the 2006 Plan (including options transferred from the 1996 Plan) must be not less than 100% of the fair market value at the date of grant. All options granted generally vest at the rate of 20% per year except that the options granted to the CEO and to the non-employee directors vest at the rate of 33 1/3% per year. All options not exercised generally expire ten years after the date of grant. Vesting of restricted stock awards (“RSAs”) is discretionary with the Board of Directors or the Compensation Committee, but awards granted to date generally vest at the rate of 50% on the third anniversary of the grant date and 25% per year for the next two years. However, the RSAs granted to the CEO and the Chief Credit Officer vest 50% on the second anniversary of the grant date and the remaining 50% the following year. RSAs granted to senior executive officers are also subject to restrictions on transfer even after vesting for as long as the Company has preferred stock outstanding to the U.S. Treasury Department pursuant to the TARP Capital Purchase Program.
The Company’s pre-tax stock-based compensation expense for employees and directors was $105,000 and $553,000 ($97,000 and $443,000 after tax effect of non-qualified stock options) for the three and nine months ended September 30, 2010, respectively, as compared to $248,000 and $726,000 ($183,000 and $542,000 after tax effect of non-qualified stock options) for the same periods in 2009, respectively. There were no options granted for the three and nine months ended September 30, 2010. The Company granted options covering 5,000 and 30,000 shares with a weighted average grant-date fair value of $2.28 and $2.09 per share for the three and nine months ended September 30, 2009, respectively.
Stock Option Awards
The fair value of the stock options granted was estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. Beginning in 2006, the expected life (estimated period of time outstanding) of options granted with a 10-year term was determined using the average of the vesting period and term. Expected volatility was based on historical volatility for a period equal to the stock option’s expected life, ending on the day of grant, and calculated on a weekly basis. No options were granted during the nine months ended September 30, 2010.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Nine Months Ended September 30, | ||||||||
2010 | 2009 | |||||||
Risk-free interest rate | — | 1.71% - 3.71% | ||||||
Expected life | — | 3 - 6.5 years | ||||||
Expected volatility | — | 14% - 113% | ||||||
Expected dividend yield | — | 0.00% - 2.21% |
These assumptions were utilized in the calculation of the compensation expense noted above. The expenses are the result of previously granted stock options and those awarded, if any, during the nine months ended September 30, 2010 and 2009, respectively.
A summary of the Company’s stock option activity and related information for the three and nine months ended September 30, 2010 and 2009 is set forth in the following table:
Outstanding Options | ||||||||||||
Shares Available For Grant | Number of Shares | Weighted Average Exercise Price | ||||||||||
Balance at June 30, 2010 | 2,298,917 | 727,940 | $ | 16.92 | ||||||||
Options granted | — | — | — | |||||||||
Options forfeited | 10,800 | (10,800 | ) | 15.21 | ||||||||
Options exercised | — | — | — | |||||||||
Balance at September 30, 2010 | 2,309,717 | 717,140 | 16.95 | |||||||||
Balance at June 30, 2009 | 2,174,752 | 865,651 | $ | 16.44 | ||||||||
Options granted | (5,000 | ) | 5,000 | 4.30 | ||||||||
Options forfeited | 14,160 | (14,160 | ) | 15.27 | ||||||||
Options exercised | 13,546 | (13,546 | ) | 3.43 | ||||||||
Balance at September 30, 2009 | 2,197,458 | 842,945 | 16.60 | |||||||||
Balance at December 31, 2009 | 2,266,612 | 760,245 | $ | 16.93 | ||||||||
Options granted | — | — | — | |||||||||
Options forfeited | 43,105 | (43,105 | ) | 16.59 | ||||||||
Options exercised | — | — | — | |||||||||
Balance at September 30, 2010 | 2,309,717 | 717,140 | 16.95 | |||||||||
Balance at December 31, 2008 | 2,190,252 | 850,151 | $ | 16.78 | ||||||||
Options granted | (30,000 | ) | 30,000 | 4.71 | ||||||||
Options forfeited | 23,660 | (23,660 | ) | 15.52 | ||||||||
Options exercised | 13,546 | (13,546 | ) | 3.43 | ||||||||
Balance at September 30, 2009 | 2,197,458 | 842,945 | 16.60 | |||||||||
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The stock options as of September 30, 2010 have been segregated into three ranges for additional disclosure as follows:
Options Outstanding | Options Exercisable | |||||||||||||||||||||||
Range of Exercise Prices | Options Outstanding | Weighted- Average Remaining Contractual Life in Years | Weighted- Average Exercise Price | Options Exercisable | Weighted- Average Remaining Contractual Life in Years | Weighted- Average Exercise Price | ||||||||||||||||||
$ 3.43 - $ 8.00 | 52,745 | 5.38 | $ | 5.02 | 32,078 | 3.38 | $ | 5.23 | ||||||||||||||||
$ 8.01 - $ 20.00 | 478,395 | 6.15 | 16.08 | 387,017 | 6.01 | 16.07 | ||||||||||||||||||
$ 20.01 - $ 25.10 | 186,000 | 6.08 | 22.56 | 162,900 | 6.07 | 22.56 | ||||||||||||||||||
As of September 30, 2010 | 717,140 | 6.08 | 16.95 | 581,995 | 5.88 | 17.29 | ||||||||||||||||||
$ 2.23 - $ 8.00 | 79,745 | �� | 5.06 | $ | 5.13 | 49,745 | 2.41 | $ | 5.38 | |||||||||||||||
$ 8.01 - $ 20.00 | 559,200 | 7.10 | 16.02 | 326,601 | 6.66 | 15.70 | ||||||||||||||||||
$ 20.01 - $ 25.10 | 204,000 | 6.99 | 22.69 | 125,767 | 6.92 | 22.75 | ||||||||||||||||||
As of September 30, 2009 | 842,945 | 6.88 | 16.60 | 502,113 | 6.30 | 16.44 | ||||||||||||||||||
The aggregate intrinsic value of options outstanding and options exercisable at September 30, 2010 was $12,000 and $4,000 compared to $0 at September 30, 2009. The aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $5.09 and $3.82 as of September 30, 2010 and 2009, respectively, and the exercise price multiplied by the number of options outstanding. No options were exercised during the three and nine months ended September 30, 2010 while 13,546 options were exercised during the same periods in 2009. Total fair value of vested options was $1.1 million and $1.3 million as of September 30, 2010 and 2009, respectively. The number of options that were not vested as of September 30, 2010 and 2009 was 135,145 and 340,832, respectively.
As of September 30, 2010 and 2009, the Company had approximately $523,000 and $1.2 million of unrecognized compensation costs related to unvested options, respectively, which are expected to be recognized over a weighted average period of 1.80 years and 2.23 years, respectively.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Restricted Stock Awards
Restricted stock activity under the 2006 Plan as of and changes during the three and nine months ended September 30, 2010 and 2009 are as follows:
Three Months Ended September 30, 2010 | Nine Months Ended September 30, 2010 | |||||||||||||||
Number of Shares | Weighted-Average Grant-Date Fair Value per Share | Number of Shares | Weighted-Average Grant-Date Fair Value per Share | |||||||||||||
Restricted Stock: | ||||||||||||||||
Nonvested, beginning of period | 57,309 | $ | 5.83 | 10,050 | $ | 13.59 | ||||||||||
Granted | 8,700 | 5.50 | 59,609 | 5.13 | ||||||||||||
Vested | — | — | (2,950 | ) | 17.00 | |||||||||||
Cancelled and forfeited | (225 | ) | 11.43 | (925 | ) | 14.29 | ||||||||||
Nonvested, at end of period | 65,784 | 5.76 | 65,784 | 5.76 | ||||||||||||
Three Months Ended September 30, 2009 | Nine Months Ended September 30, 2009 | |||||||||||||||
Number of Shares | Weighted-Average Grant-Date Fair Value per Share | Number of Shares | Weighted-Average Grant-Date Fair Value per Share | |||||||||||||
Restricted Stock: | ||||||||||||||||
Nonvested, beginning of period | 11,550 | $ | 13.93 | 10,400 | $ | 14.72 | ||||||||||
Granted | — | — | 1,150 | 3.07 | ||||||||||||
Vested | — | — | — | — | ||||||||||||
Cancelled and forfeited | (850 | ) | 15.66 | (850 | ) | 15.66 | ||||||||||
Nonvested, at end of period | 10,700 | 14.83 | 10,700 | 14.83 | ||||||||||||
The Company recorded compensation cost of $20,000 and $62,000, respectively, related to the restricted stock granted under the 2006 Plan for the three and nine months ended September 30, 2010 and $5,000 and $15,000, respectively, for the same periods in 2009. At September 30, 2010 and 2009, the Company had approximately $196,000 and $53,000 of unrecognized compensation costs related to unvested restricted stock, respectively. The costs are expected to be recognized over a weighted-average period of 2.15 years and 1.51 years as of September 30, 2010 and 2009, respectively.
16. COMMON AND PREFERRED STOCK CASH DIVIDENDS
On March 25, 2009, the Company’s board of directors suspended its quarterly cash dividends on the Company’s common stock based on adverse economic conditions and the Company’s then recent losses. The board of directors determined that this is a prudent, safe and sound practice to preserve capital, and does not expect to resume the payment of cash dividends in the foreseeable future. Unless the preferred stock issued to the Treasury Department in the TARP Capital Purchase Program has been redeemed, the Company will not be permitted to resume paying cash dividends without the consent of the Treasury Department until December 2011. In addition, the Bank and the Company have each entered into Informal Regulation Agreements with the respective regulatory agency or agencies, pursuant to which both the Bank and the Company must obtain prior regulatory approval to pay dividends.
The Company paid a preferred stock dividend of $688,000 on August 15, 2010 and accrued for the preferred stock dividends of $344,000 at September 30, 2010 which will be included in the next payment scheduled on November 15, 2010.
17. PREFERRED STOCK AND COMMON STOCK WARRANTS
The Company entered into Securities Purchase Agreements with a limited number of institutional and other accredited investors, including insiders, to sell a total of 73,500 shares of mandatorily convertible non-cumulative non-voting perpetual preferred stock, series B, without par value (the “Series B Preferred Stock”) at a price of $1,000 per share, for an aggregate gross purchase price of $73.5 million. This private placement closed on December 31, 2009, and the Company issued an aggregate of 73,500 shares of Series B Preferred Stock upon its receipt of consideration in cash. The Series B Preferred Stock converted into 19,599,981 million shares of common stock effective March 29, 2010, following shareholder approval of such conversion. The conversion ratio was equal to the quotient obtained by dividing the $1,000 per share purchase price by the conversion price of $3.75. The shares issued in this private placement were registered on a Form S-3 Registration Statement, as amended, which became effective April 8, 2010, thus removing the restrictions on resale.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The conversion price of $3.75 per share was less than the fair value of $5.23 per share of our common stock on December 29, 2009, the commitment date for the issuance of the Series B Preferred Stock. The Series B Preferred Stock was thus issued with a beneficial conversion feature with an intrinsic value of $1.48 per share or at a discount of $29,007,972. On the effective date of the conversion, the unamortized discount due to the beneficial conversion feature was immediately recognized as a dividend and accounted for as a charge to retained earnings and a reduction of net income available to common shareholders in the earnings per share computation.
The Company also issued 3,360,000 shares of common stock in a private placement which closed on November 30, 2009 (the “November Private Placement”), at a price per share of $3.71 to non-affiliated investors and $4.69 to certain directors and employees of the Company. The difference in the purchase price was necessary to comply with NASDAQ Listing Rule 5635(c). The Company obtained shareholder approval of the November Private Placement at a special meeting held on March 24, 2010 so that all investors in the November Private Placement could be treated equally. Following receipt of shareholder approval, 85,045 additional shares were issued to the directors and employees who invested in the November Private Placement, in order to effectuate this result. The shares issued in the November Private Placement were also registered on a Form S-3 Registration Statement which became effective April 8, 2010, thus removing the restrictions on resale.
The Company entered into a purchase agreement with the U.S. Treasury Department on December 12, 2008, pursuant to which the Company issued and sold 55,000 shares of the Company’s fixed-rate cumulative perpetual preferred stock for a total purchase price of $55.0 million, and a 10-year warrant to purchase 864,780 shares of the Company’s common stock at an exercise price of $9.54 per share. The number of shares underlying the Warrant was reduced to 432,290 effective December 31, 2009 as a result of the fourth quarter capital raises described above. The Company will pay the U.S. Treasury Department a five percent dividend annually for each of the first five years of the investment and a nine percent dividend thereafter until the shares are redeemed. The cumulative dividend for the preferred stock is accrued for and payable on February 15, May 15, August 15 and November 15 of each year.
The Company allocated total proceeds of $55.0 million, based on the relative fair value of preferred stock and common stock warrants, to preferred stock for $52.9 million and common stock warrants for $2.1 million, respectively, on December 12, 2008. The preferred stock discount is being accreted, on an effective yield method, to preferred stock over 10 years.
In determination of the fair value of preferred stock and common stock warrants, certain assumptions were made. The Binomial Lattice model was used with the following assumptions for common stock warrants:
• | Risk-free interest rate: The constant maturities par yield curve based on Treasury yields provided by Federal Reserve, after interpolating the yield curve beyond the maturities provided in the release data, was used to derive a risk-free interest rate curve. |
• | Stock price volatility: The volatility assumption utilized in the valuation should represent the “expected” volatility, which may or may not be the same as historical volatility. Since market events of the second half of 2008 are not likely to repeat given the current government ownership of major banks, the high market volatility during the second half of the year should be assigned a lower weighting in the 10-year term of the historical volatility. As a result of this adjustment, expected volatility of 32.0% was used in the valuation as compared to 36.5% of historical volatility. |
• | Dividend rate: The Company utilized a constant dividend payment assumption in the model. The $0.05 per share per quarter constant payment is consistent with the Company’s then current policy and Management’s intention. |
For preferred stock, the Company used a discount cash flow model to calculate the fair value with the following assumptions:
• | Dividend rate of 5% from year 1 to year 5 and 9% thereafter was used in accordance with the terms and conditions of the preferred stock. Expected life was assumed 10 years, considering the contractual term of 10 years. Risk-free interest rate was assumed at 3.66%, which is the 10-year U.S. Treasury Constant Maturity Rate for 2008. The assumed discount rate was 12% based on review of certain references. Certain actual preferred equity offerings rates in 2008 ranged from 7% to 12%. TARP is considered cheaper financing for capital and one of the objectives of the TARP is providing cheaper financing to help the capital situation in the banking sector. In this regard, the assumed discount rate should be higher than the coupon rate of 9%. |
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Using these assumptions, the fair value of common stock warrants amounted to $1.4 million and the fair value of the preferred stock amounted to $37.2 million. The relative fair values of preferred stock and common stock warrants were 96.3% and 3.7%, respectively. The total proceeds of $55.0 million were allocated, based on the relative fair value, to preferred stock in the amount of $52.9 million for preferred stock and $2.1 million for common stock warrants on December 12, 2008, respectively.
18. EARNINGS (LOSS) PER COMMON SHARE
Common stock outstanding at September 30, 2010 totaled 39,902,811 shares. Basic earnings (loss) per common share are calculated on the basis of weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Diluted earnings (loss) per common share do not include all potentially dilutive shares that may result from the future exercise or vesting of outstanding stock options and restricted stock awards. Exercise of options is not assumed if the result would be anti-dilutive such as when a loss from continuing operations is reported.
The following table sets forth the Company’s earnings (loss) per common share calculation for the three and nine months ended September 30, 2010 and 2009:
Three Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
(Dollars in thousands, except earnings per share) | ||||||||||||||||||||||||
Net Income | Average Number of Shares | Per Share Amounts | Net (Loss) | Average Number of Shares | Per Share Amounts | |||||||||||||||||||
Basic earnings (loss) per share | ||||||||||||||||||||||||
Net income (loss) | $ | 5,963 | 39,902 | $ | 0.15 | $ | (2,524 | ) | 16,789 | $ | (0.15 | ) | ||||||||||||
Less : preferred stock dividends and accretion of preferred stock discount | (748 | ) | — | (0.02 | ) | (742 | ) | — | (0.04 | ) | ||||||||||||||
Income (loss) available to common shareholders | 5,215 | 39,902 | 0.13 | (3,266 | ) | 16,789 | (0.19 | ) | ||||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||||||||
Stock options and restricted stock awards | — | 10 | — | — | — | — | ||||||||||||||||||
Diluted earnings (loss) per share | ||||||||||||||||||||||||
Income (loss) available to common shareholders | $ | 5,215 | 39,912 | $ | 0.13 | $ | (3,266 | ) | 16,789 | $ | (0.19 | ) | ||||||||||||
Nine Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
(Dollars in thousands, except earnings per share) | ||||||||||||||||||||||||
Net Income | Average Number of Shares | Per Share Amounts | Net (Loss) | Average Number of Shares | Per Share Amounts | |||||||||||||||||||
Basic earnings (loss) per share | ||||||||||||||||||||||||
Net income (loss) | $ | 16,233 | 33,763 | $ | 0.48 | $ | (18,036 | ) | 16,789 | $ | (1.07 | ) | ||||||||||||
Less : preferred stock dividends and accretion of preferred stock discount | (31,246 | ) | — | (0.92 | ) | (2,211 | ) | — | (0.14 | ) | ||||||||||||||
Income (loss) available to common shareholders | (15,013 | ) | 33,763 | (0.44 | ) | (20,247 | ) | 16,789 | (1.21 | ) | ||||||||||||||
Effect of dilutive securities: | ||||||||||||||||||||||||
Stock options and restricted stock awards | — | — | — | — | — | — | ||||||||||||||||||
Diluted earnings (loss) per share | ||||||||||||||||||||||||
Income (loss) available to common shareholders | $ | (15,013 | ) | 33,763 | $ | (0.44 | ) | $ | (20,247 | ) | 16,789 | $ | (1.21 | ) | ||||||||||
The number of common shares underlying stock options which were outstanding but not included in the calculation of diluted earnings (loss) per share because they would have had an anti-dilutive effect amounted to approximately 717,000 and 678,000 shares, respectively, for the three and nine months ended September 30, 2010 and 863,000 and 871,000 shares, respectively, for the same periods in 2009.
19. INCOME TAXES
The income tax (benefit) provision amounted to $(0.8) million and $4.4 million for the three and nine months ended September 30, 2010 representing effective tax rates of (16.5)% and 21.3%, respectively, compared to income tax benefit of $1.6 million and $13.8 million for the same periods in 2009 representing effective tax rates of (38.9)% and (43.4)%, respectively. The primary reasons for the difference from the federal statutory tax rate of 35% are the inclusion of state taxes
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
and reductions related to tax favored investments in low-income housing, dividend exclusions, treatment of share-based payments amortization, an increase in cash surrender value of bank owned life insurance and California enterprise zone interest deductions and hiring credits. In addition, the Company reduced income tax expense by $2.1 million in the third quarter of 2010 due to a reduction in the valuation allowance against deferred tax assets. The Company reduced taxes utilizing the tax credits from investments in the low-income housing projects in the amount of $345,000 and $1.1 million for the three and nine months ended September 30, 2010, respectively, as compared to zero for the same periods in 2009.
Deferred income tax assets or liabilities reflect the estimated future tax effects attributable to differences as to when certain items of income or expense are reported in the financial statements versus when they are reported in the tax returns. The Company’s net deferred tax assets were $10.1 million, net of a valuation allowance of $14.0 million at September 30, 2010, and $11.6 million, net of a valuation allowance of $16.3 million at December 31, 2009. The reduction in the valuation allowance reduced income tax expense by $2.1 million and $2.3 million for the three and nine months ended September 30, 2010. The reduction is primarily due to the expected utilization of deferred tax assets related to the 2010 tax year for state income tax purposes. As of September 30, 2010, the Company’s deferred tax assets were primarily due to the allowance for loan losses.
In assessing the future realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, the projected future taxable income, and tax-planning strategies in making this assessment.
The Internal Revenue Service (the “IRS”) and the Franchise Tax Board (the “FTB”) have examined the Company’s consolidated federal income tax returns for tax years up to and including 2007. As of September 30, 2010, the Company was under examination by the FTB for the 2005-2007 tax years and there is no open examination by the IRS. The Company does not anticipate any material changes as a result of the examination. In addition, the Company does not have any unrecognized tax benefits subject to significant increase or decrease as a result of uncertainty.
20. FAIR VALUE MEASUREMENTS
Fair Values of Financial Instruments
The Company, using available market information and appropriate valuation methodologies available to management at September 30, 2010 and December 31, 2009, has determined the estimated fair value of financial instruments. However, considerable judgment is required to interpret market data in order to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Furthermore, fair values do not reflect any premium or discount that may result from offering the instruments for sale. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The estimated fair values and related carrying amounts of the Company’s financial instruments are as follows:
September 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying or Contract Amount | Estimated Fair Value | Carrying or Contract Amount | Estimated Fair Value | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Assets | ||||||||||||||||
Cash and cash equivalents | $ | 321,012 | $ | 321,012 | $ | 232,802 | $ | 232,802 | ||||||||
Investment securities available for sale | 290,803 | 290,803 | 370,427 | 370,427 | ||||||||||||
Non-covered loans, net | 1,411,774 | 1,407,247 | 1,479,142 | 1,472,963 | ||||||||||||
Covered loans | 112,674 | 112,313 | — | — | ||||||||||||
Federal Home Loan Bank and other equity stock | 15,642 | 15,642 | 15,673 | 15,673 | ||||||||||||
FDIC loss share receivable | 23,652 | 23,652 | ||||||||||||||
Customers’ liability on acceptances | 1,412 | 1,412 | 2,341 | 2,341 | ||||||||||||
Accrued interest receivable | 5,487 | 5,487 | 6,879 | 6,879 | ||||||||||||
Income tax receivable | 16,354 | 16,354 | 16,140 | 16,140 | ||||||||||||
Liabilities | ||||||||||||||||
Deposits | 1,792,281 | 1,771,887 | 1,747,671 | 1,704,176 | ||||||||||||
Other borrowed funds | 168,538 | 180,286 | 148,443 | 157,593 | ||||||||||||
Acceptances outstanding | 1,412 | 1,412 | 2,341 | 2,341 | ||||||||||||
Accrued interest payable | 5,558 | 5,558 | 5,803 | 5,803 | ||||||||||||
Long-term subordinated debentures | 18,557 | 14,407 | 18,557 | 13,790 | ||||||||||||
Accrued expenses and other liabilities | 10,403 | 10,403 | 13,927 | 13,927 | ||||||||||||
Off-balance sheet items | ||||||||||||||||
Commitments to extend credit | 171,201 | 219 | 187,148 | 240 | ||||||||||||
Standby letter of credit | 28,151 | 422 | 21,284 | 319 | ||||||||||||
Commercial letters of credit | 27,160 | 102 | 22,190 | 84 | ||||||||||||
Performance bonds | 249 | 4 | 651 | 9 |
The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate as follows:
Cash and Cash Equivalents—The carrying amounts approximate fair value due to the short-term nature of these instruments.
Securities—The fair value of securities is generally determined by quoted market prices and the valuation techniques available under the market approach, income approach and/or cost approach are used. The Company’s evaluations are based on market data and combinations of these approaches for its valuation methods are used depending on the asset class.
Non-covered Loans—Fair values are estimated for portfolios of loans with similar financial characteristics, primarily fixed and adjustable rate interest terms. The fair values of fixed rate loans are based on discounted cash flows utilizing applicable risk-adjusted spreads relative to the current pricing of similar fixed rate loans, as well as anticipated repayment schedules. The fair value of adjustable rate loans is based on the estimated discounted cash flows utilizing the discount rates that approximate the pricing of loans collateralized by similar properties or assets. The estimated fair value is net of allowance for loan losses, deferred loan fees, and deferred gain on SBA loans.
Covered Loans—Covered loans are measured at estimated fair value on the date of acquisition. Carrying value is calculated as the present value of expected cash flows and approximates fair value.
Federal Home Loan Bank and Pacific Coast Bankers Bank stock—The carrying amounts approximate fair value, as the stocks may be sold back to the Federal Home Loan Bank and other bank at carrying value.
FDIC Loss Share Receivable— The fair value of FDIC loss share receivable is based on the discounted value of expected future cash flows under the loss sharing agreement with the FDIC.
Accrued Interest Receivable and Accrued Interest Payable—The carrying amounts approximate fair value due to the short-term nature of these assets and liabilities.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Customer’s Liability on Acceptances and Acceptances Outstanding—The carrying amounts approximate fair value due to the short-term nature of these assets.
Deposits—The fair value of nonmaturity deposits is the amount payable on demand at the reporting date. Nonmaturity deposits include non-interest-bearing demand deposits, savings accounts, NOW accounts, and money market accounts. Discounted cash flows have been used to value term deposits such as certificates of deposit. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.
Other Borrowed Funds—These funds mostly consist of FHLB advances. The fair values of FHLB advances are estimated based on the discounted value of contractual cash flows, using rates currently offered by the Federal Home Loan Bank of San Francisco for fixed-rate credit advances with similar remaining maturities.
Long-term Subordinated Debentures—The fair value of long-term subordinated debentures are estimated by discounting the cash flows through maturity based on prevailing rates offered on the 30-year Treasury bonds.
Loan Commitments, Letters of Credit, and Performance Bond—The fair value of loan commitments, standby letters of credit, commercial letters of credit and performance bonds is estimated using the fees currently charged to enter into similar agreements.
Fair Value Measurement – Three Levels
Fair value is measured in accordance with a three-level valuation hierarchy for disclosure of fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:
• | Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. |
• | Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. |
• | Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. |
Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:
Assets
Securities
U.S. Treasury – Fair values for U.S. Treasury securities are measured by using quoted market prices, a Level 1 measurement.
U.S. Government Agencies – The Company measures fair value of U.S. Government agency securities by using quoted market prices for similar securities or dealer quotes, a Level 2 measurement.
Residential mortgage-backed securities – The Company measures fair value of residential mortgage-backed securities by using quoted market prices for similar securities or dealer quotes, a Level 2 measurement.
Collateralized mortgage obligations – The Company measures fair value of collateralized mortgage obligations by using quoted market prices for similar securities or dealer quotes, a Level 2 measurement.
The Company owns one collateralized debt obligation (“CDO”) security that is backed by trust preferred securities (“TRUPS”) issued by banks and thrifts. The Company recognized an OTTI impairment during 2008 of $9.9 million to reduce the CDO TRUPS to fair value of $1.1 million. The CDO TRUPS securities market, since 2007 and continuing into the past several quarteres, has been severely impacted by the liquidity crunch and concern over the banking industry. If the weight of the evidence indicates the market is not orderly, a reporting entity shall place little, if any, weight compared with other indications of fair value on that transaction price when estimating fair value or market risk premiums. Factors that were considered to determine whether there has been a significant decrease in the volume and level of activity for the CDO TRUPS securities market when compared with normal activity include:
• | There are few recent transactions. |
• | Price quotations are not based on current information. |
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
• | Price quotations vary substantially either over time or among market makers. |
• | Indexes that were previously highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability. |
• | There is a significant increase in implied liquidity risk premiums. Yields or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability. |
• | There is a wide bid-ask spread or significant increase in the bid-ask spread. |
• | There is a significant decline or absence of new market issuances for the asset or liability. |
• | Little information is publicly available. |
The fair values of securities available for sale are generally determined by reference to the average of at least two quoted market prices obtained from independent external brokers or prices obtained from independent external pricing service providers who have experience in valuing these securities. In obtaining such valuation information from third parties, the Company has reviewed the methodologies used to develop the resulting fair values.
The Company uses Level 3 fair value measurement for the one CDO TRUPS security it owns. The fair value of the CDO TRUPS security has traditionally been based on the average of at least two quoted market prices obtained from independent brokers. However, as a result of the global financial crisis and illiquidity in the U.S. markets, the market for these securities has become increasingly inactive since mid-2007. The current broker price for the CDO TRUPS securities is based on forced liquidation or distressed sale values in very inactive markets that may not be representative of the economic value of these securities. As such, the fair value of the CDO TRUPS security has been below cost since the advent of the financial crisis. Additionally, most, if not all, of these broker quotes are nonbinding.
The Company considered whether to place little, if any, weight on transactions that are not orderly when estimating fair value. Although length of time and severity of impairment are among the factors to consider when determining whether a security that is other than temporarily impaired, the CDO TRUPS securities have only exhibited deep declines in value since the credit crisis began. The Company therefore believes that this is an indicator that the decline in price is primarily the result of the lack of liquidity in the market for these securities.
The Company continues to utilize Moody’s Analytics to compute the fair value of the CDO TRUPS security. Moody’s continues to update their valuation process in order to refine and improve the estimate of default probabilities to align the valuation methodology with industry practices.
In order to determine the appropriate discount rate used in calculating fair values derived from the income method for the CDO TRUPS security, certain assumptions were made using an exit pricing approach related to the implied rate of return which have been adjusted for general change in market rates, estimated changes in credit quality and liquidity risk premium, specific nonperformance and default experience in the collateral underlying the securities.
The Moody’s Analytics Discounted Cash flow Valuation analysis uses the 3-month London Inter-Bank Offered Rate (“LIBOR”) + 300 basis points as a discount rate (to reflect illiquidity – the credit component of the discount rate is embedded in the credit analysis). Approximating the yield premium for the illiquidity of a CDO TRUPS security has proved to be difficult and management found it more useful to measure the price impact for this illiquidity discount. The table below illustrates this.
Modified Duration | Price impact in percentage for basis point shown | |||||||||||||||||||
Maturity | 100 bp | 200 bp | 300 bp | 400 bp | ||||||||||||||||
10 yr | 8.58 | 9 | % | 17 | % | 26 | % | 34 | % | |||||||||||
20 yr | 14.95 | 15 | % | 30 | % | 45 | % | 60 | % | |||||||||||
30 yr | 19.69 | 20 | % | 39 | % | 59 | % | 79 | % |
There are three maturity assumptions, since the final maturity on the CDO TRUPS securities can be no longer than thirty years but may be less than that as well. From the percentage impact in the 300 basis points column, an illiquidity discount of 300 basis points seems to be sufficient and reasonable based on management’s opinion in consideration of current market conditions. The maturity date on the Company’s CDO TRUPS security is October 3, 2032 and that would put the price impact for illiquidity at a 45% to 59% discount as of September 30, 2010.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The spread over LIBOR does not include a credit spread as the probable credit outlook is included in the underlying cash flows. The spread over LIBOR only reflects a liquidity discount. The discount rate that reflects expectations about future defaults is appropriate if using contractual cash flows of a loan. That same rate is not used if using expected (probability-weighted) cash flows because the expected cash flows already reflect assumptions about future defaults; instead, a discount rate that is commensurate with the risk inherent in the expected cash flows is used.
SBA loans held for sale
Loans held for sale are measured at the lower of cost or fair value. As of September 30, 2010, the Company has $37.9 million of SBA loans held for sale. Management obtains quotes, bids or pricing indication sheets on all or part of these loans directly from the purchasing financial institutions. Premiums received or to be received on the quotes, bids or pricing indication sheets are indicative of the fact that cost is lower than fair value. At September��30, 2010, all loans held for sale were recorded at its cost. The Company measures loans held for sale on a nonrecurring basis with Level 2 inputs.
Nonperforming loans held for sale
The Company reclassifies certain nonperforming loans when the decision to sell those loans is made. The fair value of nonperforming loans held for sale is generally based upon the quotes, bids or sales contract price which approximate the fair value. Nonperforming loans held for sale is recorded at estimated fair value less anticipated liquidation cost. As of September 30, 2010, the Company has $12.8 million of nonperforming loans held for sale. The Company measures nonperforming loans held for sale on a nonrecurring basis with Level 3 inputs.
Impaired loans
A loan is considered impaired when it is probable that all of the principal and interest due may not be collected according to the original underwriting terms of the loan. Impaired loans are measured at the lower of its carrying value or at an observable market price if available or at the fair value of the loan’s collateral if the loan is collateral dependent. Fair value of the loan’s collateral when the loan is dependent on collateral, is determined by appraisals or independent valuation, which is then adjusted for the cost associated with liquidating the collateral. The Company measures impaired loans on a nonrecurring basis with Level 3 inputs.
Other Real Estate Owned (“OREO”)
OREO is transferred at fair value and is carried at the lower of its carrying value or its fair value less anticipated disposal cost. Fair value of the OREO is determined by appraisals or independent valuation, which is then adjusted for the cost associated with liquidating the property. The Company measures OREO on a nonrecurring basis with Level 3 inputs.
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Assets measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009 are as follows:
Assets measured at fair value on a recurring basis | Fair Value Measurements at Reporting Date Using | |||||||||||||||
Total as of 09/30/2010 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
U.S. Treasury | $ | 300 | $ | 300 | $ | — | $ | — | ||||||||
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities | 53,240 | — | 53,240 | — | ||||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 157,501 | — | 157,501 | — | ||||||||||||
Corporate trust preferred securities | 1,713 | — | — | 1,713 | ||||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,687 | — | 4,687 | — | ||||||||||||
Fixed rate collateralized mortgage obligations | 73,362 | — | 73,362 | — | ||||||||||||
Total available-for-sale securities | $ | 290,803 | $ | 300 | $ | 288,790 | $ | 1,713 | ||||||||
Total as of 12/31/2009 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
Available-for-sale securities: | ||||||||||||||||
U.S. Treasury | $ | 300 | $ | 300 | $ | — | $ | — | ||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise securities | ||||||||||||||||
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities | 74,270 | — | 74,270 | — | ||||||||||||
U.S. Governmental agencies and U.S. Government | 212,175 | — | 212,175 | — | ||||||||||||
Corporate trust preferred securities | 2,404 | — | — | 2,404 | ||||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,533 | — | 4,533 | — | ||||||||||||
Fixed rate collateralized mortgage obligations | 76,745 | — | 76,745 | — | ||||||||||||
Corporate debt securities | — | — | — | — | ||||||||||||
Total available-for-sale securities | $ | 370,427 | $ | 300 | $ | 367,723 | $ | 2,404 | ||||||||
The following table presents the Company’s reconciliation and statement of operations classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2010 and 2009, respectively.
Three months ended | ||||||||
September 30, 2010 | September 30, 2009 | |||||||
(Dollars in thousands) | ||||||||
Balance, beginning of period | $ | 1,790 | $ | 3,584 | ||||
Purchases, Issuances and Settlements | — | — | ||||||
Gain (Loss) in Earnings (Expenses) | — | — | ||||||
Gain (Loss) in Other Comprehensive Income | (77 | ) | (556 | ) | ||||
Transfer in/out of Level 3 | — | — | ||||||
Balance, end of period | $ | 1,713 | $ | 3,028 | ||||
Nine months ended | ||||||||
September 30, 2010 | September 30, 2009 | |||||||
(Dollars in thousands) | ||||||||
Balance, beginning of period | $ | 2,404 | $ | — | ||||
Purchases, Issuances and Settlements | — | — | ||||||
Gain (Loss) in Earnings (Expenses) | — | — | ||||||
Gain (Loss) in Other Comprehensive Income | (691 | ) | 1,120 | |||||
Transfer in/out of Level 3 | — | 1,908 | ||||||
Balance, end of period | $ | 1,713 | $ | 3,028 | ||||
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CENTER FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table presents the aggregated balance of assets measured at estimated fair value on a nonrecurring basis through the nine months ended September 30, 2010, and the total losses resulting from these fair value adjustments for the three and nine months ended September 30, 2010 and 2009:
Assets measured at fair value on a non-recurring basis | ||||||||||||||||||||||||
Total losses | ||||||||||||||||||||||||
As of September 30, 2010 | Three months ended | Nine months ended | ||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | September 30, 2010 | ||||||||||||||||||||
Impaired Loans | $ | — | $ | — | $ | 98,955 | $ | 98,955 | $ | 1,424 | $ | 3,281 | ||||||||||||
Loans held for sale | 50,723 | 50,723 | 4,102 | 4,558 | ||||||||||||||||||||
Non-covered OREO | — | — | 4,548 | 4,548 | — | 1,076 | ||||||||||||||||||
Covered OREO | — | — | 1,459 | 1,459 | 29 | 29 | ||||||||||||||||||
Total | $ | — | $ | — | $ | 155,685 | $ | 155,685 | $ | 5,555 | $ | 8,944 | ||||||||||||
Total losses | ||||||||||||||||||||||||
As of September 30, 2009 | Three months ended | Nine months ended | ||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | September 30, 2009 | ||||||||||||||||||||
Impaired Loans | $ | — | $ | 143,092 | $ | — | $ | 143,092 | $ | 10,904 | $ | 23,593 | ||||||||||||
Non-covered OREO | — | 4,813 | — | 4,813 | 909 | 909 | ||||||||||||||||||
Total | $ | — | $ | 147,905 | $ | — | $ | 147,905 | $ | 11,813 | $ | 24,502 | ||||||||||||
Liabilities
The Company did not identify any liabilities that are required to be presented at fair value.
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Item 2: | MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
The following is management’s discussion and analysis of the major factors that influenced the Company’s consolidated results of operations for the three and nine months ended September 30, 2010 and 2009 and financial condition as of September 30, 2010 and December 31, 2009. This analysis should be read in conjunction with the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2009 and with the unaudited consolidated financial statements and notes as set forth in this report.
Certain matters discussed under this caption may constitute forward-looking statements under Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact are forward looking statements. There can be no assurance that the results described or implied in such forward-looking statements will, in fact, be achieved and actual results, performance, and achievements could differ materially because the business of the Company involves inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company. Risks and uncertainties include, but not limited to, possible future deteriorating economic conditions in the Company’s areas of operation; risk of significant non-earning assets, and net credit losses that could occur, particularly in times of weak economic conditions or times of rising interest rates; interest rate risk associated with volatile interest rates and related asset-liability matching risk; liquidity risks; risks of available-for-sale securities declining significantly in value as interest rates rise or issuers of such securities suffer financial losses; increased competition among depository institutions; the successful integration and operations of the FDIC-assisted acquisition; the company’s ability to sustain profitable operations; the company’s ability to capitalize on strategic growth opportunities; and the company’s ability to enhance its earnings capacity; the economic and regulatory effects of the continuing war on terrorism and other events of war, including the wars in Iraq and Afghanistan; the effect of natural disasters, including earthquakes, fires and hurricanes; and regulatory risks associated with the variety of current and future regulations to which the Company is subject. All of these risks could have a material adverse impact on the Company’s financial condition, results of operations or prospects, and these risks should be considered in evaluating the Company. For additional information concerning these factors, see “Risk Factors”; and “Interest Rate Risk Management” and “Liquidity and Capital Resources” contained in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Form 10-K, as amended, for the year ended December 31, 2009, as supplemented by the information contained in this report.
Recent Legislation Impacting the Financial Services Industry
On July 21 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, will:
• | Centralize responsibility for consumer financial protection by creating a new agency, the Bureau of Consumer Financial Protection, with broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws that would apply to all banks and certain others, including the examination and enforcement powers with respect to any bank with more than $10 billion in assets. |
• | Restrict the preemption of state consumer financial protection law by federal law and disallow subsidiaries and affiliates of national banks from availing themselves of such preemption. |
• | Require new capital rules and apply the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies. |
• | Require the Office of the Comptroller of the Currency to seek to make its capital requirements for national banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction. |
• | Require publicly-traded bank holding companies with assets of $10 billion or more to establish a risk committee responsible for enterprise-wide risk management practices. |
• | Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated average assets less tangible capital. |
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• | Increase the minimum ratio of net worth to insured deposits of the Deposit Insurance Fund from 1.15% to 1.35% and require the FDIC, in setting assessments, to offset the effect of the increase on institutions with assets of less than $10 billion. |
• | Provide for new disclosure and other requirements relating to executive compensation and corporate governance. |
• | Make permanent the $250,000 limit for federal deposit insurance and provide unlimited federal deposit insurance until January 1, 2013 for non-interest bearing demand transaction accounts at all insured depository institutions. |
• | Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. |
• | Give the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. |
• | Require all bank holding companies to serve as a source of financial strength to their depository institution subsidiaries in the event such subsidiaries suffer from financial distress. |
• | Restrict proprietary trading by banks, bank holding companies and others, and their acquisition and retention of ownership interests in and sponsorship of hedge funds and private equity funds. |
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company and the financial services industry more generally. Provisions in the legislation that affect deposit insurance assessments, and payment of interest on demand deposits could increase the costs associated with deposits.
In July 2010, Dodd-Frank Act was signed into law which, among other things, limits the ability for certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital. Since the Company had less than $15 billion in assets at December 31, 2009, under the Dodd-Frank Act, the Company will be able to continue to include its existing trust preferred securities in Tier 1 capital.
Critical Accounting Policies
Accounting estimates and assumptions discussed in this section are those that the Company considers to be the most critical to an understanding of the Company’s financial statements because they inherently involve significant judgments and uncertainties. The financial information contained in these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. These critical accounting policies are those that involve subjective decisions and assessments and have the greatest potential impact on the Company’s results of operations. Management has identified its most critical accounting policies to be those relating to the following: investment securities, loan sales, allowance for loan losses, deferred income taxes and share-based compensation. The following is a summary of these accounting policies. In each area, the Company has identified the variables most important in the estimation process. The Company has used the best information available to make the estimations necessary to value the related assets and liabilities. Actual performance that differs from the Company’s estimates and future changes in the key variables could change future valuations and impact net income.
Investment Securities
Investment securities generally must be classified as held-to-maturity, available-for-sale or trading. The appropriate classification is based partially on the Company’s ability to hold the securities to maturity and largely on management’s intentions with respect to either holding or selling the securities. The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Unrealized gains and losses on trading securities flow directly through earnings during the periods in which they arise, whereas with respect to available-for-sale securities, they are recorded as a separate component of shareholders’ equity (accumulated comprehensive other income or loss) and do not affect earnings until realized. The fair values of the Company’s investment securities are generally determined by reference to quoted market prices and reliable independent sources.
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To determine whether a debt security is other-than temporarily impaired, management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment. Previously, this assessment required management to assert it has both the intent and the ability to hold a security for a period of time sufficient to allow for an anticipated recovery in fair value to avoid recognizing an other-than-temporary impairment. In instances where a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than temporary impairment needs to be recognized in the statement of operations. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
Allowance for Loan Losses
Loan losses are charged and recoveries are credited to the allowance for loan losses. Additions to the allowance are charged to the provision for loan losses. The allowance for loan losses is maintained at a level considered adequate by management to absorb inherent losses in the loan portfolio. The adequacy of the allowance for loan losses is determined by management based upon an evaluation and review of the loan portfolio, consideration of historical loan loss experience, current economic conditions, changes in the composition of the loan portfolio, analysis of collateral values, and other pertinent factors. While management uses available information to recognize possible losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additional allowance based on their judgments about information available to them at the time of their examination.
Impaired Loans
Loans are measured for impairment when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. The amount of impairment and any subsequent changes are recorded through the provision for loan losses as an adjustment to the allowance for loan losses. Impairment is measured either based on the present value of the loan’s expected future cash flows or the estimated fair value of the collateral less related liquidation costs. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The Company evaluates consumer loans for impairment on a pool basis. These loans are generally smaller homogeneous loans, and are evaluated on a portfolio basis accordingly.
Deferred Taxes
Deferred income taxes are provided for using an asset and liability approach. Deferred income tax assets and liabilities represent the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the interim consolidated financial statements. As of September 30, 2010, the Company’s deferred tax assets were primarily due to the allowance for loans losses.
A valuation allowance has been established against the deferred tax asset due to an uncertainty of realization. The valuation allowance is reviewed quarterly to analyze whether there is sufficient positive or negative evidence to support a change in management’s judgment about the realizability of the related deferred tax asset.
Share-based Compensation
In accordance with FASB ASC 718,Stock Compensation, the Company recognizes compensation expense for all share-based payments made to employees based on the fair value of the share-based payment on the date of grant. The Company elected to use the modified prospective method for adoption, which requires compensation expense to be recorded for all unvested stock options beginning in the first quarter of adoption. For all unvested options outstanding as of January 1, 2006, the previously measured but unrecognized compensation expense, based on the fair value at the original grant date, is recognized on a straight-line basis in the consolidated statements of operations over the remaining vesting period. For share-based payments granted subsequent to January 1, 2006, compensation expense, based on the fair value on the date of grant, is recognized in the consolidated statements of operations on a straight-line basis over the vesting period. In determining the fair value of stock options, the Company uses the Black-Scholes option-pricing model that employs the following assumptions:
• | Expected volatility—based on the weekly historical volatility of our stock price, over the expected life of the option. |
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• | Expected term of the option—based on historical employee stock option exercise behavior, the vesting terms of the respective option and a contractual life of ten years. |
• | Risk-free rate—based upon the rate on a zero coupon U.S. Treasury bill, for periods within the contractual life of the option, in effect at the time of grant. |
• | Dividend yield—calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant. |
The Company’s stock price volatility and option lives involve management’s best estimates at that time, both of which impact the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the life of the option.
Acquired Loans
In accordance with FASB ASC 310-30, acquired loans were aggregated into pools based on individually evaluated common risk characteristics and expected cash flows were estimated on a pool basis. A pool was accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. The Company aggregated all of the loans, with the exception of a small population of loans, acquired in the FDIC-assisted acquisition of Innovative Bank into seven different pools. A loan will be removed from a pool of loans only if the loan is sold, foreclosed, assets are received in satisfaction of the loan, or the loan is written off, and will be removed from the pool at the carrying value.
The cash flows expected to be received over the life of the pool were estimated by management with the assistance of a third party valuation specialist. These cash flows were utilized in calculating the carrying values of the pools and underlying loans, book yields, effective interest income and impairment, if any, based on actual and projected events. Default rates, loss severity, and prepayment speeds assumptions will be periodically reassessed and updated within the accounting model to update the expectation of future cash flows. The excess of the cash flows expected to be collected over the pool’s carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the loan or pool using the effective yield method. The accretable yield will change due to changes in the timing and amounts of expected cash flows. Changes in the accretable yield will be disclosed quarterly.
The excess of the contractual balances due over the cash flows expected to be collected is considered to be the nonaccretable difference. The nonaccretable difference represents the Company’s estimate of the credit losses expected to occur and was considered in determining the fair value of the loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over those expected at purchase date in excess of fair value are adjusted through the accretable difference on a prospective basis. Any subsequent decreases in expected cash flows over those expected at the purchase date are recognized by recording a provision for loan losses. Any disposals of loans, including sales of loans, payments in full or foreclosures, result in the removal of the loan from the pool at its carrying amount. The difference between actual prepayments and expected prepayments will not affect the nonaccretable difference.
The acquired loan portfolio also includes revolving lines of credit with funded and unfunded commitments. Funds advanced at the time of acquisition will be accounted for under ASC 310-30. Any additional advances on these loans subsequent to the acquisition will not be accounted for under ASC 310-30.
Recent Developments
FDIC-assisted acquisition
On April 16, 2010, the California Department of Financial Institutions closed Innovative Bank, Oakland, California, and appointed the Federal Deposit Insurance Corporation (“FDIC”) as its receiver. On the same date, Center Bank assumed the banking operations of Innovative Bank from the FDIC under a purchase and assumption agreement with loss sharing. Through this agreement, Center Bank now operates four additional branches in California.
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Center Bank assumed both the insured and non-insured deposits balance, at a premium of 0.5 percent. The loss sharing agreement between the FDIC and Center Bank, which covers all loans and other real estate owned that have been assumed, the business combination fair value adjustments, significantly mitigates the risk of future loss on the loan portfolio acquired. Under the terms of the loss sharing agreement, the FDIC will absorb 80% of losses and share in 80% of loss recoveries. The reimbursed losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the assumption. New loans made after that date are not covered by the loss sharing agreement.
2009 Fourth Quarter Capital Raises
The Company entered into Securities Purchase Agreements with a limited number of institutional and other accredited investors, including insiders, to sell a total of 73,500 shares of mandatorily convertible non-cumulative non-voting perpetual preferred stock, series B, without par value (the “Series B Preferred Stock”) at a price of $1,000 per share, for an aggregate gross purchase price of $73.5 million. This private placement closed on December 31, 2009, and the Company issued an aggregate of 73,500 shares of Series B Preferred Stock upon its receipt of consideration in cash.
The Series B Preferred Stock converted into 19,599,981 million shares of Center Financial’s common stock effective March 29, 2010 after the Company received shareholder approval of such conversion at a Special Meeting of Shareholders held on March 24, 2010. The conversion ratio for each share of Series B Preferred Stock was equal to the quotient obtained by dividing the Series B Share Price of $1,000 by the conversion price of $3.75. The shares issued in this private placement were registered on a Form S-3 Registration Statement, as amended, which became effective April 8, 2010, thus removing the restrictions on resale.
The Company also issued 3,360,000 shares of common stock in a private placement which closed on November 30, 2009 (the “November Private Placement”), at a price per share of $3.71 to non-affiliated investors and $4.69 to certain directors and employees of the Company. The difference in the purchase price was necessary to comply with NASDAQ Listing Rule 5635(c). The Company obtained shareholder approval of the November Private Placement at a special meeting held on March 24, 2010 so that all investors in the November Private Placement could be treated equally. Following receipt of shareholder approval, 85,045 additional shares were issued to the directors and employees who invested in the November Private Placement, in order to effectuate this result. The shares issued in the November Private Placement were registered on a Form S-3 Registration Statement which became effective April 8, 2010, thus removing the restrictions on resale.
Informal Regulatory Agreements
Effective December 18, 2009, the Bank entered into a memorandum of understanding (“MOU”) with the FDIC and the Department of Financial Institutions (the “DFI”). The MOU is an informal administrative agreement pursuant to which the Bank agreed to take various actions and comply with certain requirements to facilitate improvement in its financial condition. In accordance with the MOU, the Bank agreed among other things to (a) develop and implement strategic plans to restore profitability; (b) develop a capital plan containing specified elements including achieving by December 31, 2009 and thereafter maintaining a Leverage Capital Ratio of not less than 9% and a Total Risk-Based Capital Ratio of not less than 13%; (c) refrain from paying cash dividends without prior regulatory approval; (d) reduce the amounts of its assets adversely classified or criticized in its most recent FDIC examination or internally graded Special Mention within certain specified time parameters; (e) increase the allowance for loan and lease losses (“ALLL”) by $18.7 million (which was completed in the second quarter of 2009) and thereafter maintain an appropriate ALLL balance; (f) develop and implement certain specified policies and procedures relating to the ALLL, troubled debt restructurings, and non-accrual and impaired loans; (g) develop and implement a plan for reducing concentrations of commercial real estate loans; (h) make certain revisions to the Bank’s liquidity policy concerning “high-rate” deposits and reduce the Net Non-Core Funding Dependency Ratio to less than 40% by December 31, 2010; (i) conduct a complete review of management and staffing and submit written findings to the FDIC and the DFI concerning the same; (j) notify the FDIC and the DFI prior to appointing any new director or senior executive officer; (k) refrain from establishing any new offices without prior regulatory approval; and (l) submit written quarterly progress reports to the FDIC and the DFI detailing the form and manner of any actions taken to secure compliance with the MOU and the results thereof.
On December 9, 2009, the Company entered into an MOU with the Federal Reserve Bank of San Francisco (the “FRB”) pursuant to which the Company agreed, among other things, to (i) take steps to ensure that the Bank complies with the Bank’s MOU; (ii) implement a capital plan addressing specified items and submit the plan to the FRB for approval; (iii) submit annual cash flow projections to the FRB; (iv) refrain from paying cash dividends, receiving cash dividends from the Bank, increasing or guaranteeing debt, redeeming or repurchasing its stock, or issuing any additional trust preferred securities, without prior FRB approval; and (v) submit written quarterly progress reports to the FRB detailing compliance with the MOU.
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The MOUs will remain in effect until modified or terminated by the FRB, the FDIC and the DFI. We do not expect the actions called for by the MOUs to change our business strategy in any material respect, although they may have the effect of limiting or delaying the Bank’s or the Company’s ability or plans to expand. The board of directors and management of the Bank and the Company have taken various actions to comply with the MOUs, and will continue to diligently endeavor to take all actions necessary for compliance. Management believes that the Bank and the Company are currently in substantial compliance with the terms of the MOUs, although formal determinations of compliance with the MOUs can only be made by the regulatory authorities. In that regard, the Bank’s Leverage Capital Ratio and Total Risk-Based Capital ratios as of September 30, 2010 were 12.31% and 18.96%, considerably in excess of the required ratios for the Bank.
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The Company recorded consolidated net income for the three and nine months ended September 30, 2010 of $6.0 million and $16.2 million, and income of $0.13 and a loss of $0.44 per diluted common share, respectively, compared to consolidated net loss of $2.5 million and $18.0 million, or a loss of $0.19 and $1.21 per diluted common share for the same periods in 2009. The following were significant highlights related to the results during the three and nine months ended September 30, 2010 as compared to the corresponding periods of 2009:
• | The provision for loan losses on non-covered loans was $4.0 million and $16.0 million for the three and nine months ended September 30, 2010 compared to $10.6 million and $54.8 million for the same periods in 2009. The decrease was primarily due to a stabilization of risk factors as well as a reduction in loan portfolio. |
• | Net interest income before provision for loan losses was $17.1 million and $51.0 million for the three and nine months ended September 30, 2010, respectively, as compared to $14.8 million and $46.0 million for the same periods in 2009. The average investment portfolio for the three and nine months ended September 30, 2010 was $300.2 million and $326.8 million, respectively, compared to $251.9 million and $228.2 million, respectively, for the same periods in 2009. The increase in net interest income before provision for loan losses was a result of the decrease in interest expenses to greater extent than that of interest income for the three and nine months ended September 30, 2010 compared to the same periods in 2009. Most of the decrease in interest expense resulted from rate reductions in money market accounts and time certificates of deposits during the aforementioned periods noted above. |
• | The net interest margin for the three and nine months ended September 30, 2010 increased to 3.31% and 3.34%, respectively, compared to 2.85% and 3.04%, respectively, for the same periods of 2009. Interest income on non-accrual loans amounting to $373,000 and $1.6 million was not recognized during the three and nine months ended September 30, 2010 compared to $1.1 million and $2.2 million during the same periods in 2009. |
• | The Company recorded a bargain purchase gain of $5.9 million, net of expense related to equity appreciation rights exercised by the FDIC, during the nine months ended September 30, 2010 as a result of the FDIC-assisted acquisition of Innovative Bank on April 16, 2010. |
• | The Company’s efficiency ratio improved to 57.6% and 49.2% for the three and nine months ended September 30, 2010, respectively, compared to 64.6% and 59.4% for the same periods in 2009. The improvement mainly relates to the increase in net interest income, a bargain purchase gain and gain on sale of securities available for sale and gain on sale of SBA loans. |
• | Return on average assets and return on average equity increased to 1.04% and 8.83%, respectively, for the three months ended September 30, 2010, compared to (0.45)% and (5.01)% during the same period in 2009. Return on average assets and return on average equity increased to 0.97% and 8.29%, respectively, for the nine months ended September 30, 2010, compared to (1.12)% and (11.35)% during the same period in 2009. Return on average assets and the return on average equity increased due to the Company’s return to profitability primarily resulting from the improvement in the net interest margin, a decrease in the loan loss provision and an increase in total noninterest income including the bargain purchase gain during the nine months ended September 30, 2010 as compared to the same period in 2009. |
• | During the third quarter of 2010, the Company recorded a tax benefit of $846,000. The net benefit recorded during the quarter was the result of a $2.1 million reduction in the valuation reserve maintained against the Company’s deferred tax assets. |
The following are important factors in understanding the Company’s financial condition and liquidity:
• | The Company’s gross non-covered loans decreased by $71.7 million, or 4.7%, during the nine months ended September 30, 2010. Net non-covered loans and loans held for sale decreased by $67.4 million, or 4.6%, to $1.41 billion at September 30, 2010, as compared to $1.48 billion at December 31, 2009. The decrease in the loan portfolio was mainly the result of lower levels of loan production and higher levels of loan pay-offs and note sales during the first nine months of 2010. The continued economic instability has continued to adversely affect the Company’s ability to originate loans in the current year. |
• | Total non-covered nonperforming loans decreased to $43.2 million as of September 30, 2010 from $63.5 million as of December 31, 2009 and increased nominally from $43.0 million as of September 30, 2009. The decrease from December 31, 2009 to September 30, 2010 primarily resulted from the decreases in nonperforming |
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commercial real estate loans of $14.0 million and construction real estate loans of $4.4 million and trade finance of $1.5 million and commercial loans of $0.7 million offset by the increases in nonperforming SBA loans of $0.4 million. |
• | Total deposits increased $44.6 million or 2.6% to $1.79 billion at September 30, 2010 compared to $1.75 billion at December 31, 2009. The increase resulted mainly from the assumption of Innovative Bank’s deposits. |
• | The ratio of net loans to total deposits slightly increased to 85.1% at September 30, 2010 as compared to 84.6% at December 31, 2009. |
As previously noted and reflected in the interim consolidated statements of operations, the Company recorded consolidated net income of $6.0 million and $16.2 million during the three and nine months ended September 30, 2010 compared to consolidated net loss of $2.5 million and $18.0 million during the same periods in 2009. The Company earns income from two primary sources: net interest income, which is the difference between interest income generated from the successful deployment of earning assets and interest expense created by interest-bearing liabilities; and noninterest income, which is basically fees and charges earned from customer services less the operating costs associated with providing a full range of banking services to customers.
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Net Interest Income and Net Interest Margin
The following table presents the net interest spread, net interest margin, average balances, interest income and expense, and average yields and rates by asset and liability component for the three months ended September 30, 2010 and 2009:
Three Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average Balance | Interest Income/ Expense | Annualized Average Rate/Yield 1) | Average Balance | Interest Income/ Expense | Annualized Average Rate/Yield 1) | |||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans2) | $ | 1,523,012 | $ | 22,513 | 5.86 | % | $ | 1,553,814 | $ | 23,128 | 5.91 | % | ||||||||||||
Federal funds sold | 228,116 | 127 | 0.22 | 254,853 | 162 | 0.25 | ||||||||||||||||||
Investments3) 4) | 300,231 | 1,499 | 1.98 | 251,891 | 2,426 | 3.82 | ||||||||||||||||||
Total interest-earning assets | 2,051,359 | 24,139 | 4.67 | 2,060,558 | 25,716 | 4.95 | ||||||||||||||||||
Noninterest - earning assets: | ||||||||||||||||||||||||
Cash and due from banks | 109,237 | 84,367 | ||||||||||||||||||||||
Bank premises and equipment, net | 13,091 | 13,975 | ||||||||||||||||||||||
Customers’ acceptances outstanding | 2,100 | 2,587 | ||||||||||||||||||||||
Accrued interest receivables | 5,012 | 7,427 | ||||||||||||||||||||||
Other assets | 102,399 | 62,418 | ||||||||||||||||||||||
Total noninterest-earning assets | 231,839 | 170,774 | ||||||||||||||||||||||
Total assets | $ | 2,283,198 | $ | 2,231,332 | ||||||||||||||||||||
Liabilities and Shareholders’ Equity: | ||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||
Money market and NOW accounts | $ | 519,943 | $ | 1,499 | 1.14 | % | $ | 496,907 | $ | 2,194 | 1.75 | % | ||||||||||||
Savings | 92,288 | 589 | 2.53 | 80,529 | 657 | 3.24 | ||||||||||||||||||
Time certificates of deposit over $100,000 | 505,758 | 1,757 | 1.38 | 597,068 | 3,979 | 2.64 | ||||||||||||||||||
Other time certificates of deposit | 301,881 | 1,292 | 1.70 | 341,459 | 2,201 | 2.56 | ||||||||||||||||||
1,419,870 | 5,137 | 1.44 | 1,515,963 | 9,031 | 2.36 | |||||||||||||||||||
Other borrowed funds | 169,844 | 1,747 | 4.08 | 159,775 | 1,736 | 4.31 | ||||||||||||||||||
Long-term subordinated debentures | 18,557 | 155 | 3.31 | 18,557 | 156 | 3.34 | ||||||||||||||||||
Total interest-bearing liabilities | 1,608,271 | 7,039 | 1.74 | 1,694,295 | 10,923 | 2.56 | ||||||||||||||||||
Noninterest-bearing liabilities: | ||||||||||||||||||||||||
Demand deposits | 379,286 | 322,370 | ||||||||||||||||||||||
Total funding liabilities | 1,987,557 | 1.41 | % | 2,016,665 | 2.15 | % | ||||||||||||||||||
Other liabilities | 27,722 | 14,611 | ||||||||||||||||||||||
Total noninterest-bearing liabilities | 407,008 | 336,981 | ||||||||||||||||||||||
Shareholders’ equity | 267,919 | 200,056 | ||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 2,283,198 | $ | 2,231,332 | ||||||||||||||||||||
Net interest income | $ | 17,100 | $ | 14,793 | ||||||||||||||||||||
Cost of deposits | 1.13 | % | 1.95 | % | ||||||||||||||||||||
Net interest spread5) | 2.93 | % | 2.39 | % | ||||||||||||||||||||
Net interest margin6) | 3.31 | % | 2.85 | % | ||||||||||||||||||||
1) | Average rates/yields for these periods have been annualized. |
2) | Loans are net of the allowance for loan losses, deferred fees, and discount on SBA loans retained. Loan fees included in interest income were approximately $58,000 for the three months ended September 30, 2010 and ($106,000) for the same period in 2009. Amortized loan fees have been included in the calculation of net interest income. Nonperforming loans have been included in the table for computation purposes, but the foregone interest on such loans is excluded. |
3) | Investments include securities available for sale, securities held to maturity, FHLB and Pacific Coast Bankers Bank stock and money market funds and interest-bearing deposits in other banks. |
4) | Interest income on a tax equivalent basis for tax-advantaged investments was not included in the computation of yields. Such income amounted to $0 and $1,000 for the three months ended September 30, 2010 and 2009, respectively. |
5) | Represents the weighted average yield on interest-earning assets less the weighted average cost of interest-bearing liabilities. |
6) | Represents net interest income before provision for loan losses as a percentage of average interest-earning assets as adjusted for tax equivalent basis for any tax advantaged income. |
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The following table presents the net interest spread, net interest margin, average balances, interest income and expense, and average yields and rates by asset and liability component for the nine months ended September 30, 2010 and 2009:
Nine Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average Balance | Interest Income/ Expense | Annualized Average Rate/Yield 7) | Average Balance | Interest Income/ Expense | Annualized Average Rate/Yield 7) | |||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans8) | $ | 1,539,882 | $ | 64,529 | 5.60 | % | $ | 1,614,596 | $ | 72,181 | 5.98 | % | ||||||||||||
Federal funds sold | 173,785 | 289 | 0.22 | 180,436 | 310 | 0.23 | ||||||||||||||||||
Investments9) 10) | 326,820 | 7,302 | 2.99 | 228,200 | 7,060 | 4.14 | ||||||||||||||||||
Total interest-earning assets | 2,040,487 | 72,120 | 4.73 | 2,023,232 | 79,551 | 5.26 | ||||||||||||||||||
Noninterest - earning assets: | ||||||||||||||||||||||||
Cash and due from banks | 97,395 | 59,980 | ||||||||||||||||||||||
Bank premises and equipment, net | 13,099 | 14,366 | ||||||||||||||||||||||
Customers’ acceptances outstanding | 2,283 | 3,166 | ||||||||||||||||||||||
Accrued interest receivables | 5,890 | 7,108 | ||||||||||||||||||||||
Other assets | 82,536 | 54,063 | ||||||||||||||||||||||
Total noninterest-earning assets | 201,203 | 138,683 | ||||||||||||||||||||||
Total assets | $ | 2,241,690 | $ | 2,161,915 | ||||||||||||||||||||
Liabilities and Shareholders’ Equity: | ||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||
Money market and NOW accounts | $ | 500,282 | $ | 4,163 | 1.11 | % | $ | 480,777 | $ | 6,988 | 1.94 | % | ||||||||||||
Savings | 93,068 | 1,819 | 2.61 | 65,254 | 1,661 | 3.40 | ||||||||||||||||||
Time certificates of deposit over $100,000 | 511,853 | 5,930 | 1.55 | 663,781 | 11,891 | 2.40 | ||||||||||||||||||
Other time certificates of deposit | 275,656 | 3,746 | 1.82 | 222,982 | 7,128 | 4.27 | ||||||||||||||||||
1,380,859 | 15,658 | 1.52 | 1,432,794 | 27,668 | 2.58 | |||||||||||||||||||
Other borrowed funds | 166,811 | 5,021 | 4.02 | 168,199 | 5,336 | 4.24 | ||||||||||||||||||
Long-term subordinated debentures | 18,557 | 438 | 3.16 | 18,557 | 529 | 3.81 | ||||||||||||||||||
Total interest-bearing liabilities | 1,566,227 | 21,117 | 1.80 | 1,619,550 | 33,533 | 2.77 | ||||||||||||||||||
Noninterest-bearing liabilities: | ||||||||||||||||||||||||
Demand deposits | 370,831 | 311,058 | ||||||||||||||||||||||
Total funding liabilities | 1,937,058 | 1.46 | % | 1,930,608 | 2.32 | % | ||||||||||||||||||
Other liabilities | 42,879 | 18,757 | ||||||||||||||||||||||
Total noninterest-bearing liabilities | 413,710 | 329,815 | ||||||||||||||||||||||
Shareholders’ equity | 261,753 | 212,550 | ||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 2,241,690 | $ | 2,161,915 | ||||||||||||||||||||
Net interest income | $ | 51,003 | $ | 46,018 | ||||||||||||||||||||
Cost of deposits | 1.20 | % | 2.12 | % | ||||||||||||||||||||
Net interest spread11) | 2.92 | % | 2.49 | % | ||||||||||||||||||||
Net interest margin12) | 3.34 | % | 3.04 | % | ||||||||||||||||||||
7) | Average rates/yields for these periods have been annualized. |
8) | Loans are net of the allowance for loan losses, deferred fees, and discount on SBA loans retained. Loan fees included in interest income were approximately $190,000 for the nine months ended September 30, 2010 and $589,000 for the same period in 2009. Amortized loan fees have been included in the calculation of net interest income. Nonperforming loans have been included in the table for computation purposes, but the foregone interest on such loans is excluded. |
9) | Investments include securities available for sale, securities held to maturity, FHLB and Pacific Coast Bankers Bank stock and money market funds and interest-bearing deposits in other banks. |
10) | Interest income on a tax equivalent basis for tax-advantaged investments was not included in the computation of yields. Such income amounted to $0 and $3,000 for the nine months ended September 30, 2010 and 2009, respectively. |
11) | Represents the weighted average yield on interest-earning assets less the weighted average cost of interest-bearing liabilities. |
12) | Represents net interest income (before provision for loan losses) as a percentage of average interest-earning assets as adjusted for tax equivalent basis for any tax advantaged income. |
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The following table sets forth, for the periods indicated, the dollar amount of changes in interest earned and paid for interest-earning assets and interest-bearing liabilities and the amount of change attributable to (i) changes in average daily balances (volume) and (ii) changes in interest rates (rate):
Three Months Ended September 30, 2010 vs. 2009 Increase (Decrease) Due to Change In | Nine Months Ended September 30, 2010 vs. 2009 Increase (Decrease) Due to Change In | |||||||||||||||||||||||
Volume | Rate13) | Total | Volume | Rate13) | Total | |||||||||||||||||||
Interest income: | ||||||||||||||||||||||||
Loans14) | $ | (456 | ) | $ | (159 | ) | $ | (615 | ) | $ | (3,251 | ) | $ | (4,401 | ) | $ | (7,652 | ) | ||||||
Federal funds sold | (16 | ) | (19 | ) | (35 | ) | (11 | ) | (10 | ) | (21 | ) | ||||||||||||
Investments15) | 402 | (1,330 | ) | (928 | ) | 2,535 | (2,294 | ) | 241 | |||||||||||||||
Total earning assets | (70 | ) | (1,508 | ) | (1,578 | ) | (727 | ) | (6,705 | ) | (7,432 | ) | ||||||||||||
Interest expense: | ||||||||||||||||||||||||
Money market and super NOW accounts | 98 | (793 | ) | (695 | ) | 273 | (3,098 | ) | (2,825 | ) | ||||||||||||||
Savings deposits | 88 | (156 | ) | (68 | ) | 602 | (444 | ) | 158 | |||||||||||||||
Time Certificates of deposits | (772 | ) | (2,359 | ) | (3,131 | ) | (942 | ) | (8,401 | ) | (9,343 | ) | ||||||||||||
Other borrowings | 107 | (96 | ) | 11 | (45 | ) | (270 | ) | (315 | ) | ||||||||||||||
Long-term subordinated debentures | — | (1 | ) | (1 | ) | — | (91 | ) | (91 | ) | ||||||||||||||
Total interest-bearing liabilities | (479 | ) | (3,405 | ) | (3,884 | ) | (112 | ) | (12,304 | ) | (12,416 | ) | ||||||||||||
Net interest income before provision for loan losses | $ | 409 | $ | 1,897 | $ | 2,306 | $ | (615 | ) | $ | 5,599 | $ | 4,984 | |||||||||||
13) | Average rates/yields for these periods have been annualized. |
14) | Loans are net of the allowance for loan losses, deferred fees, and discount on SBA loans retained. Loan fees included in interest income were approximately $58,000 and $190,000 for the three and nine months ended September 30, 2010 and ($106,000) and $589,000 for the same periods in 2009. Amortized loan fees have been included in the calculation of net interest income. Nonperforming loans have been included in the table for computation purposes, but the foregone interest on such loans is excluded. |
15) | Interest income on a tax equivalent basis for tax-advantaged investments was not included in the computation of yields. Such income amounted to $0 for the three and nine months ended September 30, 2010 and compared to $1,000 and $3,000 for the same periods in 2009, respectively. |
The Company’s net interest income depends on the yields, volumes, and mix of its earning asset components, as well as the rates, volume, and mix associated with its funding sources. The Company’s net interest margin is its taxable-equivalent net interest income expressed as a percentage of its average earning assets.
Total interest and dividend income for the three and nine months ended September 30, 2010 were $24.1 million and $72.1 million, respectively, compared to $25.7 million and $79.6 million for the same periods in 2009. The decrease was primarily due to the reduction in interest rates. Average yield on earning assets decreased to 4.67% and 4.73% for the three and nine months ended September 30, 2010 from 4.95% and 5.26% for the same periods in 2009, respectively.
Total interest expense for the three and nine months ended September 30, 2010 decreased by $3.9 million or 35.6% and $12.4 million or 37.0%, respectively, compared to the same periods in 2009. The decreases were primarily due to the gradual decrease in deposit cost and management’s effort to change the deposit mix focusing more on lower cost deposits during the past year. The percentage of noninterest-bearing demand deposits to total deposits increased to 21.4% at September 30, 2010 compared to 20.2% at December 31, 2009. Average interest bearing liabilities decreased by $86.0 million or 5.1% and $53.3 million or 3.3% for the three and nine months ended September 30, 2010 compared to the same periods in 2009 and noninterest-bearing demand deposits increased by $31.1 million or 8.8% at September 30, 2010 compared to December 31, 2009.
As a result, net interest income before provision for loan losses was $17.1 million and $51.0 million, respectively, for three and nine months ended September 30, 2010 compared to $14.8 million and $46.0 million for the same periods in 2009, respectively. In addition, the net interest margin for the three and nine months ended September 30, 2010 increased to 3.31% and 3.34% from 2.85% and 3.04% for the same periods in 2009, respectively.
Provision for Loan Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan losses through charges to earnings, which are reflected in the consolidated statement of operations as the provision for loan losses. Specifically, the provision for loan losses represents the amount charged against current period earnings to achieve an allowance for loan losses that in management’s judgment is adequate to absorb losses inherent in the Company’s loan portfolio.
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The provision for loan losses was $4.0 million and $16.0 million for the three and nine months ended September 30, 2010 compared to $10.6 million and $54.8 million for the same periods in 2009. The decrease was primarily due to a stabilization of risk factors. Management believes that the $16.0 million loan loss provision was adequate for the nine months ended September 30, 2010 and that the allowance for loans losses of $54.5 million as of September 30, 2010 is adequate to absorb losses inherent in the Company’s loan portfolio.
While management believes that the allowance for loan losses, representing 3.71% of total non-covered loans at September 30, 2010 was adequate, future additions to the allowance will be subject to continuing evaluation of the estimated, inherent and other known risks in the loan portfolio. The procedures for monitoring the adequacy of the allowance, and detailed information on the allowance, are included below in “Allowance for Loan Losses.”
Noninterest Income
The following table sets forth the various components of the Company’s noninterest income for the periods indicated:
Three Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Change in | ||||||||||||||||||||
Amount | Percentage | |||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Customer service fees | $ | 2,043 | 46.34 | % | $ | 2,008 | 60.08 | % | $ | 35 | 1.70 | % | ||||||||||||
Fee income from trade finance transactions | 684 | 15.51 | 543 | 16.25 | 141 | 26.00 | ||||||||||||||||||
Wire transfer fees | 321 | 7.28 | 275 | 8.23 | 46 | 16.70 | ||||||||||||||||||
Gain on sale of loans | 257 | 5.83 | — | — | 257 | 100.00 | ||||||||||||||||||
Net gain (loss) on sale of securities available for sale | — | — | (7 | ) | (0.21 | ) | 7 | -100.00 | ||||||||||||||||
Loan service fees | 565 | 12.81 | 167 | 5.00 | 398 | 238.30 | ||||||||||||||||||
Other income | 539 | 12.22 | 356 | 10.65 | 183 | 51.40 | ||||||||||||||||||
Total noninterest income | $ | 4,409 | 100.00 | % | $ | 3,342 | 100.00 | % | $ | 1,067 | 31.93 | % | ||||||||||||
As a percentage of average earning assets | 0.85 | % | 0.64 | % | ||||||||||||||||||||
Nine Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Change in | ||||||||||||||||||||
Amount | Percentage | |||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Customer service fees | $ | 6,161 | 29.12 | % | $ | 6,004 | 56.89 | % | $ | 157 | 2.60 | % | ||||||||||||
Fee income from trade finance transactions | 2,062 | 9.75 | 1,679 | 15.91 | 383 | 22.80 | ||||||||||||||||||
Wire transfer fees | 933 | 4.41 | 820 | 7.77 | 113 | 13.80 | ||||||||||||||||||
Gain on business acquisition | 5,900 | 27.89 | — | — | 5,900 | 100.00 | ||||||||||||||||||
Gain on sale of loans | 1,460 | 6.90 | — | — | 1,460 | 100.00 | ||||||||||||||||||
Net gain (loss) on sale of securities available for sale | 2,209 | 10.44 | (55 | ) | (0.52 | ) | 2,264 | -4,116.40 | ||||||||||||||||
Loan service fees | 1,153 | 5.45 | 626 | 5.93 | 527 | 84.20 | ||||||||||||||||||
Other income | 1,279 | 6.05 | 1,480 | 14.02 | (201 | ) | (13.58 | ) | ||||||||||||||||
Total noninterest income | $ | 21,157 | 100.00 | % | $ | 10,554 | 100.00 | % | $ | 10,603 | 100.46 | % | ||||||||||||
As a percentage of average earning assets | 1.39 | % | 0.70 | % |
The increase in noninterest income for the three months ended September 30, 2010 was primarily due to gain on sale of SBA loans that were transferred during the second quarter of 2010 and an increase in loan service fee income resulting from increased loan origination activities compared to the same period in 2009.
The increase in noninterest income for the nine months ended September 30, 2010 primarily resulted from a bargain purchase gain of $5.9 million relating to the Innovative Bank acquisition, gain on sale of SBA loans that was recognized during the second quarter of 2010, and gain on sale of securities available for sale during the first quarter of 2010. Other income in 2009 included a nonrecurring settlement received in the amount of $350,000.
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Noninterest Expense
The following table sets forth the components of noninterest expense for the periods indicated:
Three Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Change in | ||||||||||||||||||||
Amount | Percentage | |||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Salaries and employee benefits | $ | 4,653 | 37.55 | % | $ | 4,671 | 39.91 | % | $ | (18 | ) | (0.39 | )% | |||||||||||
Occupancy | 1,388 | 11.20 | �� | 1,214 | 10.37 | 174 | 14.33 | |||||||||||||||||
Furniture, fixtures, and equipment | 756 | 6.10 | 713 | 6.09 | 43 | 6.03 | ||||||||||||||||||
Data processing | 832 | 6.71 | 591 | 5.05 | 241 | 40.78 | ||||||||||||||||||
Legal fees | 567 | 4.58 | 174 | 1.49 | 393 | 225.86 | ||||||||||||||||||
Accounting and other professional fees | 309 | 2.49 | 425 | 3.63 | (116 | ) | (27.29 | ) | ||||||||||||||||
Business promotion and advertising | 376 | 3.03 | 289 | 2.47 | 87 | 30.10 | ||||||||||||||||||
Stationery and supplies | 91 | 0.73 | 104 | 0.89 | (13 | ) | (12.50 | ) | ||||||||||||||||
Telecommunications | 227 | 1.83 | 185 | 1.58 | 42 | 22.70 | ||||||||||||||||||
Postage and courier service | 122 | 0.98 | 79 | 0.68 | 43 | 54.43 | ||||||||||||||||||
Security service | 320 | 2.58 | 269 | 2.30 | 51 | 18.96 | ||||||||||||||||||
Regulatory assessment | 1,073 | 8.66 | 642 | 5.49 | 431 | 67.13 | ||||||||||||||||||
OREO related expenses | 170 | 1.37 | 1,152 | 9.84 | (982 | ) | (85.24 | ) | ||||||||||||||||
Other operating expenses | 1,508 | 12.17 | 1,195 | 10.21 | 313 | 26.19 | ||||||||||||||||||
Total noninterest expenses | $ | 12,392 | 100.00 | % | $ | 11,703 | 100.00 | % | $ | 689 | 5.89 | % | ||||||||||||
As a percentage of average earning assets | 2.40 | % | 2.26 | % | ||||||||||||||||||||
Efficiency ratio | 57.61 | % | 64.53 | % | ||||||||||||||||||||
Nine Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | Change in | ||||||||||||||||||||
Amount | Percentage | |||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Salaries and employee benefits | $ | 13,640 | 38.39 | % | $ | 13,645 | 40.62 | % | $ | (5 | ) | (0.04 | )% | |||||||||||
Occupancy | 4,020 | 11.32 | 3,644 | 10.85 | 376 | 10.32 | ||||||||||||||||||
Furniture, fixtures, and equipment | 1,903 | 5.36 | 1,757 | 5.23 | 146 | 8.31 | ||||||||||||||||||
Data processing | 1,950 | 5.49 | 1,708 | 5.08 | 242 | 14.17 | ||||||||||||||||||
Legal fees | 1,152 | 3.24 | 824 | 2.45 | 328 | 39.81 | ||||||||||||||||||
Accounting and other professional fees | 1,170 | 3.29 | 1,187 | 3.53 | (17 | ) | (1.43 | ) | ||||||||||||||||
Business promotion and advertising | 1,048 | 2.95 | 971 | 2.89 | 77 | 7.93 | ||||||||||||||||||
Stationery and supplies | 214 | 0.60 | 318 | 0.95 | (104 | ) | (32.70 | ) | ||||||||||||||||
Telecommunications | 575 | 1.62 | 506 | 1.51 | 69 | 13.64 | ||||||||||||||||||
Postage and courier service | 311 | 0.88 | 272 | 0.81 | 39 | 14.34 | ||||||||||||||||||
Security service | 840 | 2.36 | 775 | 2.31 | 65 | 8.39 | ||||||||||||||||||
Regulatory assessment | 3,096 | 8.71 | 2,876 | 8.56 | 220 | 7.65 | ||||||||||||||||||
Merger-related expenses | 129 | 0.36 | — | — | 129 | — | ||||||||||||||||||
OREO related expenses | 1,529 | 4.30 | 1,305 | 3.88 | 224 | 17.16 | ||||||||||||||||||
Other operating expenses | 3,950 | 11.12 | 3,807 | 11.33 | 143 | 3.76 | ||||||||||||||||||
Total noninterest expenses | $ | 35,527 | 100.00 | % | $ | 33,595 | 100.00 | % | $ | 1,932 | 5.75 | % | ||||||||||||
As a percentage of average earning assets | 2.33 | % | 2.22 | % | ||||||||||||||||||||
Efficiency ratio | 49.23 | % | 59.38 | % |
For the three ended September 30, 2010, the increase in noninterest expense was mainly due to increases in occupancy expense, data processing, legal expenses, and regulatory assessments offset by the decrease in OREO related expenses compared to the same period in 2009. The acquisition of Innovative Bank in April 2010 contributed to the increase in occupancy and data processing expenses. An overall increase in FDIC insurance and the increase in deposits from the Innovative Bank acquisition resulted in an increase in regulatory assessments expenses. Significant collection related expenses were recorded as legal expenses in the current quarter. The Company recorded significant fair value adjustment for acquired OREO during the third quarter of 2009.
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For the nine months ended September 30, 2010, the increase in noninterest expense was mainly due to increases in occupancy expenses, data processing expenses, legal fees, regulatory assessment and OREO related expenses compared to the same period in 2009. The acquisition of Innovative Bank in April 2010 contributed to the increase in occupancy and data processing expenses. The increase in regulatory assessment was due to the significant increase in quarterly FDIC insurance premium offset by one-time special assessment of $1.0 million during the third quarter of 2009.
Noninterest expense as a percentage of average earning assets increased to 2.40% and 2.33%, respectively, for the three and nine months ended September 30, 2010 compared to 2.26% and 2.22%, respectively, for the same periods in 2009.
The Company’s efficiency ratio, which is defined as noninterest expense divided by the sum of net interest income and noninterest income, improved to 57.61% and 49.23% for the three and nine months ended September 30, 2010, compared to 64.53% and 59.38% for the same periods in 2009. The improvement mainly relates to the increase in net interest income, a bargain purchase gain and gain on sale of securities available for sale and gain on sale of SBA loans.
Provision for Income Taxes
Income tax expense (benefit) consists of current and deferred tax expense (benefit). Current tax expense (benefit) is the result of applying the current tax rate to current taxable income (loss). The deferred portion is intended to reflect income or loss that differs from financial statement pre-tax income or loss because some items of income and expense are recognized in different years for income tax purposes than in the financial statements.
Deferred income tax assets or liabilities reflect the estimated future tax effects attributable to differences as to when certain items of income or expense are reported in the financial statements versus when they are reported in the tax returns. The Company’s net deferred tax assets were $10.1 million as of September 30, 2010, and $11.6 million as of December 31, 2009. As of September 30, 2010, the Company’s deferred tax assets were primarily due to the allowance for loan losses and the bargain purchase gain.
At September 30, 2010, the Company maintained a valuation reserve of $14.0 million against its deferred tax assets. This was a $2.1 million decline from the valuation reserve balance as of June 30, 2010. This reduction in the valuation reserve reduced income tax expense by $2.1 million and $2.3 million for the three and nine months ended September 30, 2010. The reduction is primarily due to the expected utilization of deferred tax assets related to the 2010 tax year for state income tax purposes.
The income tax (benefit) provision amounted to $(0.8) million and $4.4 million for the three and nine months ended September 30, 2010 representing effective tax rates of (16.5)% and 21.3%, respectively, compared to income tax benefit of $1.6 million and $3.8 million for the same periods in 2009, representing effective tax rates of 38.9% and 43.4%, respectively. The primary reasons for the difference from the federal statutory tax rate of 35% are the reduction in the valuation reserve for deferred tax assets as discussed above, inclusion of state taxes and reductions related to tax favored investments in low-income housing, dividend exclusions, treatment of share-based payments amortization, an increase in cash surrender value of bank owned life insurance and California enterprise zone interest deductions and hiring credits. The Company reduced taxes utilizing the tax credits from investments in the low-income housing projects in the amount of $345,000 and $1.1 million for the three and nine months ended September 30, 2010, respectively, as compared to zero for the same periods in 2009.
It is management’s policy to separately disclose any penalties or interest arising from the application of federal or state income taxes. There were no penalties or interest assessed for the nine months ended September 30, 2010.
The Internal Revenue Service (the “IRS”) and the Franchise Tax Board (the “FTB”) have examined the Company’s consolidated federal income tax returns for tax years up to and including 2005. As of September 30, 2010, the Company was under examination by the FTB for the 2005-2007 tax years and there is no open examination by the IRS. The Company does not anticipate any material changes as a result of the examination. In addition, the Company does not have any unrecognized tax benefits subject to significant increase or decrease as a result of uncertainty.
The major components of the Company’s earning asset base are its interest-earning short-term investments, investment securities portfolio and loan portfolio. The detailed composition and growth characteristics of these three portfolios are significant to any analysis of the financial condition of the Company, and the loan portfolio analysis will be discussed in a later section of this Form 10-Q.
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Short-term Investments
The Company invests its excess available funds from daily operations primarily in overnight Fed Funds and Money Market Funds. Money Market Funds are composed primarily of government funds and high quality short-term commercial paper. The Company can redeem the funds at any time. As of September 30, 2010 and December 31, 2009, the amounts invested in Federal Funds were $198.3 million and $145.8 million, respectively. The average yield earned on these funds was 0.22% for the nine months ended September 30, 2010 compared to 0.23% for the same period in 2009.
Investment Portfolio
The following table summarizes the amortized cost, fair value and distribution of the Company’s investment securities as of the dates indicated:
As of September 30, 2010 | ||||||||||||||||
(Dollars in thousands) | Amortized Cost | Gross Unrealized Gain | Gross Unrealized Loss | Fair Value | ||||||||||||
Available for Sale: | ||||||||||||||||
U.S. Treasury | $ | 300 | $ | — | $ | — | $ | 300 | ||||||||
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities | 53,037 | 203 | — | 53,240 | ||||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 152,585 | 4,916 | — | 157,501 | ||||||||||||
Corporate trust preferred security | 2,730 | — | (1,017 | ) | 1,713 | |||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,500 | 187 | — | 4,687 | ||||||||||||
Collateralized mortgage obligations | 72,386 | 1,051 | (75 | ) | 73,362 | |||||||||||
Total securities available for sale | $ | 285,538 | $ | 6,357 | $ | (1,092 | ) | $ | 290,803 | |||||||
Total investment securities | $ | 285,538 | $ | 6,357 | $ | (1,092 | ) | $ | 290,803 | |||||||
As of December 31, 2009 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gain | Gross Unrealized Loss | Fair Value | |||||||||||||
Available for Sale: | ||||||||||||||||
U.S. Treasury | $ | 300 | $ | — | $ | — | $ | 300 | ||||||||
U.S. Governmental agencies securities and U.S. Government sponsored enterprise securities | 74,001 | 274 | (5 | ) | 74,270 | |||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 206,975 | 5,358 | (158 | ) | 212,175 | |||||||||||
Corporate trust preferred security | 2,713 | — | (309 | ) | 2,404 | |||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,500 | 33 | — | 4,533 | ||||||||||||
Collateralized mortgage obligations | 76,533 | 728 | (516 | ) | 76,745 | |||||||||||
Total securities available for sale | $ | 365,022 | $ | 6,393 | $ | (988 | ) | $ | 370,427 | |||||||
Total investment securities | $ | 365,022 | $ | 6,393 | $ | (988 | ) | $ | 370,427 | |||||||
The Company strives to maintain an investment portfolio with an adequate mix of fixed-rate and adjustable-rate securities with relatively short to moderate maturities to minimize overall interest rate risk. The Company’s investment securities portfolio consists of U.S. Treasury securities, U.S. Government agency securities, U.S. Government sponsored enterprise debt securities, mortgage-backed securities, and corporate debt. The mortgage backed securities and collateralized mortgage obligations (“CMO”) are all agency-guaranteed residential mortgages. The Company regularly models, evaluates and analyzes each agency CMO’s to capture its unique allocation of principal and interest.
As of September 30, 2010, securities available for sale totaled $290.8 million, compared to $370.4 million as of December 31, 2009. Securities available for sale as a percentage of total assets decreased to 12.8% as of September 30, 2010 compared to 16.9% at December 31, 2009. The Company sold $56.8 million of securities available for sale during the nine months ended September 30, 2010. The Company sold $4.7 million (at book value) of its municipal holdings in the held-to-maturity category and reclassified the remaining $3.8 million (at fair value) to the available-for-sale category during the first quarter of 2009. The Company sold municipal securities due to concerns about declining credit quality in the municipal securities market and to improve liquidity in the investment portfolio.
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The investment securities purchased by the Company generally include U.S. agency and government sponsored entities (“GSE”), mortgage-backed securities (“MBS”) and CMO’s as well as agency debentures. The Company increased its holdings of Ginnie Mae (“GNMA”) securities during the quarter since GNMA securities are backed by the full faith and credit of the U.S. government and carry a zero risk weight for regulatory capital purposes. Although the investment yields on GNMA securities are generally lower than other comparable “non-GNMA” labeled securities, the Company believes that the purchases of GNMA securities are a prudent risk-reduction strategy.
Available-for-sale securities represented 100.0% of the investment portfolio as of September 30, 2010 and December 31, 2009. For the three and nine months ended September 30, 2010, the yields on the average investment portfolio were 1.98% and 2.99%, respectively, as compared to 3.82% and 4.14%, respectively, for the same periods in 2009.
The following table summarizes, as of September 30, 2010, the maturity characteristics of the investment portfolio, by investment category. Expected remaining maturities may differ from remaining contractual maturities because obligors may have the right to prepay certain obligations with or without penalties.
Within one Year | After One But Within Five Years | After Five But Within Ten Years | After Ten Years | Total | ||||||||||||||||||||||||||||||||||||
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||
Available for Sale (Fair Value): | ||||||||||||||||||||||||||||||||||||||||
U.S. Treasury | $ | 300 | 0.22 | % | $ | — | — | % | $ | — | 0 | % | $ | — | 0 | % | $ | 300 | 0.22 | % | ||||||||||||||||||||
U.S. Governmental agencies securities and U.S Government sponsored enterprise securities | — | — | 51,237 | 1.46 | 2,003 | 1.07 | — | — | 53,240 | 1.45 | ||||||||||||||||||||||||||||||
U.S. Governmental agencies and U.S. Government sponsored and enterprise mortgage-backed securities | 6 | 5.77 | 1,808 | 4.62 | 41,878 | 3.00 | 113,809 | 3.47 | 157,501 | 3.36 | ||||||||||||||||||||||||||||||
Corporate trust preferred securities | — | — | — | — | — | — | 1,713 | 12.24 | 1,713 | 12.24 | ||||||||||||||||||||||||||||||
Mutual Funds backed by adjustable rate mortgages | 4,687 | 3.52 | — | — | — | — | — | — | 4,687 | 3.52 | ||||||||||||||||||||||||||||||
Collateralized mortgage obligations | — | — | — | — | 13,354 | 1.92 | 60,008 | 2.81 | 73,362 | 2.65 | ||||||||||||||||||||||||||||||
Total available for sale | $ | 4,993 | 3.32 | $ | 53,045 | 1.57 | $ | 57,235 | 2.68 | $ | 175,530 | 3.33 | $ | 290,803 | 2.88 | |||||||||||||||||||||||||
The following table shows the Company’s investments with gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2010.
As of September 30, 2010 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities | $ | 29 | $ | — | $ | — | $ | — | $ | 29 | $ | — | ||||||||||||
Corporate trust preferred security | 1,713 | (1,017 | ) | — | — | 1,713 | (1,017 | ) | ||||||||||||||||
Collateralized mortgage obligations | 11,614 | (75 | ) | — | — | 11,614 | (75 | ) | ||||||||||||||||
Total | $ | 13,356 | $ | (1,092 | ) | — | — | $ | 13,356 | $ | (1,092 | ) | ||||||||||||
As of December 31, 2009 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise securities | $ | 7,988 | $ | (5 | ) | $ | — | $ | — | $ | 7,988 | $ | (5 | ) | ||||||||||
U.S. Governmental agencies and U.S. Government sponsored enterprise mortgage-backed securities | 30,070 | (144 | ) | 937 | (14 | ) | 31,007 | (158 | ) | |||||||||||||||
Corporate trust preferred security | 2,404 | (309 | ) | — | — | 2,404 | (309 | ) | ||||||||||||||||
Collateralized mortgage obligations | 41,880 | (516 | ) | — | — | 41,880 | (516 | ) | ||||||||||||||||
Total | $ | 82,342 | $ | (974 | ) | $ | 937 | $ | (14 | ) | $ | 83,279 | $ | (988 | ) | |||||||||
The Company regularly reviews the composition of the investment portfolio, taking into account market risks, the current and expected interest rate environment, liquidity needs, and overall interest rate risk profile and strategic goals. On a quarterly basis, the Company evaluates each security in the portfolio with an individual unrealized loss to determine if that loss represents an other-than-temporary impairment.
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The Company considers the following factors in evaluating the securities: whether the securities were guaranteed by the U.S. government or its agencies and the securities’ public ratings, if available, and how those two factors affect credit quality and recovery of the full principal balance, the relationship of the unrealized losses to increases in market interest rates, the length of time the securities have had temporary impairment, and the Company’s intent and ability to hold the securities for the time necessary to recover the amortized cost. The Company also considers the payment performance, delinquency history and credit support of the underlying collateral for certain securities in the portfolio.
As of September 30, 2010, the Company had a total fair value of $13.4 million of securities, with unrealized losses of $1.1 million. We believe these unrealized losses are due to a temporary condition, primarily changes in interest rates, and do not reflect a deterioration of credit quality of the issuers. The market value of securities that have been in a continuous loss position for 12 months or more was $0 without any unrealized losses.
All individual securities that have been in a continuous unrealized loss position at September 30, 2010 had investment grade ratings upon purchase. The issuers of these securities have not, to our knowledge, established any cause for default on these securities and the various rating agencies have reaffirmed these securities’ long-term investment grade status at September 30, 2010. These securities have decreased in value since their purchase dates as market interest rates have changed. However, the Company has the ability, and management intends, to hold these securities until their fair values recover to cost.
The Company owns one collateralized debt obligation (“CDO”) security that is backed by trust preferred securities (“TRUPS”) issued by banks and thrifts. The Company recognized an OTTI impairment during 2008 of $9.9 million to reduce the CDO TRUPS to fair value of $1.1 million. As of April 1, 2009, the noncredit related portion of the previous OTTI of $1.6 million was reinstated to the amortized cost of the security. At September 30, 2010, the fair value of the security was $1.7 million due to the decline in the fair value which is considered temporary.
The CDO TRUPS securities market, since 2007 and continuing into the past several quarteres ,has been severely impacted by the liquidity crunch and concern over the banking industry. If the weight of the evidence indicates the market is not orderly, a reporting entity shall place little, if any, weight compared with other indications of fair value on that transaction price when estimating fair value or market risk premiums. Factors that were considered to determine whether there has been a significant decrease in the volume and level of activity for the CDO TRUPS securities market when compared with normal activity include:
• | There are few recent transactions. |
• | Price quotations are not based on current information. |
• | Price quotations vary substantially either over time or among market makers. |
• | Indexes that were previously highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability. |
• | There is a significant increase in implied liquidity risk premiums. Yields or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability. |
• | There is a wide bid-ask spread or significant increase in the bid-ask spread. |
• | There is a significant decline or absence of new market issuances for the asset or liability. |
• | Little information is publicly available. |
The fair values of securities available for sale are generally determined by reference to the average of at least two quoted market prices obtained from independent external brokers or prices obtained from independent external pricing service providers who have experience in valuing these securities. In obtaining such valuation information from third parties, the Company has reviewed the methodologies used to develop the resulting fair values.
The Company uses Level 3 fair value measurement for the one CDO TRUPS security it owns. The fair value of the CDO TRUPS security has traditionally been based on the average of at least two quoted market prices obtained from independent brokers. However, as a result of the global financial crisis and illiquidity in the U.S. markets, the market for these securities has become increasingly inactive since mid-2007. The current broker price for the CDO TRUPS securities is based on forced liquidation or distressed sale values in very inactive markets that may not be representative of the economic value of these securities. As such, the fair value of the CDO TRUPS security has been below cost since the advent of the financial crisis. Additionally, most, if not all, of these broker quotes are nonbinding.
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The Company considered whether to place little, if any, weight on transactions that are not orderly when estimating fair value. Although length of time and severity of impairment are among the factors to consider when determining whether a security that is other than temporarily impaired, the CDO TRUPS securities have only exhibited deep declines in value since the credit crisis began. The Company therefore believes that this is an indicator that the decline in price is primarily the result of the lack of liquidity in the market for these securities.
The Company continues to utilize Moody’s Analytics to compute the fair value of the CDO TRUPS security. Moody’s continues to update their valuation process in order to refine and improve the estimate of default probabilities to better align the valuation methodology with industry practices.
In order to determine the appropriate discount rate used in calculating fair values derived from the income method for the CDO TRUPS security, certain assumptions were made using an exit pricing approach related to the implied rate of return which have been adjusted for general change in market rates, estimated changes in credit quality and liquidity risk premium, specific nonperformance and default experience in the collateral underlying the securities.
The Moody’s Analytics Discounted Cash flow Valuation analysis uses 3-month London Inter-Bank Offered Rate (“LIBOR”) + 300 basis points as a discount rate (to reflect illiquidity – the credit component of the discount rate is embedded in the credit analysis). Approximating the yield premium for the illiquidity of a CDO TRUPS security has proved to be difficult and management found it more useful to measure the price impact for this illiquidity discount. The table below illustrates this.
Modified Duration | Price impact in percentage for basis point shown | |||||||||||||||||||
Maturity | 100 bp | 200 bp | 300 bp | 400 bp | ||||||||||||||||
10 yr | 8.58 | 9 | % | 17 | % | 26 | % | 34 | % | |||||||||||
20 yr | 14.95 | 15 | % | 30 | % | 45 | % | 60 | % | |||||||||||
30 yr | 19.69 | 20 | % | 39 | % | 59 | % | 79 | % |
There are three maturity assumptions since the final maturity on the CDO TRUPS securities can be no longer than thirty years but may be less than that as well. From the percentage impact in the 300 basis points column, an illiquidity discount of 300 basis points seems to be sufficient and reasonable based on management’s opinion in consideration of current market conditions. The maturity date on the Company’s CDO TRUPS security is October 3, 2032 and that would put the price impact for illiquidity at a 45% to 59% discount as of September 30, 2010.
The spread over LIBOR does not include a credit spread as the probable credit outlook is included in the underlying cash flows. The spread over LIBOR only reflects a liquidity discount. The discount rate that reflects expectations about future defaults is appropriate if using contractual cash flows of a loan. That same rate is not used if using expected (probability-weighted) cash flows because the expected cash flows already reflect assumptions about future defaults; instead, a discount rate that is commensurate with the risk inherent in the expected cash flows should be used.
In addition to the fair value computation of Moody’s Analytics, the Company considers additional factors to determine any OTTI for the CDO TRUPS security including review of trustee reports, monitoring of “break in yield” tests, analysis of current defaults and deferrals and the expectation for future defaults and deferrals. The Company reviews the key financial characteristics for individual issuers (commercial banks or thrifts) in the CDO TRUPS security and tracked issuer participation in the U.S. Treasury Department’s Capital Purchase Program (“CPP”). Also, the Company considers capital ratios, leverage ratios, nonperforming loan and nonperforming asset ratios, in addition to the review of changes to the credit ratings. The credit ratings of the Company’s CDO TRUPS security are “Ca” (Moody’s) and “C” (Fitch) as of September 30, 2010.
The cash flow projection for the purpose of assessing OTTI incorporates certain credit events in the underlying collaterals and prepayment assumptions. The projected issuer default rates are assumed at a rate equivalent to 75 basis points applied annually and have a 15% recovery factor after 2 years from the initial default date. The principal is assumed to be prepaying at 1% annually and at 100% at maturity. There were no changes in the assumptions used in the cash flow analysis during the current quarter from the prior quarter.
Based on the cash flow model, the CDO TRUPS security did not experience an adverse change in its cash flow status. As such, based on all of these factors, the Company determined that there was no OTTI adjustment in the current quarter. The risk of future OTTI will be highly dependent upon the performance of the underlying issuers. The Company does not have the intention to sell and does not believe it will be required to sell the CDO TRUPS security.
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Non-covered Loan Portfolio
The following table sets forth the composition of the Company’s non-covered loan portfolio, including loans held for sale, as of the dates indicated:
September 30, 2010 | December 31, 2009 | |||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Real Estate: | ||||||||||||||||
Construction | $ | 14,987 | 1.0 | % | $ | 21,014 | 1.4 | % | ||||||||
Commercial16) | 918,882 | 62.6 | 1,007,794 | 65.5 | ||||||||||||
Commercial | 279,450 | 19.0 | 295,289 | 19.2 | ||||||||||||
Trade Finance17) | 65,666 | 4.5 | 39,290 | 2.6 | ||||||||||||
SBA18) | 69,029 | 4.7 | 49,933 | 3.2 | ||||||||||||
Other19) | 50,219 | 3.4 | 50,037 | 3.3 | ||||||||||||
Consumer | 68,968 | 4.7 | 75,523 | 4.8 | ||||||||||||
Total Non-covered Loans | 1,467,201 | 100.0 | % | 1,538,880 | 100.0 | % | ||||||||||
Less: | ||||||||||||||||
Allowance for Loan Losses | 54,460 | 58,543 | ||||||||||||||
Deferred Loan Fees | 31 | 331 | ||||||||||||||
Discount on SBA Loans Retained | 936 | 864 | ||||||||||||||
Net Non-covered Loans and Loans Held for Sale | $ | 1,411,774 | $ | 1,479,142 | ||||||||||||
16) | Real estate commercial loans are loans secured by deeds of trust on real estate. Balance includes non-covered loans held for sale $12.8 million, at the lower of cost or fair value, at September 30, 2010. There were no non-covered loans held for sale at December 31, 2009. |
17) | Includes advances on trust receipts, clean advances, cash advances, acceptances discounted, and documentary negotiable advances under commitments. |
18) | Balance includes non-covered SBA loans held for sale of $37.9 million and $23.3 million, at the lower of cost or fair value, at September 30, 2010 and December 31, 2009, respectively. |
19) | Consists of term fed funds sold for maturity of greater than 1 day, transactions in process and overdrafts. |
The Company’s total non-covered loans decreased by $71.7 million, or 4.7%, during the nine months ended September 30, 2010. Net non-covered loans and loans held for sale decreased by $67.4 million, or 4.6%, to $1.42 billion at September 30, 2010, as compared to $1.48 billion at December 31, 2009. The decrease in the loan portfolio was mainly the result of charge-offs of $20.1 million and note sales of $39.8 million exclusive of the portion financed by the Company in real estate and commercial loans during the first nine months of 2010 offset by the loan originations in trade finance and SBA loans. Net non-covered loans and loans held for sale as of September 30, 2010 represented 62.3% of total assets, compared to 67.5% as of December 31, 2009.
The decrease in total non-covered loans is comprised primarily of net decreases in commercial real estate loans of $88.9 million or 8.8%, commercial business loans of $15.8 million or 5.4%, consumer loans of $6.6 million or 8.7%, and construction real estate loans of $6.0 million or 28.7% , offset by net increases in trade finance loans of $26.4 million, or 67.1% and SBA loans of $19.1 million or 38.2%.
Construction real estate loans decreased to $15.0 million representing 1.0% of total non-covered loans as of September 30, 2010 compared to $21.0 million representing 1.4% of total loans as of December 31, 2009. As of September 30, 2010, commercial real estate loans remained the largest component of the Company’s total non-covered loan portfolio. Commercial real estate loans decreased to $918.9 million representing 62.6% of total non-covered loans as of September 30, 2010 compared to $1.0 billion representing 65.5% of total loans as of December 31, 2009.
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Commercial business loans decreased to $279.5 million as of September 30, 2010 compared to $295.3 million at December 31, 2009. Trade finance loans increased to $65.7 million as of September 30, 2010 from $39.3 million at December 31, 2009.
The Company’s SBA portfolio increased to $69.0 million at September 30, 2010 compared to $49.9 million at December 31, 2009. During the three months ended September 30, 2010, the Company sold $3.0 million of SBA loans to a secondary market. As of September 30, 2010, the Company was servicing $119.7 million of sold SBA loans, compared to $113.0 million of sold SBA loans as of December 31, 2009.
Other loans mainly consisting of term fed funds sold slightly increased to $50.2 million representing 3.4% of total non-covered loans as of September 30, 2010 compared to $50.0 million representing 3.3% of total non-covered loans as of December 31, 2009. Consumer loans decreased to $69.0 million representing 4.7% of total loans as of September 30, 2010 compared to $75.5 million representing 4.8% of total loans as of December 31, 2009.
It is currently the management’s intention to focus more on commercial business loans, SBA loans and trade finance loans than construction real estate loans and commercial real estate loans mainly due to the high concentration of real estate loans in the loan portfolio.
The Company has determined it has no reportable foreign credit risk.
Covered Loan Portfolio
Total covered loans at September 30, 2010 were $112.7 million. The following table presents the concentration of the covered loan portfolio at September 30, 2010.
September 30, 2010 | ||||||||
Amount | Percent of Total | |||||||
(Dollars in thousands) | ||||||||
Real Estate: | ||||||||
Construction | $ | — | — | % | ||||
Commercial | 73,043 | 64.8 | ||||||
Commercial | 9,698 | 8.6 | ||||||
Trade Finance | — | — | ||||||
SBA | 29,022 | 25.8 | ||||||
Consumer and other | 911 | 0.8 | ||||||
Total Covered Loans | $ | 112,674 | 100.00 | % | ||||
The covered loans are subject to loss sharing agreement with the FDIC. Under the terms of the loss sharing agreement, the FDIC will absorb 80% of losses and share in 80% of loss recoveries. The reimbursed losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the assumption. New loans made after that date are not covered by the loss sharing agreement.
Non-covered Nonperforming Assets
Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due as scheduled according to the contractual terms of the loan agreement, including contractual interest and principal payments. Impaired loans are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, alternatively, at the loan’s observable market price or the fair value of the collateral if the loan is collateralized, less costs to sell. Loans are identified for specific allowances from information provided by several sources including asset classification, third party reviews, delinquency reports, periodic updates to financial statements, public records, and industry reports. All loan types are subject to impairment evaluation for a specific allowance once identified as impaired.
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The following table provides information on non-covered impaired loans:
Impaired Loans | ||||||||||||||||||||
At September 30, 2010 | ||||||||||||||||||||
Balance | Allowance | Allowance as a % of Balance | Cumulative Charge-off | Cumulative Charge-off as a % of Original Balance | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
With no allocated allowance | ||||||||||||||||||||
Without charge-off | $ | 44,961 | $ | — | — | % | $ | — | — | % | ||||||||||
With charge-off | 9,150 | — | — | 7,778 | 45.9 | |||||||||||||||
With allocated allowance | ||||||||||||||||||||
Without charge-off | 39,645 | 7,992 | 20.2 | — | 0.0 | |||||||||||||||
With charge-off | 5,199 | 290 | 5.6 | 2,317 | 30.8 | |||||||||||||||
Total | $ | 98,955 | $ | 8,282 | 8.4 | % | $ | 10,095 | 9.3 | % | ||||||||||
Allowance allocated to impaired loans as a percentage of impaired loans with allowance allocated | 18.5 | % | ||||||||||||||||||
Impaired Loans | ||||||||||||||||||||
At December 31, 2009 | ||||||||||||||||||||
Balance | Allowance | Allowance as a % of Balance | Cumulative Charge-off | Cumulative Charge-off as a % of Original Balance | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
With no allocated allowance | ||||||||||||||||||||
Without charge-off | $ | 32,768 | $ | — | — | % | $ | — | — | % | ||||||||||
With charge-off | 22,290 | — | — | 11,864 | 34.7 | |||||||||||||||
With allocated allowance | ||||||||||||||||||||
Without charge-off | 17,579 | 2,071 | 11.8 | — | 0.0 | |||||||||||||||
With charge-off | 4,466 | 579 | 13.0 | 2,072 | 31.7 | |||||||||||||||
Total | $ | 77,103 | $ | 2,650 | 3.4 | % | $ | 13,936 | 15.3 | % | ||||||||||
Allowance allocated to impaired loans as a percentage of impaired loans with allowance allocated | 12.0 | % |
During the first nine months of 2010, the continued economic instability was a major contributor to the increase in impaired loans, along with the continued weakness of the commercial real estate market in Southern California. As of September 30, 2010, specific reserves of $8.3 million represented 18.5% of the impaired loans with specific reserves as compared to 12.0% as of December 31, 2009.
Nonperforming assets are comprised of loans on non-accrual status, Other Real Estate Owned (“OREO”), and Troubled Debt Restructurings (“TDRs”). TDRs are considered non-performing assets for regulatory purposes even though they are fully performing, and they are required to be disclosed in the table below. Performing TDRs of $23.9 million at September 30, 2010 and $4.4 million at December 31, 2009 are not considered nonperforming assets for purposes of computing the ratios of nonperforming loans to total gross loans, and nonperforming assets as a percentage of total gross loans and OREO. The Company generally places loans on non-accrual status when they become 90 days past due, unless they are both fully secured and in process of collection. OREO consists of real property acquired through foreclosure or similar means that the Company intends to offer for sale.
At September 30, 2010, the Company held TDR’s of $43.0 million. A TDR is a debt restructuring in which a bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDR’s may include, but are not necessarily limited to:
1. | the transfer from the borrower to the bank of real estate, receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan; |
2. | a modification of the loan terms, such as a reduction of the stated interest rate, principal, or accrued interest or an extension of the maturity date at a stated interest lower than current market rates for new debt with similar risk, or |
3. | a combination of the above. |
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A TDR that has been formally restructured so as to be reasonably assured of repayment and of performance according to its modified terms need not be maintained in a non-accrual or nonperforming status, provided the TDR is supported by a current well documented credit evaluation and positive prospects of repayment under the revised terms. If these conditions can not be met, the Company will classify the TDR as non-accrual or nonperforming.
All TDR’s at September 30, 2010 are impaired, and $19.1 million were non-accrual and are included in the table below by the appropriate category. The remaining $23.9 million of the Company’s TDR’s meet the conditions that qualify these loans as performing at September 30, 2010. At December 31, 2009, TDR’s amounted to $27.1 million.
The Company’s classification of a loan as non-accrual is an indication that there is reasonable doubt as to the full collectibility of principal or interest on the loan. At this point, the Company stops recognizing income from the interest on the loan and reverses any uncollected interest that had been accrued but unpaid. The remaining balance of the loan will be charged off if the loan deteriorates further due to a borrower’s bankruptcy or similar financial problems, unsuccessful collection efforts or a loss classification by regulators and/or internal credit examiners. These loans may or may not be collateralized, but collection efforts are continuously pursued. Subsequent collection of payments will reduce the principal balance of the loan until the collateral is liquidated or the loan is paid.
The following table provides information with respect to the components of the Company’s non-covered nonperforming assets as of the dates indicated:
September 30, 2010 | December 31, 2009 | September 30, 2009 | ||||||||||
(Dollars in thousands) | ||||||||||||
Non-covered nonperforming loans: | ||||||||||||
Real estate: | ||||||||||||
Construction | $ | 4,029 | $ | 8,441 | $ | 5,309 | ||||||
Commercial | 28,639 | 42,678 | 25,167 | |||||||||
Commercial | 7,631 | 8,290 | 8,236 | |||||||||
Consumer | 229 | 339 | 909 | |||||||||
Trade Finance | — | 1,498 | 1,196 | |||||||||
SBA | 2,653 | 2,207 | 2,185 | |||||||||
Total non-covered nonperforming loans | 43,181 | 63,453 | 43,002 | |||||||||
Other real estate owned (OREO) | 4,548 | 4,278 | 4,813 | |||||||||
Non-covered nonperforming assets | $ | 47,729 | $ | 67,731 | $ | 47,815 | ||||||
Guaranteed portion of nonperforming loans | $ | 3,022 | $ | 2,816 | $ | 3,134 | ||||||
Total non-covered nonperforming assets, net of guarantee | $ | 44,707 | $ | 64,915 | $ | 44,681 | ||||||
Performing TDR’s not included above | $ | 23,898 | $ | 4,414 | $ | 4,400 | ||||||
Nonperforming loans as a percent of total non-covered loans | 2.94 | % | 4.12 | % | 2.70 | % | ||||||
Nonperforming assets as a percent of non-covered loans and OREO | 3.24 | % | 4.39 | % | 2.99 | % | ||||||
Allowance for loan losses to non-covered nonperforming loans | 126.1 | % | 92.3 | % | 148.8 | % |
Total non-covered nonperforming loans decreased to $43.2 million as of September 30, 2010 from $63.5 million as of December 31, 2009 and increased nominally from $43.0 million as of September 30, 2009. The decrease from December 31, 2009 to September 30, 2010 primarily resulted from the decreases in nonperforming commercial real estate loans of $14.0 million and construction real estate loans of $4.4 million and trade finance of $1.5 million and commercial loans of $0.7 million offset by the increases in nonperforming SBA loans of $0.4 million. In addition, non-covered nonperforming loans of $12.8 million were reclassified as non-covered loans held for sale during the three months ended September 30, 2010.
Total non-covered nonperforming assets were $47.7 million, representing 3.24% of total non-covered loans and OREO at September 30, 2010 compared to $67.7 million, representing 4.39% of total non-covered loans and OREO at December 31, 2009. Total non-covered nonperforming assets, net of the guarantees, decreased to $44.7 million as of September 30, 2010 from $64.9 million as of December 31, 2010. The decrease from December 31, 2009 was a result of significant charge-offs and reclassification to non-covered loans held for sale.
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Covered Nonperforming Assets
Covered nonperforming assets totaled $12.3 million at September 30, 2010. These covered nonperforming assets are subject to loss sharing agreement with the FDIC. The covered nonperforming assets at September 30, 2010 are as follows:
September 30, 2010 | ||||
(Dollars in thousands) | ||||
Covered loans on non-accrual status | $ | 10,890 | ||
Covered other real estate owned | 1,459 | |||
Total covered nonperforming assets | $ | 12,349 | ||
Allowance for Loan Losses
The Company’s allowance for loan loss methodologies incorporate a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements and to quantifiable external factors including commodity and finished goods prices as well as acts of nature (earthquakes, floods, fires, etc.) that occur in a particular period. Qualitative factors include the general economic environment in the Company’s markets and, in particular, the state of certain industries. The size and complexity of individual credits, loan structure, extent and nature of waivers of existing loan policies and pace of portfolio growth are other qualitative factors that are considered in its methodologies. As the Company adds new products, increases the complexity of the loan portfolio, and expands the geographic coverage, the Company will enhance the methodologies to keep pace with the size and complexity of the loan portfolio. Changes in any of the above factors could have significant impact to the loan loss calculation. The Company believes that its methodologies continue to be appropriate given its size and level of complexity.
The allowance for loan losses reflects management’s judgment of the level of allowance adequate to provide for probable losses inherent in the loan portfolio as of the date of the consolidated statements of financial condition. On a quarterly basis, the Company assesses the overall adequacy of the allowance for loan losses, utilizing a disciplined and systematic approach which includes the application of a specific allowance for identified impaired loans, a formula allowance for identified graded loans and an allocated allowance for large groups of smaller balance homogeneous loans.
Formula Allowance for Identified Graded Loans. Non-homogenous loans such as commercial real estate, construction, commercial business, trade finance and SBA loans that are not subject to the allowance for specifically identified loans discussed above are reviewed individually (rated) and subject to a formula allowance. The formula allowance is calculated by applying loss factors to outstanding Pass, Special Mention, Substandard and Doubtful loans. The evaluation of the inherent loss for these loans involves a high degree of uncertainty, subjectivity and judgment because probable loan losses are not identified with a specific loan. In determining the formula allowance, the Company relies on a mathematical formulation that incorporates a six-quarter rolling average of historical losses. Current quarter losses are measured against previous quarter loan balances to develop the loss factors. Loans risk rated Pass, Special Mention and Substandard for the most recent three quarters are adjusted to an annual basis as follows:
• | the most recent quarter is weighted 4/1; |
• | the second most recent is weighted 4/2; |
• | the third most recent is weighted 4/3. |
The formula allowance may be further adjusted to account for the following qualitative factors:
• | Changes in national and local economic and business conditions and developments, including the condition of various market segments; |
• | Changes in the trend of the volume and severity of past due and classified loans, and trends in the volume of non-accrual loans and troubled debt restructurings, and other loan modifications; |
• | The existence and effect of any concentrations of credit, and changes in the level of such concentrations; |
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• | The effect of external factors such as competition and legal and regulatory requirements on the level of estimated losses in the Company’s loan portfolio; |
• | Changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices; |
• | Changes in the nature and volume of the loan portfolio; |
• | Changes in the experience, ability, and depth of lending management and staff; and |
• | Changes in the quality of the Company’s loan review system and the degree of oversight by the directors. |
Allowance for Large Groups of Smaller Balance Homogenous Loans. The portion of the allowance allocated to large groups of smaller balance homogenous loans is focused on loss experience for the pool rather than on an analysis of individual loans. Large groups of smaller balance homogenous loans consist of consumer loans to individuals. The allowance for groups of performing loans is based on historical losses over a six-quarter period. In determining the level of allowance for delinquent groups of loans, the Company classifies groups of homogenous loans based on the number of days delinquent and other qualitative factors and trends.
The process of assessing the adequacy of the allowance for loan losses involves judgmental discretion, and eventual losses may differ from even the most recent estimates. To assist management in monitoring the allowance for loan losses, the Company’s independent loan review consultants review the allowance as an integral part of their examination process.
The following table sets forth the composition of the allowance for loan losses as of September 30, 2010 and December 31, 2009:
September 30, 2010 | December 31, 2009 | |||||||
(Dollars in thousands) | ||||||||
Specific (Impaired loans) | $ | 8,282 | $ | 2,656 | ||||
Formula (non-homogeneous) | 45,694 | 55,539 | ||||||
Homogeneous | 484 | 348 | ||||||
Total allowance for loan losses | $ | 54,460 | $ | 58,543 | ||||
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The table below summarizes the activity in the Company’s allowance for loan losses for the periods indicated:
Nine Months Ended September 30, 2010 | Year Ended December 31, 2009 | Nine Months Ended September 30, 2009 | ||||||||||
(Dollars in thousands) | ||||||||||||
Balances | ||||||||||||
Average total non-covered loans outstanding during the period20) | $ | 1,498,908 | $ | 1,637,703 | $ | 1,661,384 | ||||||
Total non-covered loans outstanding at end of period20) | $ | 1,466,234 | $ | 1,537,685 | $ | 1,592,331 | ||||||
Allowance for Loan Losses: | ||||||||||||
Balance at beginning of period | $ | 58,543 | $ | 38,172 | $ | 38,172 | ||||||
Charge-offs: | ||||||||||||
Real estate | ||||||||||||
Construction | 419 | 6,844 | 5,078 | |||||||||
Commercial | 16,178 | 23,742 | 7,173 | |||||||||
Commercial | 5,011 | 23,795 | 15,305 | |||||||||
Consumer | 563 | 1,599 | 1,298 | |||||||||
Trade finance | 1,448 | 911 | — | |||||||||
SBA | 1,008 | 941 | 786 | |||||||||
Total charge-offs | 24,627 | 57,832 | 29,640 | |||||||||
Recoveries | ||||||||||||
Real estate | ||||||||||||
Construction | 123 | — | — | |||||||||
Commercial | 1,357 | — | — | |||||||||
Commercial | 2,817 | 269 | 253 | |||||||||
Consumer | 96 | 394 | 299 | |||||||||
Trade finance | — | 1 | 1 | |||||||||
SBA | 151 | 67 | 46 | |||||||||
Total recoveries | 4,544 | 731 | 599 | |||||||||
Net loan charge-offs | 20,083 | 57,101 | 29,041 | |||||||||
Provision for loan losses | 16,000 | 77,472 | 54,847 | |||||||||
Balance at end of period | $ | 54,460 | $ | 58,543 | $ | 63,978 | ||||||
Ratios: | ||||||||||||
Net loan charge-offs to average non-covered loans* | 1.79 | % | 3.49 | % | 2.33 | % | ||||||
Provision for loan losses to average total non-covered loans* | 1.43 | 4.73 | 4.40 | |||||||||
Allowance for loan losses to gross non-covered loans at end of period | 3.71 | 3.81 | 4.01 | |||||||||
Allowance for loan losses to non-covered nonperforming loans | 126.12 | 92.26 | 148.8 | |||||||||
Net loan charge-offs to allowance for loan losses at end of period* | 49.30 | 97.54 | 60.52 | |||||||||
Net loan charge-offs to provision for loan losses | 125.52 | 73.71 | 52.95 |
* | Ratios are annualized for comparability purposes |
20) | Total non-covered loans are net of deferred loan fees and discount on SBA loans sold. |
Based on a quarterly migration and qualitative analysis which evaluates the loan portfolio credit quality, the allowance for loan losses decreased to $54.5 million as of September 30, 2010 compared to $58.5 million at December 31, 2009. The Company recorded a provision of $16.0 million for the nine months ended September 30, 2010 compared to $54.8 million for the same period of 2009. For the nine months ended September 30, 2010, the Company charged off $24.6 million and recovered $4.5 million resulting in net loan charge-offs of $20.1 million, compared to net loan charge-offs of $29.0 million for the same period in 2009.
Management believes the level of the allowance as of September 30, 2010 is adequate to absorb the estimated losses from any known or inherent risks in the loan portfolio. However, no assurance can be given that economic conditions which adversely affect our service areas or other circumstances may not require increased provisions for loan losses in the future.
The ratio of the Company’s allowance for loan losses to gross non-covered loans decreased to 3.71% at September 30, 2010 from 3.81% at December 31, 2009 of gross non-covered loans. The ratio of the allowance for loan losses to total non-covered nonperforming loans increased to 126% as of September 30, 2010 compared to 92% as of December 31, 2009 due to a reduction in nonperforming loans. Management is committed to maintaining the allowance for loan losses at a level that is considered commensurate with estimated and known risks in the portfolio. Although the adequacy of the allowance is reviewed quarterly, management performs an ongoing assessment of the risks inherent in the portfolio. Commercial real estate is the principal collateral for the Company’s loans.
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Deposits
The composition and cost of the Company’s deposit base are important components in analyzing its net interest margin and balance sheet liquidity characteristics, both of which are discussed in greater detail in other sections herein. Net interest margin is improved to the extent that growth in deposits can be concentrated in lower-cost core deposits, namely noninterest-bearing demand, NOW accounts, savings accounts and money market deposit accounts. Liquidity is impacted by the volatility of deposits or other funding instruments, or in other words their propensity to leave the institution for rate-related or other reasons. Potentially, the most volatile deposits in a financial institution are large certificates of deposit (e.g., generally time deposits with balances exceeding $250,000). Because these deposits (particularly when considered together with a customer’s other specific deposits) may exceed FDIC insurance limits, depositors may select shorter maturities to offset perceived risk elements associated with such deposits.
The Company’s average interest bearing deposit cost decreased to 1.44% and 1.52%, respectively, for the three and nine months ended September 30, 2010, compared to 2.36% and 2.58%, respectively, for the same periods in 2009. The decreases were a result of the management’s effort to change the deposit mix focusing more on lower cost deposits during the past year.
The Company can deter, to some extent, the rate sensitive customers who demand high cost certificates of deposit because of local market competition by using wholesale funding sources. As of September 30, 2010, the Company held brokered deposits in the amount of $160.6 million compared to $260.2 million as of December 31, 2009. The Company also had certificates of deposit with State of California in the amount of $115.6 million as of September 30, 2010 and $115.0 million as of December 31, 2009.
The following table summarizes deposits and the composition of deposits as a percentage of total deposits as of the dates indicated:
September 30, | December 31, | Change in | ||||||||||||||||||||||
2010 | 2009 | Amount | Percentage | |||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Demand deposits (noninterest-bearing) | $ | 383,508 | 21.4 | % | $ | 352,395 | 20.2 | % | $ | 31,113 | 8.8 | % | ||||||||||||
Money market accounts and NOW | 497,362 | 27.8 | 528,331 | 30.2 | (30,969 | ) | (5.9 | ) | ||||||||||||||||
Savings | 89,067 | 5.0 | 86,567 | 5.0 | 2,500 | 2.9 | ||||||||||||||||||
969,937 | 54.1 | 967,293 | 55.3 | 2,644 | 0.3 | |||||||||||||||||||
Time deposits | ||||||||||||||||||||||||
Less than $100,000 | 302,745 | 16.9 | 256,020 | 14.6 | 46,725 | 18.3 | ||||||||||||||||||
$100,000 or more | 519,599 | 29.0 | 524,358 | 30.0 | (4,759 | ) | (0.9 | ) | ||||||||||||||||
Total | $ | 1,792,281 | 100.0 | % | $ | 1,747,671 | 100.0 | % | $ | 44,610 | 2.6 | % | ||||||||||||
Total deposits increased $44.6 million or 2.6% at September 30, 2010 compared to $1.75 billion at December 31, 2009. During the first nine months of 2010, noninterest-bearing demand deposits increased by $31.1 million, or 8.8%, and represented 21.4% of total deposits at September 30, 2010 compared to 20.2% at December 31, 2009. MMDA and NOW decreased by $31.0 million, or 5.9%, declining to 27.8% of total deposits at September 30, 2010 from 30.2% at December 31, 2009. Savings account balances increased by $2.5 million, or 2.9%, and represented 5.0% of total deposits at September 30, 2010 and 2009. Time deposits under $100,000, which are classified as core deposits, increased by $46.7 million, or 18.3%. Jumbo time deposits, or time deposits greater than or equal to $100,000, decreased by $4.8 million, or 0.9%. The increases in deposits were mostly due to the assumption of Innovative Bank’s deposits.
Time deposits by maturity dates are as follows at September 30, 2010:
$100,000 or Greater | Less Than $100,000 | Total | ||||||||||
(Dollars in thousands) | ||||||||||||
2010 | $ | 199,813 | $ | 64,778 | $ | 264,591 | ||||||
2011 | 241,721 | 176,206 | 417,927 | |||||||||
2012 | 50,340 | 54,048 | 104,388 | |||||||||
2013 | 21,387 | 7,434 | 28,821 | |||||||||
2014 and thereafter | 6,338 | 279 | 6,617 | |||||||||
Total | $ | 519,599 | $ | 302,745 | $ | 822,344 | ||||||
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Information concerning the average balance and average rates paid on deposits by deposit type for the three and nine months ended September 30, 2010 and 2009 is contained in the tables above in the section entitled “Net Interest Income and Net Interest Margin.”
Other Borrowed Funds
The Company regularly uses FHLB advances and short-term borrowings, which consist of notes issued to the U.S. Treasury to manage Treasury Tax and Loan payments. The Company’s outstanding FHLB borrowings were $167.5 million and $146.8 million at September 30, 2010 and December 31, 2009, respectively. Notes issued to the U.S. Treasury amounted to $1.0 million as of September 30, 2010 compared to $1.6 million as of December 31, 2009. The total borrowed amount outstanding at September 30, 2010 and December 31, 2009 was $168.5 million and $148.4 million, respectively.
In addition, the issuance of long-term subordinated debentures at the end of 2003 of $18.0 million in “pass-through” trust preferred securities created another source of funding.
Contractual Obligations
The following table presents, as of September 30, 2010, the Company’s significant fixed and determinable contractual obligations, within the categories described below, by payment date. These contractual obligations, except for the operating lease obligations, are included in the Consolidated Statements of Financial Condition. The payment amounts represent those amounts contractually due to the recipient.
Remaining 3 months in 2010 | 2011 | 2012 | 2013 | 2014 | 2015 & thereafter | Total | ||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||
Debt obligations21) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 18,557 | $ | 18,557 | ||||||||||||||
FHLB advances | 92 | 40,381 | 105,295 | 157 | 167 | 20,477 | 166,569 | |||||||||||||||||||||
Deposits | 272,232 | 435,403 | 114,441 | 35,924 | 8,030 | 3,791 | 869,821 | |||||||||||||||||||||
Operating lease obligations | 744 | 1,890 | 1,853 | 1,405 | 1,184 | 2,478 | 9,554 | |||||||||||||||||||||
Total contractual obligations | $ | 273,068 | $ | 477,674 | $ | 221,589 | $ | 37,486 | $ | 9,381 | $ | 45,303 | $ | 1,064,501 | ||||||||||||||
21) | Includes principal payment only and may be redeemed quarterly by the issuer. |
LIQUIDITY AND MARKET RISK/INTEREST RISK MANAGEMENT
Liquidity
The objective of liquidity risk management is to ensure that the Company has the continuing ability to maintain cash flows that are adequate to fund operations and meet its other obligations on a timely and cost-effective basis in various market conditions. Changes in each of the composition of its balance sheet, the ongoing diversification of its funding sources, risk tolerance levels and market conditions are among the factors that influence the Company’s liquidity profile. The Company establishes liquidity guidelines and maintains contingency liquidity plans that provide for specific actions and timely responses to liquidity stress situations.
As a means of augmenting the liquidity sources, the Company has available a combination of borrowing sources comprised of FHLB advances, federal funds lines with various correspondent banks, and access to the wholesale markets. The Company believes these liquidity sources to be stable and adequate. At September 30, 2010, the Company was not aware of any information that was reasonably likely to have a material adverse effect on our liquidity position.
The liquidity of the Company is primarily dependent on the payment of cash dividends by its subsidiary, Center Bank, subject to limitations imposed by the laws of the State of California, and by the terms of the MOUs between the Company and the Bank and their respective regulatory agencies (see “Recent Developments” above). Center Financial held $5.4 million in liquid funds with Center Bank at September 30, 2010 which can be used to pay dividends on Center Financial’s preferred stock, interest on its capital trust pass-through securities and other expenses as needed.
As part of the Company’s liquidity management, the Company utilizes FHLB borrowings to supplement our deposit source of funds. Therefore, there could be fluctuations in these balances depending on the short-term liquidity and longer-term financing need of the Company. The Company’s primary sources of liquidity are derived from financing activities, which include customer and brokered deposits, federal funds facilities, and advances from the FHLB.
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Because the Company’s primary sources and uses of funds are deposits and loans, respectively, the relationship between net loans and total deposits provides one measure of the Company’s liquidity. Typically, if the ratio is over 100%, the Company relies more on borrowings, wholesale deposits and repayments from the loan portfolio to provide liquidity. Alternative sources of funds such as FHLB advances and brokered deposits and other collateralized borrowings provide liquidity as needed from liability sources are an important part of the Company’s asset liability management strategy.
At September 30, 2010 | At December 31, 2009 | |||||||
Net loans | $ | 1,524,448 | $ | 1,479,142 | ||||
Deposits | $ | 1,792,281 | $ | 1,747,671 | ||||
Net loan to deposit ratio | 85.1 | % | 84.6 | % |
As of September 30, 2010 and December 31, 2009, the Company’s liquidity ratio, which is the ratio of available liquid funds to net deposits and short-term liabilities, was 23.7% and 23.5%, respectively. The Company’s liquidity ratio remained consistent as cash and other short-term marketable assets remained relatively unchanged during the first nine months in 2010. Total available on balance sheet liquidity as of September 30, 2010 was $434.2 million, consisting of excessive cash holdings or balances in due from banks, overnight Fed funds sold, money market funds and unpledged available-for-sale securities.
The Company’s net non-core fund dependence ratio was 30.6% under applicable regulatory guidelines, which assumes all certificates of deposit over $100,000 (“Jumbo CD’s”) as volatile sources of funds. The net non-core fund dependence ratio is the ratio of net short-term investment less non-core liabilities divided by long-term assets. All of the ratios were in compliance with internal guidelines as of and for the nine months ended September 30, 2010. In addition to the Company’s on balance sheet liquidity, the Company is looking toward the growth of retail core and time deposits to meet its liquidity needs in the future.
At September 30, 2010, the Company had $194.1 million in FHLB borrowings, $77.7 million with FRB and $36.0 million in federal funds lines totaling $307.8 million of available funding sources. Additionally, $106.8 million in investment securities may be pledged as collateral for repurchase agreements and other credit facilities. The Company was approved for the Borrower In Custody arrangement by the FRB in January 2009. Collateral held in such an arrangement may be used to secure advances and/or credit for the discount window program and will provide the Company with additional source of liquidity. This total available funding availability does not include the Company’s ability to purchase brokered deposits, which is limited by the Company’s policy to 20% of total deposits.
FHLB | FRB | Federal Funds Facility | Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Total capacity | $ | 360,698 | $ | 77,745 | $ | 36,000 | $ | 474,443 | ||||||||
Used | (166,569 | ) | — | — | (166,569 | ) | ||||||||||
Available | $ | 194,129 | $ | 77,745 | $ | 36,000 | $ | 307,874 | ||||||||
Market Risk/Interest Rate Risk Management
Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from interest rate risk inherent in its lending, investment and deposit taking activities. The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. To that end, Management actively monitors and manages its interest rate risk exposure.
The Company’s strategy for asset and liability management is formulated and monitored by the Company’s Asset/Liability Board Committee (the “Board Committee”). This Board Committee is composed of four non-employee directors and the President. The Board Committee meets quarterly to review and adopt recommendations of the Asset/Liability Management Committee (“ALCO”).
The ALCO consists of executive and manager level officers from various areas of the Company including lending, investment, and deposit gathering, in accordance with policies approved by the board of directors. The primary goal of the Company’s ALCO is to manage the financial components of the Company’s balance sheet to optimize the net income under varying interest rate environments. The focus of this process is the development, analysis, implementation, and monitoring of earnings enhancement strategies, which provide stable earnings and capital levels during periods of changing interest rates.
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The ALCO meets regularly to review, among other matters, the sensitivity of the Company’s assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, and maturities of investments and borrowings. The ALCO also approves and establishes pricing and funding decisions with respect to overall asset and liability composition, and reports regularly to the Board Committee and the board of directors.
Interest Rate Risk
Interest rate risk occurs when assets and liabilities reprice at different times as interest rates change. In general, the interest the Company earns on its assets and pays on its liabilities are established contractually for specified periods of time. Market interest rates change over time and if a financial institution cannot quickly adapt to changes in interest rates, it may be exposed to volatility in earnings. For instance, if the Company were to fund long-term fixed rate assets with short-term variable rate deposits, and interest rates were to rise over the term of the assets, the short-term variable deposits would rise in cost, adversely affecting net interest income. Similar risks exist when rate sensitive assets (for example, prime rate based loans) are funded by longer-term fixed rate liabilities in a falling interest rate environment.
The Company’s overall strategy is to minimize the adverse impact of immediate incremental changes in market interest rates (rate shock) on net interest income and economic value of equity. Economic value of equity is defined as the present value of assets, minus the present value of liabilities and off-balance sheet instruments. The attainment of this goal requires a balance between profitability, liquidity and interest rate risk exposure. To minimize the adverse impact of changes in market interest rates, the Company simulates the effect of instantaneous interest rate changes on net interest income and economic value of equity (“EVE”) on a quarterly basis. The table below shows the estimated impact of changes in interest rates on our net interest income and market value of equity as of September 30, 2010 and June 30, 2010, respectively, assuming a parallel shift of 100 to 300 basis points in both directions.
Net Interest Income (NII) 22) | Economic Value of Equity (EVE) 23) | |||||||||||||||
Change | September 30, 2010 % Change | June 30, 2010 % Change | September 30, 2010 % Change | June 30, 2010 % Change | ||||||||||||
+300 | 30.47 | % | 29.12 | % | -10.68 | % | -10.68 | % | ||||||||
+200 | 19.84 | % | 18.64 | % | -6.43 | % | -6.43 | % | ||||||||
+100 | 9.87 | % | 9.25 | % | -2.91 | % | -2.91 | % | ||||||||
Level | ||||||||||||||||
-100 | -0.49 | % | -0.71 | % | 1.27 | % | 1.27 | % | ||||||||
-200 | 3.29 | % | 0.89 | % | 3.94 | % | 3.94 | % | ||||||||
-300 | 4.76 | % | 1.90 | % | 4.49 | % | 4.49 | % |
22) | The percentage change represents net interest income for twelve months in a stable interest rate environment versus net interest income in the various rate scenarios |
23) | The percentage change represents economic value of equity of the Company in a stable interest rate environment versus economic value of equity in the various rate scenarios |
All interest-earning assets and interest-bearing liabilities are included in the interest rate sensitivity analysis at September 30, 2010 and June 30, 2010, respectively. The changes in NII and EVE were primarily attributable to the acquisition of Innovative Bank. At September 30, 2010 and June 30, 2010, respectively, our estimated changes in net interest income and economic value of equity were within the ranges established by the Board of Directors. In a declining rate environment, the interest rate floors on the loans contribute to the favorable impact on the net interest income while in the rising rate environment, these interest rate floors also serve to lessen the full benefit of higher interest rates.
The primary analytical tool used by the Company to gauge interest rate sensitivity is a simulation model used by many community banks, which is based upon the actual maturity and repricing characteristics of interest-rate-sensitive assets and liabilities. The model attempts to forecast changes in the yields earned on assets and the rates paid on liabilities in relation to changes in market interest rates. As an enhancement to the primary simulation model, other factors are incorporated into the model, including prepayment assumptions and market rates of interest provided by independent broker/dealer quotations, an independent pricing model, and other available public information. The model also factors in projections of anticipated activity levels of the Company’s product lines. Management believes that the assumptions it uses to evaluate the vulnerability of the Company’s operations to changes in interest rates approximate actual experience and considers them reasonable; however, the interest rate sensitivity of the Company’s assets and liabilities and the estimated effects of changes in interest rates on the Company’s net interest income and EVE could vary substantially if different assumptions were used or if actual experience were to differ from the historical experience on which they are based.
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Shareholders’ equity as of September 30, 2010 was $270.7 million, compared to $256.1 million as of December 31, 2009. The increase was due primarily to net earnings of $16.2 million in the first nine months of 2010. The primary sources of capital have historically been retained earnings and relatively nominal proceeds from the exercise of employee incentive and/or nonqualified stock options, though there were no option exercises during the first nine months of 2010. Shareholders’ equity is also affected by increases and decreases in unrealized losses on securities classified as available-for-sale. In addition, during the fourth quarter of 2009, the Company raised an aggregate of $86.3 million in gross proceeds from the successful consummation of two private placements. See “Recent Developments – Fourth Quarter Capital Raises” above.
As part of the TARP Capital Purchase Program, the Company entered into a purchase agreement with the Treasury Department on December 12, 2008, pursuant to which the Company issued and sold 55,000 shares of fixed-rate cumulative perpetual preferred stock for a purchase price of $55 million and 10-year warrants to purchase 864,780 shares of the Company’s common stock at an exercise price of $9.54 per share. The number of shares underlying the Warrant was reduced to 432,290 effective December 31, 2009 as a result of the fourth quarter capital raises referenced above. The Company will pay the Treasury Department a five percent dividend annually for each of the first five years of the investment and a nine percent dividend thereafter until the shares are redeemed.
The Company is committed to maintaining capital at a level sufficient to assure shareholders, customers and regulators that the Company is financially sound and able to support its growth from its retained earnings. From October 2003 to January 2009 Center Financial paid quarterly cash dividends to its shareholders. On March 25, 2009, the Company’s board of directors suspended its quarterly cash dividends based on adverse economic conditions and the Company’s then recent losses. The Company has determined that this is a prudent, safe and sound practice to preserve capital. The Company would be required to obtain the U.S. Treasury Department’s approval to reestablish common stock dividend in the future until it has redeemed the preferred stock issued under TARP CPP. The Company is also required to obtain prior approval of the FRB to pay dividends pursuant to is MOU with the FRB (see “Recent Developments – Informal Regulatory Agreements” above).
The Company is subject to risk-based capital regulations adopted by the federal banking regulators. These guidelines are used to evaluate capital adequacy and are based on an institution’s asset risk profile and off-balance sheet exposures. The risk-based capital guidelines assign risk weightings to assets both on and off-balance sheet and place increased emphasis on common equity. According to the regulations, institutions whose Tier I risk based capital ratio, total risk based capital ratio and leverage ratio meet or exceed 6%, 10% and 5%, respectively, are deemed to be “well-capitalized.” As of September 30, 2010, all of the Company’s capital ratios were above the minimum regulatory requirements for a “well-capitalized” institution.
The MOU the Bank has entered into with the FDIC and the DFI requires the development of a capital plan that includes obtaining a minimum Tier 1 leverage capital ratio of not less than 9% and a total risk-based capital ratio of not less than 13% by December 31, 2009, and maintaining such minimum levels while the MOU remains in effect. The Bank’s regulatory capital ratios as of September 30, 2010 and December 31, 2009 exceeded these requirements.
The following table compares the Company’s and Bank’s actual capital ratios at September 30, 2010, to those required by regulatory agencies for capital adequacy and well-capitalized classification purposes:
Regulatory Capital Ratios
Center Financial Corporation | Center Bank | Minimum Regulatory Requirements | Well Capitalized Requirements | |||||||||||||
Total Capital (to Risk-Weighted Assets) | 19.32 | % | 18.96 | % | 8.00 | % | 10.00 | % | ||||||||
Tier 1 Capital (to Risk-Weighted Assets) | 18.04 | % | 17.68 | % | 4.00 | % | 6.00 | % | ||||||||
Tier 1 Capital (to Average Assets) | 12.55 | % | 12.31 | % | 4.00 | % | 5.00 | % |
Item 3: | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The information concerning quantitative and qualitative disclosures about market risk is included as part of Part I, Item 2 above. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Market Risk/Interest Rate Risk Management.”
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Item 4: | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer (principal executive officer) and the Chief Financial Officer (principal financial officer), as appropriate to allow timely decisions regarding required disclosure.
Management previously disclosed a material weakness in internal control over financial reporting in its quarterly report on Form 10-Q/A, as amended, filed on August 19, 2010 for the quarter ended March 31, 2010, relating to our internal controls over the review process utilized to interpret the applicable accounting literature for computing and allocating the amount attributable to the beneficial conversion feature related to the issuance of preferred stock.
An evaluation was performed under the supervision and with the participation of our management, including our CEO and interim CFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2010. Based on the evaluation, our CEO and interim CFO have concluded that the previously identified deficiency in internal control over financial reporting has caused our disclosure controls and procedures to be not effective as of September 30, 2010.
Remediation of Material Weakness
The Company is in the process of actively remediating this material weakness. The Company established extra financial reporting review process in case of unusual or nonroutine transactions.
Management believes the additional control procedure, when implemented and validated, will remediate this material weakness. However, the effectiveness of any system of internal controls is subject to inherent limitations and there can be no assurance that the Company’s internal control over financial reporting will prevent or detect all errors. The Company intends to continue to evaluate and strengthen its internal control over financial reporting system.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except for the process to remediate the material weakness described above. As a result of these actions, management of the Company anticipates this material weakness will be remediated by the end of the fourth quarter of 2010.
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Item 1: | LEGAL PROCEEDINGS |
In the normal course of business, the Company from time to time is involved in various claims and legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the Company’s financial condition or results of operation.
Item 1A: | RISK FACTORS |
In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Part I – Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2009, and supplemented and updated in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010. These factors could materially affect the Company’s business, financial condition, liquidity, results of operations and capital position, and could cause the Company’s actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report.
Item 2: | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Not applicable
Item 3: | DEFAULTS UPON SENIOR SECURITIES |
Not applicable
Item 4: | (REMOVED AND RESERVED) |
Item 5: | OTHER INFORMATION |
Not applicable
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Item 6: | EXHIBITS |
Exhibit No. | Description | |
3.1 | Restated Articles of Incorporation of Center Financial Corporation1 | |
3.2 | Amended and Restated Bylaws of Center Financial Corporation2 | |
3.3 | Amendment to Bylaws of Center Financial Corporation3 | |
3.4 | Amendment to Articles of Incorporation of Center Financial Corporation4 | |
4.1 | Certificate of Determination for Series A Preferred Stock of Center Financial Corporation3 | |
10.1 | Employment Agreement between Center Financial Corporation and Jae Whan Yoo effective January 13, 20105 | |
10.2 | 2006 Stock Incentive Plan, as Amended and Restated June 13, 20076 | |
10.3 | Lease for Corporate Headquarters Office7 | |
10.4 | Indenture dated as of December 30, 2003 between Wells Fargo Bank, National Association, as Trustee, and Center Financial Corporation, as Issuer8 | |
10.5 | Amended and Restated Declaration of Trust of Center Capital Trust I, dated as of December 30, 20038 | |
10.6 | Guarantee Agreement between Center Financial and Wells Fargo Bank, National Association dated as of December 30, 20038 | |
10.7 | Deferred compensation plan and list of participants9 | |
10.8 | Split dollar plan and list of participants9 | |
10.9 | Survivor income plan and list of participants9 | |
10.10 | Warrant to Purchase Common Stock3 | |
10.11 | Letter Agreement, dated as of December 12, 2008, including the Securities Purchase Agreement – Standard Terms incorporated by reference therein, between Center Financial Corporation and the United States Department of the Treasury3 | |
10.12 | Form of Securities Purchase Agreement between the Company and each of the Purchasers, dated as of December 29, 200910 | |
10.13 | Form of Subscription Agreement for Directors or Officers of the Company Dated as of November 24, 200911 | |
10.14 | Form of Subscription Agreement for Non-affiliated Investors Executed in November 200911 | |
11 | Statement of Computation of Per Share Earnings (included in Note 9 to Interim Consolidated Financial Statements included herein.) | |
31.1 | Certification of Principal Executive Officer (Section 302 Certification) | |
31.2 | Certification of Principal Financial Officer (Section 302 Certification) | |
32 | Certification of Periodic Financial Report (Section 906 Certification) |
1 | Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended June 30, 2008 and incorporated herein by reference |
2 | Filed as an Exhibit to the Form 8-K filed with the SEC on May 12, 2006 and incorporated herein by reference |
3 | Filed as an Exhibit to the Form 8-K filed with the SEC on December 16, 2008 and incorporated herein by reference |
4 | Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended March 31, 2010 and incorporated herein by reference |
5 | Filed as an Exhibit to the Form 8-K filed with the SEC on January 15, 2010 and incorporated herein by reference |
6 | Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended June 30, 2007 and incorporated herein by reference |
7 | Filed as an Exhibit of the same number to the Company’s Registration Statement on Form S-4 filed with the SEC on June 14, 2002 and incorporated herein by reference |
8 | Filed as an Exhibit of the same number to the Form 10-K for the fiscal year ended December 31, 2003 and incorporated herein by reference |
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9 | Filed as an Exhibit of the same number to the Form 10-Q for the quarterly period ended March 31, 2006 and incorporated herein by reference |
10 | Filed as an Exhibit to the Form 8-K filed with the SEC on December 31, 2009 and incorporated herein by reference |
11 | Filed as an Exhibit to the Form 8-K filed with the SEC on December 1, 2009 and incorporated herein by reference |
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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:
Center Financial Corporation | ||||
Date: November 8, 2010 | By: | /S/ JAE WHAN YOO | ||
Jae Whan Yoo President & Chief Executive Officer (Principal Executive Officer) | ||||
Date: November 8, 2010 | By: | /S/ HWA KYUNG KIM | ||
Hwa Kyung Kim Controller (Principal Accounting Officer) |
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