Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2014
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
CU BANCORP
(Exact name of registrant as specified in its charter)
California | 90-0779788 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
15821 Ventura Boulevard, Suite 110 Encino, California | 91436 | |
(Address of principal executive offices) | (Zip Code) |
(818) 257-7700
(Registrant’s telephone number, including area code)
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. Yes x 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer | ¨ | Accelerated Filer | x | |||
Non Accelerated Filer | ¨ | 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 3, 2014 the number of shares outstanding of the registrant’s no par value Common Stock was 11,228,175.
Table of Contents
CU BANCORP
September 30, 2014 FORM 10-Q
Page 2 of 71
Table of Contents
CU BANCORP
(Dollars in thousands)
September 30, 2014 | December 31, 2013 | |||||||
(Unaudited) | (Audited) | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 27,882 | $ | 23,156 | ||||
Interest earning deposits in other financial institutions | 167,859 | 218,131 | ||||||
|
|
|
| |||||
Total Cash and Cash Equivalents | 195,741 | 241,287 | ||||||
Certificates of deposit in other financial institutions | 74,473 | 60,307 | ||||||
Investment securities available-for-sale, at fair value | 139,552 | 106,488 | ||||||
Loans | 978,800 | 933,194 | ||||||
Allowance for loan loss | (11,348 | ) | (10,603 | ) | ||||
|
|
|
| |||||
Net loans | 967,452 | 922,591 | ||||||
Premises and equipment, net | 3,648 | 3,531 | ||||||
Deferred tax assets, net | 10,369 | 11,835 | ||||||
Goodwill | 12,292 | 12,292 | ||||||
Core deposit and leasehold right intangibles | 2,246 | 2,525 | ||||||
Bank owned life insurance | 21,663 | 21,200 | ||||||
Accrued interest receivable and other assets | 23,921 | 25,760 | ||||||
|
|
|
| |||||
Total Assets | $ | 1,451,357 | $ | 1,407,816 | ||||
|
|
|
| |||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
LIABILITIES | ||||||||
Non-interest bearing demand deposits | $ | 698,251 | $ | 632,192 | ||||
Interest bearing transaction accounts | 145,899 | 155,735 | ||||||
Money market and savings deposits | 365,945 | 380,915 | ||||||
Certificates of deposit | 52,852 | 63,581 | ||||||
|
|
|
| |||||
Total deposits | 1,262,947 | 1,232,423 | ||||||
Securities sold under agreements to repurchase | 13,618 | 11,141 | ||||||
Subordinated debentures, net | 9,498 | 9,379 | ||||||
Accrued interest payable and other liabilities | 16,521 | 16,949 | ||||||
|
|
|
| |||||
Total Liabilities | 1,302,584 | 1,269,892 | ||||||
|
|
|
| |||||
Commitments and Contingencies (Note 14) | — | — | ||||||
SHAREHOLDERS’ EQUITY | ||||||||
Serial Preferred Stock – authorized, 50,000,000 shares no par value, no shares issued or outstanding | — | — | ||||||
Common stock – authorized, 75,000,000 shares no par value, 11,231,801 and 11,081,364 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively | 122,952 | 121,675 | ||||||
Additional paid-in capital | 9,940 | 8,377 | ||||||
Retained earnings | 15,678 | 8,077 | ||||||
Accumulated other comprehensive income (loss) | 203 | (205 | ) | |||||
|
|
|
| |||||
Total Shareholders’ Equity | 148,773 | 137,924 | ||||||
|
|
|
| |||||
Total Liabilities and Shareholders’ Equity | $ | 1,451,357 | $ | 1,407,816 | ||||
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
Page 3 of 71
Table of Contents
CU BANCORP
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share data)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Interest Income | ||||||||||||||||
Interest and fees on loans | $ | 12,401 | $ | 12,203 | $ | 36,691 | $ | 36,090 | ||||||||
Interest on investment securities | 589 | 441 | 1,557 | 1,420 | ||||||||||||
Interest on interest bearing deposits in other financial institutions | 248 | 178 | 665 | 495 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Interest Income | 13,238 | 12,822 | 38,913 | 38,005 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Interest Expense | ||||||||||||||||
Interest on interest bearing transaction accounts | 70 | 57 | 194 | 173 | ||||||||||||
Interest on money market and savings deposits | 225 | 263 | 681 | 772 | ||||||||||||
Interest on certificates of deposit | 58 | 47 | 169 | 197 | ||||||||||||
Interest on securities sold under agreements to repurchase | 8 | 23 | 27 | 63 | ||||||||||||
Interest on subordinated debentures | 109 | 126 | 323 | 376 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Interest Expense | 470 | 516 | 1,394 | 1,581 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net Interest Income | 12,768 | 12,306 | 37,519 | 36,424 | ||||||||||||
Provision for loan losses | 35 | 631 | 518 | 1,918 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net Interest Income After Provision For Loan Losses | 12,733 | 11,675 | 37,001 | 34,506 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Non-Interest Income | ||||||||||||||||
Gain on sale of securities, net | — | — | — | 5 | ||||||||||||
Gain on sale of SBA loans, net | 331 | 263 | 936 | 673 | ||||||||||||
Deposit account service charge income | 631 | 598 | 1,891 | 1,749 | ||||||||||||
Other non-interest income | 1,042 | 610 | 2,750 | 2,160 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Non-Interest Income | 2,004 | 1,471 | 5,577 | 4,587 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Non-Interest Expense | ||||||||||||||||
Salaries and employee benefits (includes stock based compensation expense of $445 and $241 for the three months, and $1,332 and $716 for the nine months ended September 30, 2014 and 2013, respectively) | 6,066 | 5,673 | 17,886 | 17,003 | ||||||||||||
Occupancy | 999 | 1,074 | 2,970 | 3,157 | ||||||||||||
Data processing | 472 | 452 | 1,423 | 1,413 | ||||||||||||
Legal and professional | 456 | 530 | 1,390 | 1,609 | ||||||||||||
FDIC deposit assessment | 195 | 219 | 596 | 654 | ||||||||||||
Merger related expenses | 631 | — | 1,128 | 43 | ||||||||||||
OREO valuation write-downs and expenses | 8 | 39 | 14 | 88 | ||||||||||||
Office services expenses | 219 | 261 | 721 | 786 | ||||||||||||
Other operating expenses | 985 | 1,182 | 3,150 | 3,267 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Non-Interest Expense | 10,031 | 9,430 | 29,278 | 28,020 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net Income Before Provision for Income Tax Expense | 4,706 | 3,716 | 13,300 | 11,073 | ||||||||||||
Provision for income tax expense | 2,157 | 1,239 | 5,699 | 4,120 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net Income | $ | 2,549 | $ | 2,477 | $ | 7,601 | $ | 6,953 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Earnings Per Share | ||||||||||||||||
Basic earnings per share | $ | 0.23 | $ | 0.24 | $ | 0.70 | $ | 0.66 | ||||||||
Diluted earnings per share | $ | 0.23 | $ | 0.23 | $ | 0.68 | $ | 0.65 |
The accompanying notes are an integral part of these consolidated financial statements.
Page 4 of 71
Table of Contents
CU BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net Income | $ | 2,549 | $ | 2,477 | $ | 7,601 | $ | 6,953 | ||||||||
Other Comprehensive Income, net of tax: | ||||||||||||||||
Non-credit portion of other-than-temporary impairments arising during the period | — | — | — | (19 | ) | |||||||||||
Net unrealized gains (losses) on investment securities arising during the period | 8 | (533 | ) | 408 | (1,319 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Other Comprehensive Income (Loss) Before Reclassifications | 8 | (533 | ) | 408 | (1,338 | ) | ||||||||||
Reclassification adjustment for gains realized in net income | — | — | — | (3 | ) | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Net Other Comprehensive Income (Loss) | 8 | (533 | ) | 408 | (1,341 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Comprehensive Income | $ | 2,557 | $ | 1,945 | $ | 8,009 | $ | 5,612 | ||||||||
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
Page 5 of 71
Table of Contents
CU BANCORP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Year Ended December 31, 2013 and the Nine Months Ended September 30, 2014
(2014 activity unaudited)
(Dollars and shares in thousands)
Common Stock | ||||||||||||||||||||||||
Outstanding Shares | Amount | Additional Paid in Capital | Retained Earnings (Deficit) | Accumulated Other Comprehensive Income (Loss) | Total Shareholders’ Equity | |||||||||||||||||||
Balance at December 31, 2012 | 10,759 | $ | 118,885 | $ | 7,052 | $ | (1,708 | ) | $ | 1,394 | $ | 125,623 | ||||||||||||
Net Issuance of Restricted Stock | 69 | — | — | — | — | — | ||||||||||||||||||
Exercise of Stock Options | 282 | 2,790 | — | — | — | 2,790 | ||||||||||||||||||
Stock based compensation expense related to employee stock options and restricted stock | — | — | 1,088 | — | — | 1,088 | ||||||||||||||||||
Restricted Stock Repurchase | (29 | ) | — | (422 | ) | — | — | (422 | ) | |||||||||||||||
Excess tax benefit – stock based compensation | — | — | 659 | — | — | 659 | ||||||||||||||||||
Net Income | — | — | — | 9,785 | — | 9,785 | ||||||||||||||||||
Other Comprehensive (Loss) | — | — | — | — | (1,599 | ) | (1,599 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance at December 31, 2013 | 11,081 | $ | 121,675 | $ | 8,377 | $ | 8,077 | $ | (205 | ) | $ | 137,924 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Net Issuance of Restricted Stock | 46 | — | — | — | — | — | ||||||||||||||||||
Exercise of Stock Options | 131 | 1,277 | — | — | — | 1,277 | ||||||||||||||||||
Stock based compensation expense related to employee stock options and restricted stock | — | — | 1,332 | — | — | 1,332 | ||||||||||||||||||
Restricted Stock Repurchase | (26 | ) | — | (246 | ) | — | — | (246 | ) | |||||||||||||||
Excess tax benefit – stock based compensation | — | — | 477 | — | — | 477 | ||||||||||||||||||
Net Income | — | — | — | 7,601 | — | 7,601 | ||||||||||||||||||
Other Comprehensive Income | — | — | — | — | 408 | 408 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance at September 30, 2014 | 11,232 | $ | 122,952 | $ | 9,940 | $ | 15,678 | $ | 203 | $ | 148,773 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
Page 6 of 71
Table of Contents
CU BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Nine Months Ended September 30, | ||||||||
2014 | 2013 | |||||||
Cash flows from operating activities: | ||||||||
Net income: | $ | 7,601 | $ | 6,953 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for loan losses | 518 | 1,918 | ||||||
Provision for unfunded loan commitments | 76 | 48 | ||||||
Stock based compensation expense | 1,332 | 716 | ||||||
Depreciation | 725 | 825 | ||||||
Net accretion of discounts/premiums for loans acquired and deferred loan fees/costs | (3,947 | ) | (4,749 | ) | ||||
Net amortization from investment securities | 1,133 | 1,286 | ||||||
Increase in bank owned life insurance | (463 | ) | (465 | ) | ||||
Amortization of core deposit intangibles | 203 | 240 | ||||||
Amortization of time deposit premium | (13 | ) | (127 | ) | ||||
Net amortization of leasehold right intangible asset and liabilities | 158 | (347 | ) | |||||
Accretion of subordinated debenture discount | 119 | 170 | ||||||
Gain on sale of securities, net | — | (5 | ) | |||||
Gain on sale of SBA loans, net | (936 | ) | (673 | ) | ||||
Decrease in deferred tax assets | 1,176 | 1,602 | ||||||
(Increase) decrease in accrued interest receivable and other assets | 1,838 | (1,912 | ) | |||||
Increase (decrease) in accrued interest payable and other liabilities | 255 | 522 | ||||||
Decrease in fair value of derivative swap liability | (841 | ) | (1,593 | ) | ||||
|
|
|
| |||||
Net cash provided by operating activities | 8,934 | 4,409 | ||||||
|
|
|
| |||||
Cash flows from investing activities: | ||||||||
Purchases of available-for-sale investment securities | (48,656 | ) | (20,395 | ) | ||||
Proceeds from sales of available-for-sale investment securities | — | 2,854 | ||||||
Proceeds from repayment and maturities from available-for-sale investment securities | 15,157 | 29,355 | ||||||
Loans originated, net of principal payments | (40,495 | ) | (50,018 | ) | ||||
Purchases of premises and equipment | (842 | ) | (484 | ) | ||||
Net increase in certificates of deposit in other financial institutions | (14,166 | ) | (20,118 | ) | ||||
Net purchase of Federal Home Loan Bank and other bank stock | — | 151 | ||||||
|
|
|
| |||||
Net cash (used in) investing activities | (89,002 | ) | (58,655 | ) | ||||
|
|
|
| |||||
Cash flows from financing activities: | ||||||||
Net increase in Non-interest bearing demand deposits | 66,059 | 66,080 | ||||||
Net increase (decrease) in Interest bearing transaction accounts | (9,836 | ) | 17,039 | |||||
Net increase (decrease) in Money market and savings deposits | (14,970 | ) | 29,064 | |||||
Net decrease in Certificates of deposit | (10,716 | ) | (13,783 | ) | ||||
Net increase (decrease) in Securities sold under agreements to repurchase | 2,477 | (6,814 | ) | |||||
Net proceeds from stock options exercised | 1,277 | 484 | ||||||
Restricted stock repurchase | (246 | ) | (422 | ) | ||||
Net excess in tax benefit on stock compensation | 477 | 101 | ||||||
|
|
|
| |||||
Net cash provided by financing activities | 34,522 | 91,749 | ||||||
|
|
|
| |||||
Net increase (decrease) in cash and cash equivalents | (45,546 | ) | 37,503 | |||||
Cash and cash equivalents, beginning of year | 241,287 | 182,896 | ||||||
|
|
|
| |||||
Cash and cash equivalents, end of period | $ | 195,741 | $ | 220,399 | ||||
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements
Page 7 of 71
Table of Contents
CU BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(Dollars in thousands)
Nine Months Ended September 30, | ||||||||
2014 | 2013 | |||||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid during the period for interest | $ | 1,301 | $ | 1,557 | ||||
Cash paid during the period for taxes | $ | 2,550 | $ | 2,450 | ||||
Supplemental disclosures of non-cash investing activities: | ||||||||
Net increase (decrease) in unrealized gain or loss on investment securities, net of tax | $ | 408 | $ | (1,341 | ) | |||
Loans transferred to other real estate owned | $ | 219 | $ | — |
Page 8 of 71
Table of Contents
CU BANCORP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 1 - Basis of Financial Statement Presentation
CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. CU Bancorp was established to facilitate the reorganization and merger of Premier Commercial Bank, N.A. into California United Bank, which took place after the close of business on July 31, 2012. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company”, as used throughout this document, refers to the consolidated balance sheets and consolidated statements of income of CU Bancorp and California United Bank.
California United Bank (the “Bank”) is a full-service commercial business bank offering a broad range of banking products and services including: deposit services, lending and cash management to small and medium-sized businesses in Los Angeles, Orange and Ventura counties, to non-profit organizations, to business principals and entrepreneurs, to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors. The Bank opened for business in 2005, with its headquarters office located in Encino, California. As a state chartered non-member bank, the Bank is subject to regulation by the California Department of Business Oversight, (the “DBO”) and the Federal Deposit Insurance Corporation (“FDIC”). The deposits of the Bank are insured by the FDIC, to the maximum amount allowed by law.
On June 3, 2014, CU Bancorp and 1st Enterprise Bank (“1st Enterprise”) announced the execution of a definitive agreement and plan of merger whereby 1st Enterprise will merge into California United Bank in a transaction valued at approximately $102.2 million. The transaction combines two of the leading commercial banking franchises in Southern California with more than $2.2 billion in combined assets which operate offices in Los Angeles, Orange, Ventura and San Bernardino counties. California United Bank will survive the merger and will continue the commercial banking operations of the combined bank following the merger. The transaction is intended to qualify as a tax-free reorganization under the applicable provision of the Internal Revenue Code and 1st Enterprise shareholders who receive shares of CU Bancorp common stock in the merger should not recognize any taxable gain on the exchange. Shareholders of 1st Enterprise will receive a fixed exchange ratio at closing of 1.3450 shares of CU Bancorp common stock for each share of 1st Enterprise common stock. Based on the CU Bancorp stock price as of November 3, 2014, total consideration for each 1st Enterprise share would be $26.63.
The consolidated financial statements include the accounts of the Company and the Bank. Significant intercompany items have been eliminated in consolidation. The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission.
CU Bancorp is the common shareholder of Premier Commercial Statutory Trust I, Premier Commercial Statutory Trust II, and Premier Commercial Statutory Trust III, entities which were acquired in the merger with Premier Commercial Bancorp (“PC Bancorp”). These trusts were established for the sole purpose of issuing trust preferred securities and do not meet the criteria for consolidation in accordance with ASC 810 Consolidation. For more detail, see Note 8 – Borrowings and Subordinated Debentures.
Certain information and footnote disclosures presented in the annual consolidated financial statements are not included in the interim consolidated financial statements. Accordingly, the accompanying unaudited interim consolidated financial statements should be read in conjunction with the Company’s 2013 Annual Report on Form 10-K. In the opinion of management, the accompanying financial statements contain all necessary adjustments of a normal recurring nature to present fairly the consolidated financial position of the Company and the results of its operations for the interim period presented.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, these accounting principles require the disclosure of contingent assets and liabilities as of the date of the financial statements.
Page 9 of 71
Table of Contents
Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan loss and various assets and liabilities measured at fair value. While management uses the most current available information to recognize losses on loans, future additions to the allowance for loan loss may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan loss. Regulatory agencies may require the Company to recognize changes to the allowance for loan loss based on their judgment about information available to them at the time of their examination.
Business Segments
The Company is organized and operated as a single reporting segment, principally engaged in commercial business banking. The Company conducts its lending and deposit operations through eight full service branch offices located in Los Angeles, Orange, and Ventura counties.
Note 2 - Recent Accounting Pronouncements
In January 2014, the FASB issued ASU No. 2014-01,Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).ASU 2014-01 modifies the conditions that a reporting entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. If the modified conditions are met, the amendments permit an entity to amortize the initial cost of the investment in proportion to the amount of the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). Additionally, ASU 2014-01 introduces new recurring disclosures about all investments in qualified affordable housing projects irrespective of the method used to account for the investments. Prior to these amendments, a reporting entity that invests in qualified affordable housing projects may elect to account for that investment using the level yield method if specific conditions are met. For investments that are not accounted for using the effective yield method, the investment must be accounted for under either the equity method or the cost method. Because the conditions which allow an entity to utilize the effective yield method were overly restrictive, this prevented many investors from using the effective yield method. Under the effective yield method, all tax credits, tax benefits, and the write-down of the investments are accounted for net of taxes as a component of income tax expense (benefit). This method more fairly represents the economics of the transaction than accounting under the equity method or cost method. The amendments in ASU 2014-01 are expected to enable more entities to qualify for the proportional amortization method to account for affordable housing project investments than the number of entities that currently qualify for the effective yield method. The amendments are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. For all entities other than public business entities, the amendments are effective for annual periods beginning after December 15, 2014, and interim periods within annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company early adopted ASU 2014-01 in the fourth quarter of 2013. See Note 11 – Investments in Qualified Affordable Housing Projects, in the Company’s 2013 Form 10-K, for the Company’s disclosures on its investments in LIHTC projects required under ASU 2014-01.
In January 2014, the FASB issued ASU No. 2014-04,Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon foreclosure (a consensus of the FASB Emerging Issues Task Force).The objective of this Update is to reduce diversity in practice by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. These amendments are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. For entities other than public business entities, the amendments are effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. An entity can elect to adopt these amendments using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. We do not expect the adoption of this ASU to have a material impact on the Company’s financial position or results of operations.
Page 10 of 71
Table of Contents
In June 2014, the FASB issued ASU No. 2014-11,Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures,to address investor concerns about the distinction in generally accepted accounting principles between repurchase agreements that settle at the same time as the maturity of the transferred financial asset and those that settle any time before maturity. ASU 2014-11 aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions all will be accounted for as secured borrowings. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. ASU 2014-11 also requires a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Further, the ASU requires expanded disclosures about the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The accounting changes are effective for public companies for the first interim or annual period beginning after December 15, 2014. In addition, for public companies, the disclosure for certain transactions accounted for as a sale is effective for the first interim or annual period beginning after December 15, 2014, and the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2014. For all other entities, all changes are effective for annual periods beginning after December 14, 2014, and interim periods beginning after December 15, 2015. Earlier application for a public company is prohibited, but all other companies and organizations may elect to apply the requirements for interim periods beginning after December 15, 2014. We do not expect the adoption of this ASU to have an impact on the Company’s financial position or results of operations.
Page 11 of 71
Table of Contents
Note 3 - Computation of Book Value and Tangible Book Value per Common Share
The Company utilizes the term Tangible Common Equity (“TCE”), a non-GAAP financial measure. Management believes that TCE is useful because it is a measure utilized by both regulators and market analysts in evaluating a consolidated bank holding company’s financial condition and capital strength. TCE represents common shareholders’ equity less goodwill and certain intangible assets.
Book value per common share was calculated by dividing total shareholders’ equity by the number of common shares issued and outstanding. Tangible book value per common share was calculated by dividing tangible common equity by the number of common shares issued and outstanding.
The table below presents the computation of TCE, book value and tangible book value per common share as of the dates indicated (dollars in thousands, except share and per share data):
September 30, 2014 | December 31, 2013 | |||||||
Total Shareholders’ Equity | $ | 148,773 | $ | 137,924 | ||||
Less: Goodwill | 12,292 | 12,292 | ||||||
Less: Core deposit and leasehold right intangibles | 2,246 | 2,525 | ||||||
|
|
|
| |||||
Tangible common equity | $ | 134,235 | $ | 123,107 | ||||
|
|
|
| |||||
Common shares issued and outstanding | 11,231,801 | 11,081,364 | ||||||
Book value per common share | $ | 13.25 | $ | 12.45 | ||||
|
|
|
| |||||
Tangible book value per common share | $ | 11.95 | $ | 11.11 | ||||
|
|
|
|
Note 4 - Computation of Earnings per Common Share
Basic and diluted earnings per common share were determined by dividing the net income by the applicable basic and diluted weighted average common shares outstanding. The following table shows weighted average basic shares outstanding, potential dilutive shares related to stock options, unvested restricted stock, and weighted average diluted shares for the periods indicated (dollars in thousands, except share and per share data):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net Income | $ | 2,549 | $ | 2,477 | $ | 7,601 | $ | 6,953 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Weighted average basic common shares outstanding | 10,986,065 | 10,546,288 | 10,937,507 | 10,511,327 | ||||||||||||
Dilutive effect of potential common share issuances from stock options and unvested restricted stock | 203,837 | 301,419 | 210,154 | 271,543 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Weighted average diluted common shares outstanding | 11,189,902 | 10,847,707 | 11,147,661 | 10,782,870 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Income per common share | ||||||||||||||||
Basic | $ | 0.23 | $ | 0.24 | $ | 0.70 | $ | 0.66 | ||||||||
Diluted | $ | 0.23 | $ | 0.23 | $ | 0.68 | $ | 0.65 | ||||||||
|
|
|
|
|
| |||||||||||
Anti-dilutive shares not included in the calculation of diluted earnings per share | 81,000 | 141,924 | 82,625 | 197,411 |
Page 12 of 71
Table of Contents
Note 5 - Investment Securities
The investment securities portfolio has been classified as available-for-sale, and as such is recorded at estimated fair market value.
The following tables present the amortized cost and estimated fair values of investment securities by major category as of the dates indicated. There were no other than temporary impairment losses in the securities portfolio for the periods indicated in the tables below (dollars in thousands):
Gross Unrealized | ||||||||||||||||
September 30, 2014 – Available-for-sale: | Amortized Cost | Gains | Losses | Fair Market Value | ||||||||||||
U.S. Govt Agency and Sponsored Agency - Note Securities | $ | 3,054 | $ | 3 | $ | — | $ | 3,057 | ||||||||
U.S. Govt Agency - SBA Securities | 50,710 | 763 | 345 | 51,128 | ||||||||||||
U.S. Govt Agency - GNMA Mortgage-Backed Securities | 23,481 | 232 | 479 | 23,234 | ||||||||||||
U.S. Govt Sponsored Agency - CMO & Mortgage-Backed Securities | 35,821 | 375 | 308 | 35,888 | ||||||||||||
U. S. Treasury Notes | 20,035 | 6 | 7 | 20,034 | ||||||||||||
Corporate Securities | 4,050 | 95 | — | 4,145 | ||||||||||||
Municipal Securities | 2,051 | 15 | — | 2,066 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total investment securities | $ | 139,202 | $ | 1,489 | $ | 1,139 | $ | 139,552 | ||||||||
|
|
|
|
|
|
|
|
Gross Unrealized | ||||||||||||||||
December 31, 2013 – Available-for-sale: | Amortized Cost | Gains | Losses | Fair Market Value | ||||||||||||
U.S. Govt Agency and Sponsored Agency - Note Securities | $ | 4,153 | $ | 1 | $ | 2 | $ | 4,152 | ||||||||
U.S. Govt Agency - SBA Securities | 50,521 | 875 | 491 | 50,905 | ||||||||||||
U.S. Govt Agency - GNMA Mortgage-Backed Securities | 28,107 | 180 | 909 | 27,378 | ||||||||||||
U.S. Govt Sponsored Agency - CMO & Mortgage-Backed Securities | 15,348 | 345 | 479 | 15,214 | ||||||||||||
Corporate Securities | 5,086 | 125 | — | 5,211 | ||||||||||||
Municipal Securities | 3,621 | 9 | 2 | 3,628 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total investment securities | $ | 106,836 | $ | 1,535 | $ | 1,883 | $ | 106,488 | ||||||||
|
|
|
|
|
|
|
|
The Company’s investment securities portfolio at September 30, 2014 consists of U.S. Treasury Notes, U.S. Agency and U.S. Sponsored Agency issued AAA and AA rated investment-grade securities, investment grade corporate bond securities, and municipal securities. As of September 30, 2014 and December 31, 2013, securities available-for-sale with a fair value of $104.0 million and $92.8 million were pledged as collateral for securities sold under agreements to repurchase, public deposits, outstanding standby letters of credit and other purposes as required by various statutes and agreements.
Page 13 of 71
Table of Contents
The following tables present investment securities with unrealized losses that are considered to be temporarily-impaired, summarized and classified according to the duration of the loss period as of the dates indicated (dollars in thousands).
< 12 Continuous Months | > 12 Continuous Months | Total | ||||||||||||||||||||||
September 30, 2014 | Fair Value | Net Unrealized Loss | Fair Value | Net Unrealized Loss | Fair Value | Net Unrealized Loss | ||||||||||||||||||
Temporarily-impaired available-for-sale investment securities: | ||||||||||||||||||||||||
U.S. Govt. - Agency and Sponsored Agency Note Securities | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
U.S. Govt. Agency SBA Securities | 9,020 | 61 | 8,384 | 284 | 17,404 | 345 | ||||||||||||||||||
U.S. Govt. Agency – GNMA Mortgage-Backed Securities | 6,152 | 73 | 8,639 | 300 | 14,791 | 373 | ||||||||||||||||||
U.S. Govt. Sponsored Agency – CMO & Mortgage-Backed Securities | 12,452 | 114 | 9,396 | 300 | 21,848 | 414 | ||||||||||||||||||
U.S. Treasury Notes | 10,025 | 7 | — | — | 10,025 | 7 | ||||||||||||||||||
Corporate Securities | — | — | — | — | — | — | ||||||||||||||||||
Municipal Securities | — | — | — | — | — | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total temporarily-impaired available-for-sale investment securities | $ | 37,649 | $ | 255 | $ | 26,419 | $ | 884 | $ | 64,068 | $ | 1,139 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
< 12 Continuous Months | > 12 Continuous Months | Total | ||||||||||||||||||||||
December 31, 2013 | Fair Value | Net Unrealized Loss | Fair Value | Net Unrealized Loss | Fair Value | Net Unrealized Loss | ||||||||||||||||||
Temporarily-impaired available-for-sale investment securities: | ||||||||||||||||||||||||
U.S. Govt. - Agency and Sponsored Agency Note Securities | $ | 1,041 | $ | 2 | $ | — | $ | — | $ | 1,041 | $ | 2 | ||||||||||||
U.S. Govt. Agency SBA Securities | 11,686 | 491 | — | — | 11,686 | 491 | ||||||||||||||||||
U.S. Govt. Agency – GNMA Mortgage-Backed Securities | 15,693 | 721 | 1,864 | 188 | 17,557 | 909 | ||||||||||||||||||
U.S. Govt. Sponsored Agency – CMO & Mortgage-Backed Securities | 7,650 | 479 | — | — | 7,650 | 479 | ||||||||||||||||||
Corporate Securities | — | — | — | — | — | — | ||||||||||||||||||
Municipal Securities | — | — | 1,029 | 2 | 1,029 | 2 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total temporarily-impaired available-for-sale investment securities | $ | 36,070 | $ | 1,693 | $ | 2,893 | $ | 190 | $ | 38,963 | $ | 1,883 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
The Company evaluates all securities for declines in the fair market values below the securities cost basis for possible other than temporary impairment on each reporting date. There were no other than temporary impairment losses in the securities portfolio for the periods indicated in the tables
The Company did not sell any available-for-sale securities during the nine months ended September 30, 2014, and recognized a gross gain of $5,000 and net proceeds of $2.9 million for the nine months ended September 30, 2013.
Page 14 of 71
Table of Contents
The amortized cost, estimated fair value and average yield of debt securities at September 30, 2014, are reflected in the table below (dollars in thousands). Maturity categories are determined as follows:
• | U.S. Treasury Notes, U.S. Govt. Agency and U.S. Govt. Sponsored Agency bonds and notes – maturity date |
• | U.S. Govt. Sponsored Agency CMO or Mortgage-Backed Securities, U.S. Govt. Agency GNMA Mortgage-Backed Securities and U.S. Govt. Agency SBA Securities – estimated cash flow taking into account estimated pre-payment speeds |
• | Investment grade Corporate Bonds and Municipal Securities – maturity date |
Although, U.S. Government Agency and U.S. Government Sponsored Agency mortgage-backed and CMO securities have contractual maturities through 2048, the expected maturity will differ from the contractual maturities because borrowers or issuers may have the right to prepay such obligations without penalties.
September 30, 2014 | ||||||||||||
Maturities Schedule of Securities | Amortized Cost | Fair Value | Weighted Average Yield | |||||||||
Due through one year | $ | 16,010 | $ | 16,146 | 1.77 | % | ||||||
Due after one year through five years | 61,527 | 61,894 | 1.52 | % | ||||||||
Due after five years through ten years | 32,152 | 31,865 | 2.34 | % | ||||||||
Due after ten years | 29,513 | 29,647 | 2.97 | % | ||||||||
|
|
|
| |||||||||
Total | $ | 139,202 | $ | 139,552 | 2.04 | % | ||||||
|
|
|
|
The weighted average yields in the above table are based on effective rates of book balances at the end of the period. Yields are derived by dividing interest income, adjusted for amortization of premiums and accretion of discounts, by total amortized cost.
Investment in FHLB Common Stock
The Company’s investment in the common stock of the FHLB of San Francisco is carried at cost and was $4.2 million as of September 30, 2014 and December 31, 2013. See Note 8—Borrowings and Subordinated Debentures for a detailed discussion regarding the Company’s borrowings and the requirements to purchase FHLB common stock. See Note 5—Investment Securities in the Company’s December 31, 2013 10-K for additional discussion on the Company’s evaluation and accounting for its investment in FHLB common stock.
Page 15 of 71
Table of Contents
Note 6 - Loans
The following table presents the composition of the Company’s loan portfolio as of the dates indicated (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||
Commercial and Industrial Loans: | $ | 297,853 | $ | 299,473 | ||||
Loans Secured by Real Estate: | ||||||||
Owner-Occupied Nonresidential Properties | 198,406 | 197,605 | ||||||
Other Nonresidential Properties | 303,605 | 271,818 | ||||||
Construction, Land Development and Other Land | 58,474 | 47,074 | ||||||
1-4 Family Residential Properties | 68,134 | 65,711 | ||||||
Multifamily Residential Properties | 27,937 | 33,780 | ||||||
|
|
|
| |||||
Total Loans Secured by Real Estate | 656,556 | 615,988 | ||||||
|
|
|
| |||||
Other Loans: | 24,391 | 17,733 | ||||||
|
|
|
| |||||
Total Loans | $ | 978,800 | $ | 933,194 | ||||
|
|
|
|
The following table is a breakout of the Company’s loan portfolio stratified by the industry concentration of the borrower by their respective NAICS code as of the dates indicated (dollars in thousands):
September 30, | December 31, | |||||||
2014 | 2013 | |||||||
Real Estate | $ | 422,509 | $ | 381,830 | ||||
Manufacturing | 87,140 | 83,319 | ||||||
Hotel/Lodging | 82,728 | 76,143 | ||||||
Construction | 67,189 | 62,835 | ||||||
Wholesale | 59,563 | 60,291 | ||||||
Professional Services | 44,346 | 49,739 | ||||||
Finance | 63,496 | 46,393 | ||||||
Healthcare | 30,125 | 38,662 | ||||||
Restaurant/Food Service | 24,187 | 35,244 | ||||||
Other Services | 23,467 | 21,448 | ||||||
Retail | 16,891 | 23,157 | ||||||
Administrative Management | 19,085 | 15,218 | ||||||
Information | 11,327 | 11,709 | ||||||
Education | 9,625 | 10,270 | ||||||
Transportation | 10,393 | 9,531 | ||||||
Entertainment | 5,382 | 6,207 | ||||||
Other | 1,347 | 1,198 | ||||||
|
|
|
| |||||
Total | $ | 978,800 | $ | 933,194 | ||||
|
|
|
|
SBA Loans
The Company originates loans under the guidelines of the Small Business Administration (“SBA”) program. The total portfolio of the SBA contractual loan balances being serviced by the Company at September 30, 2014 was $101.8 million, of which $71.0 million has been sold. Of the $30.8 million remaining on the Company’s books, $22.7 million is un-guaranteed and $8.1 million is guaranteed by the SBA.
For SBA guaranteed loans, a secondary market exists to purchase the guaranteed portion of these loans with the Company continuing to “service” the entire loan. The secondary market for guaranteed loans is comprised of investors seeking long term assets with yields that adapt to the prevailing interest rates. These investors are typically financial institutions, insurance companies, pension funds, and other types of investors specializing in the acquisition of this product. When a decision to sell the guaranteed portion of an SBA loan is made by the Company, bids are solicited from secondary market investors and the loan is normally sold to the highest bidder.
Page 16 of 71
Table of Contents
At September 30, 2014, there were no loans classified as held for sale. At September 30, 2014, the balance of unsold SBA 7a loans that have been originated in 2014 is $1.0 million, of which $0.7 million is guaranteed by the SBA. The Company does not currently plan on selling these loans, but it may choose to do so in the future.
Allowance for Loan Loss
The following table is a summary of the activity for the allowance for loan loss for the periods indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Allowance for loan loss at beginning of period | $ | 11,284 | $ | 9,412 | $ | 10,603 | $ | 8,803 | ||||||||
Provision for loan losses | 35 | 631 | 518 | 1,918 | ||||||||||||
Net (charge-offs) recoveries: | ||||||||||||||||
Charge-offs | (8 | ) | (786 | ) | (165 | ) | (1,523 | ) | ||||||||
Recoveries | 37 | 781 | 392 | 840 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net recoveries (charge-offs) | 29 | (5 | ) | 227 | (683 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Allowance for loan loss at end of period | $ | 11,348 | $ | 10,038 | $ | 11,348 | $ | 10,038 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net (charge-offs) recoveries to average loans | 0.00 | % | 0.00 | % | (0.02 | )% | (0.08 | )% |
September 30, 2014 | December 30, 2013 | |||||||
Allowance for loan loss to total loans | 1.16 | % | 1.14 | % | ||||
Allowance for loan loss to total loans accounted for at historical cost, which excludes loans and the related allowance for loans acquired through acquisition | 1.43 | % | 1.50 | % |
The allowance for losses on unfunded loan commitments to extend credit is primarily related to commercial lines of credit and construction loans. The amount of unfunded loan commitments at September 30, 2014 and December 31, 2013 was $419.1 million and $345.9 million, respectively. The inherent risk associated with a loan is evaluated at the same time the credit is extended. However, the allowance held for the commitments is reported in other liabilities within the accompanying balance sheets and not as part of the allowance for loan loss in the above table. The allowance for losses on unfunded loan commitments to extend credit was $405,000 and $329,000 at September 30, 2014 and December 31, 2013, respectively.
Page 17 of 71
Table of Contents
The following tables present, by portfolio segment, the changes in the allowance for loan loss and the recorded investment in loans as of the dates and for the periods indicated (dollars in thousands):
Commercial and Industrial | Construction, Land Development and Other Land | Commercial and Other Real Estate | Other | Total | ||||||||||||||||
Three Months Ended September 30, 2014 | ||||||||||||||||||||
Allowance for loan loss – Beginning balance | $ | 5,385 | $ | 1,422 | $ | 4,426 | $ | 51 | $ | 11,284 | ||||||||||
Provision for loan losses | 333 | (205 | ) | (429 | ) | 336 | 35 | |||||||||||||
Net (charge-offs) recoveries: | ||||||||||||||||||||
Charge-offs | — | — | (8 | ) | — | (8 | ) | |||||||||||||
Recoveries | 36 | — | 1 | — | 37 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Net (charge offs) recoveries | 36 | — | (7 | ) | — | 29 | ||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Ending balance | $ | 5,754 | $ | 1,217 | $ | 3,990 | $ | 387 | $ | 11,348 | ||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Three Months Ended September 30, 2013 | ||||||||||||||||||||
Allowance for loan loss – Beginning balance | $ | 4,659 | $ | 2,360 | $ | 2,351 | $ | 42 | $ | 9,412 | ||||||||||
Provision for loan losses | 1,103 | (1,095 | ) | 596 | 27 | 631 | ||||||||||||||
Net (charge-offs) recoveries: | ||||||||||||||||||||
Charge-offs | (786 | ) | — | — | — | (786 | ) | |||||||||||||
Recoveries | 11 | 763 | 6 | 1 | 781 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Net (charge-offs) recoveries | (775 | ) | 763 | 6 | 1 | (5 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Ending balance | $ | 4,987 | $ | 2,028 | $ | 2,953 | $ | 70 | $ | 10,038 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Commercial and Industrial | Construction, Land Development and Other Land | Commercial and Other Real Estate | Other | Total | ||||||||||||||||
Nine Months Ended September 30, 2014 | ||||||||||||||||||||
Allowance for loan loss – Beginning balance | $ | 5,534 | $ | 1,120 | $ | 3,886 | $ | 63 | $ | 10,603 | ||||||||||
Provision for loan losses | 25 | 97 | 72 | 324 | 518 | |||||||||||||||
Net (charge-offs) recoveries: | ||||||||||||||||||||
Charge-offs | (93 | ) | — | (72 | ) | — | (165 | ) | ||||||||||||
Recoveries | 288 | — | 104 | — | 392 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Net recoveries | 195 | — | 32 | — | 227 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Ending balance | $ | 5,754 | $ | 1,217 | $ | 3,990 | $ | 387 | $ | 11,348 | ||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Nine Months Ended September 30, 2013 | ||||||||||||||||||||
Allowance for loan loss – Beginning balance | $ | 4,572 | $ | 2,035 | $ | 2,084 | $ | 112 | $ | 8,803 | ||||||||||
Provision for loan losses | 1,754 | (770 | ) | 974 | (40 | ) | 1,918 | |||||||||||||
Net (charge-offs) recoveries: | ||||||||||||||||||||
Charge-offs | (1,398 | ) | — | — | (8 | ) | (1,523 | ) | ||||||||||||
Recoveries | 59 | 763 | 11 | 6 | 840 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Net (charge-offs) recoveries | (1,339 | ) | 763 | (105 | ) | (2 | ) | (683 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Ending balance | $ | 4,987 | $ | 2,028 | $ | 2,953 | $ | 70 | $ | 10,038 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Page 18 of 71
Table of Contents
The following tables present both the allowance for loan loss and the associated loan balance classified by loan portfolio segment and by credit evaluation methodology (dollars in thousands):
Commercial and Industrial | Construction, Land Development and Other Land | Commercial and Other Real Estate | Other | Total | ||||||||||||||||
September 30, 2014 | ||||||||||||||||||||
Allowance for loan loss: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 243 | $ | — | $ | — | $ | — | $ | 243 | ||||||||||
Collectively evaluated for impairment | 5,511 | 1,217 | 3,990 | 387 | 11,105 | |||||||||||||||
Purchased credit impaired (loans acquired with deteriorated credit quality) | — | — | — | — | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total Allowance for Loan Loss | $ | 5,754 | $ | 1,217 | $ | 3,990 | $ | 387 | $ | 11,348 | ||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Loans receivable: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 2,545 | $ | — | $ | 850 | $ | — | $ | 3,395 | ||||||||||
Collectively evaluated for impairment | 294,836 | 58,474 | 595,628 | 24,390 | 973,328 | |||||||||||||||
Purchased credit impaired (loans acquired with deteriorated credit quality) | 472 | — | 1,604 | 1 | 2,077 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total Loans Receivable | $ | 297,853 | $ | 58,474 | $ | 598,082 | $ | 24,391 | $ | 978,800 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Commercial and Industrial | Construction, Land Development and Other Land | Commercial and Other Real Estate | Other | Total | ||||||||||||||||
December 31, 2013 | ||||||||||||||||||||
Allowance for loan loss: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 4 | $ | — | $ | — | $ | — | $ | 4 | ||||||||||
Collectively evaluated for impairment | 5,520 | 1,120 | 3,886 | 63 | 10,589 | |||||||||||||||
Purchased credit impaired (loans acquired with deteriorated credit quality) | 10 | — | — | — | 10 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total Allowance for Loan Loss | $ | 5,534 | $ | 1,120 | $ | 3,886 | $ | 63 | $ | 10,603 | ||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Loans receivable: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 2,640 | $ | — | $ | 3,680 | $ | — | $ | 6,320 | ||||||||||
Collectively evaluated for impairment | 295,787 | 47,074 | 561,952 | 17,733 | 922,546 | |||||||||||||||
Purchased credit impaired (loans acquired with deteriorated credit quality) | 1,046 | — | 3,282 | — | 4,328 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total Loans Receivable | $ | 299,473 | $ | 47,074 | $ | 568,914 | $ | 17,733 | $ | 933,194 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Page 19 of 71
Table of Contents
Credit Quality of Loans
The Company utilizes an internal loan classification system as a means of reporting problem and potential problem loans. Under the Company’s loan risk rating system, loans are classified as “Pass,” with problem and potential problem loans as “Special Mention,” “Substandard,” “Doubtful” and “Loss”. Individual loan risk ratings are updated continuously or at any time the situation warrants. In addition, management regularly reviews problem loans to determine whether any loan requires a classification change, in accordance with the Company’s policy and applicable regulations. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The internal loan classification risk grading system is based on experiences with similarly graded loans.
The Company’s internally assigned grades are as follows:
• | Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. There are several different levels of Pass rated credits, including “Watch” which is considered a transitory grade for Pass rated loans that require greater monitoring. Loans not meeting the criteria of special mention, substandard, doubtful or loss that have been analyzed individually as part of the above described process are considered to be Pass-rated loans. |
• | Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. Special Mention loans do not currently expose the Company to sufficient risk to warrant classification as a Substandard, Doubtful or Loss classification, but possess weaknesses that deserve management’s close attention. |
• | Substandard – loans that have a well-defined weakness based on objective evidence and can be characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. |
• | Doubtful – loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. |
• | Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. |
The following tables present the risk category of loans by class of loans based on the most recent internal loan classification as of the dates indicated (dollars in thousands):
Commercial and Industrial | Construction, Land Development and Other Land | Commercial and Other Real Estate | Other | Total | ||||||||||||||||
September 30, 2014 | ||||||||||||||||||||
Pass | $ | 275,252 | $ | 58,474 | $ | 579,365 | $ | 24,388 | $ | 937,479 | ||||||||||
Special Mention | 5,142 | — | 3,845 | — | 8,987 | |||||||||||||||
Substandard | 17,459 | — | 14,872 | 2 | 32,333 | |||||||||||||||
Doubtful | — | — | — | 1 | 1 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 297,853 | $ | 58,474 | $ | 598,082 | $ | 24,391 | $ | 978,800 | ||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
December 31, 2013 | ||||||||||||||||||||
Pass | $ | 289,594 | $ | 47,074 | $ | 547,600 | $ | 17,731 | $ | 901,999 | ||||||||||
Special Mention | 1,540 | — | 2,613 | — | 4,153 | |||||||||||||||
Substandard | 8,339 | — | 18,701 | 2 | 27,042 | |||||||||||||||
Doubtful | — | — | — | — | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Total | $ | 299,473 | $ | 47,074 | $ | 568,914 | $ | 17,733 | $ | 933,194 | ||||||||||
|
|
|
|
|
|
|
|
|
|
Page 20 of 71
Table of Contents
Age Analysis of Past Due and Non-Accrual Loans
The following tables present an aging analysis of the recorded investment of past due loans and non-accrual loans as of the dates indicated (dollars in thousands):
31-60 Days Past Due | 61-90 Days Past Due | Greater than 90 Days Past Due and Accruing | Total Past Due and Accruing | Total Non Accrual | Current | Total Loans | ||||||||||||||||||||||
September 30, 2014 | ||||||||||||||||||||||||||||
Commercial and Industrial | $ | 88 | $ | 233 | $ | 0 | $ | 321 | $ | 3,014 | $ | 294,518 | $ | 297,853 | ||||||||||||||
Construction, Land Development and Other Land | — | — | — | — | — | 58,474 | 58,474 | |||||||||||||||||||||
Commercial and Other Real Estate | — | 629 | — | 629 | 1,339 | 596,114 | 598,082 | |||||||||||||||||||||
Other | — | — | — | — | 1 | 24,390 | 24,391 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total | $ | 88 | $ | 862 | $ | — | $ | 950 | $ | 4,354 | $ | 973,496 | $ | 978,800 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31-60 Days Past Due | 61-90 Days Past Due | Greater than 90 Days Past Due and Accruing | Total Past Due and Accruing | Total Non Accrual | Current | Total Loans | ||||||||||||||||||||||
December 31, 2013 | ||||||||||||||||||||||||||||
Commercial and Industrial | $ | — | $ | 241 | $ | — | $ | 241 | $ | 3,682 | $ | 295,550 | $ | 299,473 | ||||||||||||||
Construction, Land Development and Other Land | — | — | — | — | — | 47,074 | 47,074 | |||||||||||||||||||||
Commercial and Other Real Estate | — | — | — | — | 5,874 | 563,040 | 568,914 | |||||||||||||||||||||
Other | — | — | — | — | — | 17,733 | 17,733 | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Total | $ | — | $ | 241 | $ | — | $ | 241 | $ | 9,556 | $ | 923,397 | $ | 933,194 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page 21 of 71
Table of Contents
Impaired Loans
Impaired loans are evaluated by comparing the fair value of the collateral, if the loan is collateral dependent, and the present value of the expected future cash flows discounted at the loan’s effective interest rate, if the loan is not collateral dependent.
A valuation allowance is established for an impaired loan when the fair value of the loan is less than the recorded investment. In certain cases, portions of impaired loans are charged-off to realizable value instead of establishing a valuation allowance and are included, when applicable, in the table below as impaired loans “with no specific allowance recorded.” The valuation allowance disclosed below is included in the allowance for loan loss reported in the consolidated balance sheets as of September 30, 2014 and December 31, 2013.
The following tables present, by loan category, the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable, for the dates and periods indicated (dollars in thousands). This table excludes purchased credit impaired loans (loans acquired in acquisitions with deteriorated credit quality) of $2.1 million and $4.3 million at September 30, 2014 and December 31, 2013, respectively.
September 30, 2014 | December 31, 2013 | |||||||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | Recorded Investment | Unpaid Principal Balance | Related Allowance | |||||||||||||||||||
With no specific allowance recorded: | ||||||||||||||||||||||||
Commercial and Industrial | $ | 1,051 | $ | 1,137 | $ | — | $ | 2,540 | $ | 5,347 | $ | — | ||||||||||||
Commercial and Other Real Estate | 850 | 1,078 | — | 3,680 | 6,112 | — | ||||||||||||||||||
With a specific allowance recorded: | ||||||||||||||||||||||||
Commercial and Industrial | 1,494 | 1,901 | 243 | 100 | 355 | 4 | ||||||||||||||||||
Total | ||||||||||||||||||||||||
Commercial and Industrial | 2,545 | 3,038 | 243 | 2,640 | 5,702 | 4 | ||||||||||||||||||
Commercial and Other Real Estate | 850 | 1,078 | — | 3,680 | 6,112 | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 3,395 | $ | 4,116 | $ | 243 | $ | 6,320 | $ | 11,814 | $ | 4 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||||||||||||||||||
Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | |||||||||||||||||||||||||
With no specific allowance recorded: | ||||||||||||||||||||||||||||||||
Commercial and Industrial | $ | 1,051 | $ | — | $ | 2,235 | $ | — | $ | 1,035 | $ | 34 | $ | 1,528 | $ | — | ||||||||||||||||
Construction, Land Development and Other Land | — | — | 1,159 | — | — | — | 1,172 | — | ||||||||||||||||||||||||
Commercial and Other Real Estate | 2,960 | — | 4,044 | — | 3,207 | — | 3,613 | — | ||||||||||||||||||||||||
With a specific allowance recorded: | ||||||||||||||||||||||||||||||||
Commercial and Industrial | 1,494 | — | 150 | — | 1,533 | — | 150 | — | ||||||||||||||||||||||||
Total: | ||||||||||||||||||||||||||||||||
Commercial and Industrial | 2,545 | — | 2,385 | — | 2,568 | 34 | 1,678 | — | ||||||||||||||||||||||||
Construction, Land Development and Other Land | — | — | 1,159 | — | — | — | 1,172 | — | ||||||||||||||||||||||||
Commercial and Other Real Estate | 2,960 | — | 4,044 | — | 3,207 | — | 3,613 | — | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
Total | $ | 5,505 | $ | — | $ | 7,588 | $ | — | $ | 5,775 | $ | 34 | $ | 6,462 | $ | — | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page 22 of 71
Table of Contents
The following is a summary of additional information pertaining to impaired loans for the periods indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Interest foregone on impaired loans | $ | 72 | $ | 264 | $ | 346 | $ | 495 | ||||||||
Cash collections applied to reduce principal balance | $ | 18 | $ | 1,885 | $ | 2,889 | $ | 2,037 | ||||||||
Interest income recognized on cash collections | $ | — | $ | — | $ | 34 | $ | — |
Troubled Debt Restructuring
The Company’s loan portfolio contains certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers experiencing financial difficulties. Loans are restructured in an effort to maximize collections. Economic concessions can include: reductions to the interest rate, payment extensions, forgiveness of principal or other actions.
The modification process includes evaluation of impairment based on the present value of expected future cash flows, discounted at the effective interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the loan collateral. In these cases, management uses the current fair value of the collateral, less selling costs, to evaluate the loan for impairment. If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and unamortized premium or discount), impairment is recognized through a specific allowance or a charge-off.
The following tables include the recorded investment and unpaid principal balances for troubled debt restructured loans at September 30, 2014 and December 31, 2013 (dollars in thousands). For the nine months ended September 30, 2014, and for the year ended December 31, 2013, there was no interest income recognized on TDR loans. The tables below include TDR loans that were purchased credit impaired (“PCI”). As of September 30, 2014, there were three PCI loans with a recorded investment of $224,000 and unpaid principal balances of $403,000.
September 30, 2014 | Recorded Investment | Unpaid Principal Balance | Interest Income Recognized | |||||||||
Commercial and Industrial | $ | 656 | $ | 1,093 | $ | — | ||||||
|
|
|
|
|
| |||||||
Total | $ | 656 | $ | 1,093 | $ | — | ||||||
|
|
|
|
|
| |||||||
December 31, 2013 | Recorded Investment | Unpaid Principal Balance | Interest Income Recognized | |||||||||
Commercial and Industrial | $ | 541 | $ | 843 | $ | — | ||||||
Commercial and Other Real Estate | 2,173 | 2,785 | — | |||||||||
|
|
|
|
|
| |||||||
Total | $ | 2,714 | $ | 3,628 | $ | — | ||||||
|
|
|
|
|
|
Page 23 of 71
Table of Contents
The following table shows the pre- and post-modification recorded investment in TDR loans by loan segment that have occurred during the periods indicated (dollars in thousands):
Three Months Ended September 30, | ||||||||||||||||||||||||
2014 | 2013 | |||||||||||||||||||||||
Number of Loans | Pre-Modification Recorded Investment | Post- Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | Post- Modification Recorded Investment | |||||||||||||||||||
Troubled Debt Restructured Loans: | ||||||||||||||||||||||||
Commercial and Industrial | — | $ | — | $ | — | — | $ | — | $ | — | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | — | $ | — | $ | — | — | $ | — | $ | — | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, | ||||||||||||||||||||||||
2014 | 2013 | |||||||||||||||||||||||
Number of Loans | Pre-Modification Recorded Investment | Post- Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | Post- Modification Recorded Investment | |||||||||||||||||||
Troubled Debt Restructured Loans: | ||||||||||||||||||||||||
Commercial and Industrial | 1 | $ | 224 | $ | 224 | 1 | $ | 310 | $ | 310 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | 1 | $ | 224 | $ | 224 | 1 | $ | 310 | $ | 310 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Loans are restructured in an effort to maximize collections. There was no financial impact for specific reserves or from charge-offs for the modified loans included in the table above. Impairment analyses are performed on the Company’s troubled debt restructured loans in conjunction with the Company’s allowance for loan loss process. The Company’s troubled debt restructured loans are analyzed to ensure adequate cash flow or collateral supports the carrying value of the loan.
There have been no payment defaults in the nine months ended September 30, 2014 or September 30, 2013 subsequent to modification on troubled debt restructured loans that have been modified within the last twelve months.
Loans Acquired Through Acquisition
The following table reflects the accretable net discount for loans acquired through acquisition, for the periods indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Balance, beginning of period | $ | 6,412 | $ | 10,130 | $ | 7,912 | $ | 12,189 | ||||||||
Accretion, included in interest income | (813 | ) | (967 | ) | (2,264 | ) | (3,050 | ) | ||||||||
Reclassifications (to) from non-accretable yield | — | (547 | ) | (49 | ) | (523 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Balance, end of period | $ | 5,599 | $ | 8,616 | $ | 5,599 | $ | 8,616 | ||||||||
|
|
|
|
|
|
|
|
The above table reflects the fair value adjustment on the loans acquired from mergers that will be amortized to loan interest income based on the effective yield method over the remaining life of the loans. These amounts do not include the fair value adjustments on the purchased credit impaired loans acquired from mergers.
Page 24 of 71
Table of Contents
Purchased Credit Impaired Loans
Purchased Credit Impaired Loans (“PCI”) loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable at the acquisition date, that the Company will not be able to collect all contractually required amounts.
When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans.
The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans.
The following table reflects the outstanding balance and related carrying value of PCI loans as of the dates indicated (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||||||||||
Unpaid Principal Balance | Carrying Value | Unpaid Principal Balance | Carrying Value | |||||||||||||
Commercial and Industrial | $ | 781 | $ | 472 | $ | 1,599 | $ | 1,046 | ||||||||
Commercial and Other Real Estate | 2,876 | 1,604 | 5,611 | 3,282 | ||||||||||||
Other | 62 | 1 | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 3,719 | $ | 2,077 | $ | 7,210 | $ | 4,328 | ||||||||
|
|
|
|
|
|
|
|
The following table reflects the activities in the accretable net discount for PCI loans for the period indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Balance, beginning of period | $ | 360 | $ | 428 | $ | 395 | $ | 9 | ||||||||
Accretion, included in interest income | (18 | ) | (17 | ) | (53 | ) | (17 | ) | ||||||||
Reclassifications from non-accretable yield | — | — | — | 419 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Balance, end of period | $ | 342 | $ | 411 | $ | 342 | $ | 411 | ||||||||
|
|
|
|
|
|
|
|
Note 7 – Qualified Affordable Housing Project Investments
The Company’s investment in Qualified Affordable Housing Projects that generate Low Income Housing Tax Credits (“LIHTC”) at September 30, 2014 was $4.2 million, compared to $4.5 million at December 31, 2013. The decrease of $0.3 million represents the amortization of the investment for the nine months of 2014. The funding liability for the LIHTC at September 30, 2014 was $3.2 million compared to $4.0 million, at December 31, 2013. See Note 11 – Qualified Affordable Housing Project Investments in the Company’s 10-K financial statements at December 31, 2013 for additional detail regarding the Company’s investment in LIHTC.
Page 25 of 71
Table of Contents
Note 8 - Borrowings and Subordinated Debentures
Securities Sold Under Agreements to Repurchase
The Company enters into certain transactions, the legal form of which are sales of securities under agreements to repurchase (“Repos”) at a later date at a set price. Securities sold under agreements to repurchase generally mature within 1 day to 180 days from the issue date and are routinely renewed.
As discussed in Note 5 – Investment Securities, the Company has pledged certain investments as collateral for these agreements. Securities with a fair value of $14.1 million and $11.8 million were pledged to secure the Repos at September 30, 2014 and December 31, 2013, respectively. The Company segregates both the principal and accrued interest on these securities with the Company’s third party safekeeping custodians. All principal and interest payments on the investment securities that are pledged as collateral on the Repo program are received directly by the safekeeping custodian.
The tables below describe the terms and maturity of the Company’s securities sold under agreements to repurchase as of the dates indicated (dollars in thousands):
September 30, 2014 | ||||||||||||||
Date Issued | Amount | Interest Rate | Original Term | Maturity Date | ||||||||||
September 30, 2014 | $ | 13,618 | 0.13% – 0.25 | % | 1 day | October 1, 2014 | ||||||||
|
| |||||||||||||
Total | $ | 13,618 | 0.22 | % | ||||||||||
|
| |||||||||||||
December 31, 2013 | ||||||||||||||
Date Issued | Amount | Interest Rate | Original Term | Maturity Date | ||||||||||
December 3, 2013 | $ | 750 | 0.10 | % | 62 days | February 3, 2014 | ||||||||
December 31, 2013 | 10,391 | 0.10% – 0.40 | % | 2 days | January 2, 2014 | |||||||||
|
| |||||||||||||
Total | $ | 11,141 | 0.30 | % | ||||||||||
|
|
Federal Home Loan Bank Borrowings
The Company maintains a secured credit facility with the Federal Home Loan Bank of San Francisco (“FHLB”), allowing the Company to borrow on an overnight and term basis. The Company’s credit facility with the FHLB is $357.3 million, which represents approximately 25% of the Bank’s total assets, as reported by the Bank in its June 30, 2014 FFIEC Call Report.
As of September 30, 2014, the Company had $605.8 million of loan collateral pledged with the FHLB which provides $259.2 million in borrowing capacity. The Company has no investment securities pledged with the FHLB to support this credit facility. In addition, the Company must maintain an investment in the Capital Stock of the FHLB. Under the FHLB Act, the FHLB has a statutory lien on the FHLB capital stock that the Company owns and the FHLB capital stock serves as further collateral under the borrowing line.
The Company had no outstanding advances (borrowings) with the FHLB as of September 30, 2014 or December 31, 2013.
Page 26 of 71
Table of Contents
Subordinated Debentures
The following table summarizes the terms of each issuance of subordinated debentures outstanding as of September 30, 2014:
Series | Amount (in thousands) | Issuance Date | Maturity Date | Rate Index | Current Rate | Next Reset Date | ||||||||||||||||||
Trust I | $ | 6,186 | 12/10/04 | 03/15/35 | 3 month LIBOR + 2.05 | % | 2.28 | % | 12/15/14 | |||||||||||||||
Trust II | 3,093 | 12/23/05 | 03/15/36 | 3 month LIBOR + 1.75 | % | 1.98 | % | 12/15/14 | ||||||||||||||||
Trust III | 3,093 | 06/30/06 | 09/15/36 | 3 month LIBOR + 1.85 | % | 2.08 | % | 12/15/14 | ||||||||||||||||
|
| |||||||||||||||||||||||
Subtotal | 12,372 | |||||||||||||||||||||||
Unamortized fair value adjustment | (2,874 | ) | ||||||||||||||||||||||
|
| |||||||||||||||||||||||
Net | $ | 9,498 | ||||||||||||||||||||||
|
|
The Company had an aggregate outstanding contractual balance of $12.4 million in subordinated debentures at September 30, 2014. These subordinated debentures were issued in three separate series. Each issuance had a maturity of 30 years from their approximate date of issue. All three subordinated debentures are variable rate instruments that reprice quarterly based on the three month LIBOR plus a margin (see tables above). All three subordinated debentures had their interest rates reset in September 2014 at the current three month LIBOR plus their spread, and will continue to reprice quarterly through their maturity date. All three subordinated debentures are currently callable at par with no prepayment penalties.
The Company currently includes in Tier 1 capital an amount of subordinated debentures equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity less goodwill, core deposit and leasehold right intangibles and a portion of the SBA servicing assets.
Interest payments made by the Company on subordinated debentures are considered dividend payments under FRB regulations. Notification to the FRB is required prior to the Company declaring and paying a dividend during any period in which the Company’s quarterly net earnings are insufficient to fund the dividend amount. This notification requirement is included in regulatory guidance regarding safety and soundness surrounding capital and includes other non-financial measures such as asset quality, financial condition, capital adequacy, liquidity, future earnings projections, capital planning and credit concentrations. Should the FRB object to the dividend payments, the Company would be precluded from paying interest on the subordinated debentures after giving notice within 15 days before the payment date. Payments would not commence until approval is received or the Company no longer needs to provide notice under applicable guidance. The Company has the right, assuming no default has occurred, to defer payments of interest on the subordinated debentures at any time for a period not to exceed 20 consecutive quarters. The Company has not deferred any interest payments.
Page 27 of 71
Table of Contents
Note 9 - Derivative Financial Instruments
At September 30, 2014, the Company has twenty three pay-fixed, receive-variable, interest rate contracts that are designed to convert fixed rate loans into variable rate loans. The Company acquired these interest rate swap contracts (“swaps”) on July 31, 2012 as a result of the merger with PC Bancorp.
Prior to the merger with PC Bancorp, the Company did not utilize interest rate swaps to manage its interest rate risk position. The Company has incorporated these instruments into its asset liability program when monitoring its interest rate risk position. All of the interest rate swap contracts are with the same counterparty bank. The total notional amount of the outstanding swap contracts as of September 30, 2014 is $31.1 million. The outstanding swaps have original maturities of up to 15 years.
Balance Sheet Classification of Derivative Financial Instruments
The following tables present the notional amount and the fair values of the asset and liability of the Company’s derivative instruments as of the dates and periods indicated (dollars in thousands):
Derivative Liabilities | ||||||||
September 30, 2014 | December 31, 2013 | |||||||
Interest rate contracts notional amount | $ | 31,057 | $ | 31,914 | ||||
Derivatives not designated as hedging instruments: | ||||||||
Interest rate swap contracts fair value | $ | 559 | $ | 738 | ||||
Derivatives designated as hedging instruments: | ||||||||
Interest rate swap contracts fair value | 2,543 | 3,205 | ||||||
|
|
|
| |||||
Total interest rate contracts fair value | $ | 3,102 | $ | 3,943 | ||||
|
|
|
| |||||
Balance sheet location | | Accrued Interest Payable and Other Liabilities | | | Accrued Interest Payable and Other Liabilities | |
Page 28 of 71
Table of Contents
The Effect of Derivative Instruments on the Consolidated Statements of Income
The following table summarizes the effect of derivative financial instruments on the consolidated statements of income for the periods indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||
Interest rate swap contracts – loans | ||||||||||||||||
Increase in fair value of interest rate swap contracts | $ | 86 | $ | 94 | $ | 179 | $ | 311 | ||||||||
Payments on interest rate swap contracts on loans | (69 | ) | (139 | ) | (205 | ) | (296 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net increase (decrease) in other non-interest income | 17 | (45 | ) | (26 | ) | 15 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Interest rate swap contracts – subordinated debenture | ||||||||||||||||
Increase in fair value of interest rate swap contracts | — | — | — | 70 | ||||||||||||
Payments on interest rate swap contracts on subordinated debentures | — | — | — | (70 | ) | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Net decrease in other non-interest income | — | — | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net increase (decrease) in other non-interest income | $ | 17 | $ | (45 | ) | $ | (26 | ) | $ | 15 | ||||||
|
|
|
|
|
|
|
| |||||||||
Derivatives designated as hedging instruments: | ||||||||||||||||
Interest rate swap contracts – loans | ||||||||||||||||
Increase in fair value of interest rate swap contracts | $ | 361 | $ | 156 | $ | 663 | $ | 1,352 | ||||||||
Increase (decrease) in fair value of hedged loans | (104 | ) | 136 | 135 | (454 | ) | ||||||||||
Payments on interest rate swap contracts on loans | (317 | ) | (328 | ) | (950 | ) | (961 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net decrease in interest income on loans | $ | (60 | ) | $ | (36 | ) | $ | (152 | ) | $ | (63 | ) | ||||
|
|
|
|
|
|
|
|
The interest rate swap contract associated with the subordinated debenture that was to mature in June 2013 was liquidated during the first quarter of 2013.
Under the interest rate swap contracts, the Company is required to pledge and maintain collateral for the credit support under these agreements. At September 30, 2014, the Company had $2.7 million in certificates of deposit and $1.8 million in non-interest bearing balances for a total of $4.5 million with the counterparty, Pacific Coast Bankers Bank. Of this amount, $3.4 million is required to be pledged as collateral under the interest rate swap contracts.
Page 29 of 71
Table of Contents
Note 10 – Balance Sheet Offsetting
Assets and liabilities relating to certain financial instruments, including derivatives, and securities sold under repurchase agreements (“Repos”), may be eligible for offset in the consolidated balance sheets as permitted under accounting guidance. The Company’s interest rate swap derivatives are subject to a master bilateral netting and offsetting arrangement under specific conditions as defined within a master agreement governing all interest rate swap contracts that the Company and the counterparty bank have entered into. In addition, the master agreement under which the interest rate contracts have been written require the pledging of assets by the Company based on certain risk thresholds. The Company has pledged as collateral, both a certificate of deposit and cash that is maintained in a due from bank account with the counterparty bank. The pledged collateral under the swap agreements are reported in the Company’s consolidated balance sheets, unless the Company defaults under the master agreement. The Company currently does not net or offset the interest rate swap contracts in its consolidated balance sheets, as reflected within the table below.
The Company’s securities sold under repurchase agreements represent transactions the Company has entered into with several individual deposit customers. These transactions represent the sale of securities on an overnight or on a term basis to our deposit customers under an agreement to repurchase the securities from the customers the next business day or at maturity. There is an individual contract for each customer with only one transaction per customer. There is no master agreement that provides for the netting arrangement or the offsetting of these individual transactions or for the netting of collateral positions. The Company does not net or offset the Repos in its consolidated balance sheets as reflected within the table below.
The table below presents the Company’s financial instruments that may be eligible for offsetting which include securities sold under agreements to repurchase that have no enforceable master netting arrangement and derivative securities that could be offset in the consolidated financial statements due to an enforceable master netting arrangement (dollars in thousands):
Gross Amounts Recognized in the Consolidated Balance Sheets | Gross Amounts Offset in the Consolidated Balance Sheets | Net Amounts of Assets Presented in the Consolidated Balance Sheets | Gross Amounts Not Offset in the Consolidated Balance Sheets | Net Amount (Collateral over liability balance required to be pledged) | ||||||||||||||||||||
Financial Instruments | Collateral Pledged | |||||||||||||||||||||||
September 30, 2014 | ||||||||||||||||||||||||
Financial Liabilities: | ||||||||||||||||||||||||
Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments) | $ | 3,102 | $ | — | $ | 3,102 | $ | 3,102 | $ | 3,379 | $ | 277 | ||||||||||||
Securities sold under agreements to repurchase (See Note 8 – Borrowings and Subordinated Debentures) | 13,618 | — | 13,618 | 13,618 | 14,136 | 518 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 16,720 | $ | — | $ | 16,720 | $ | 16,720 | $ | 17,515 | $ | 795 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
December 31, 2013 | ||||||||||||||||||||||||
Financial Liabilities: | ||||||||||||||||||||||||
Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments) | $ | 3,943 | $ | — | $ | 3,943 | $ | 3,943 | $ | 4,194 | $ | 251 | ||||||||||||
Securities sold under agreements to repurchase (See Note 8 – Borrowings and Subordinated Debentures) | 11,141 | — | 11,141 | 11,141 | 11,750 | 609 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 15,084 | $ | — | $ | 15,084 | $ | 15,084 | $ | 15,944 | $ | 860 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Page 30 of 71
Table of Contents
Note 11 - Stock Options and Restricted Stock
Equity Compensation Plans
The Company’s 2007 Equity and Incentive Plan, the (“Equity Plan”) was adopted by the Company in 2007 and replaced two prior equity compensation plans. The Equity Plan provides for significant flexibility in determining the types and terms of awards that may be granted to participants that include stock options, restricted stock, restricted stock award units and performance units. The Equity Plan was revised and approved by the Company’s shareholders in 2011 and adopted by the Company as part of the Bank holding company reorganization. The Equity Plan is designed to promote the interests of the Company to attract and retain employees, officers and non-employee directors who are expected to contribute to the future success of the organization. The Equity Plan is intended to provide participants with incentives to maximize their efforts on behalf of the Company through stock-based awards that provide an opportunity for stock ownership. Certain options and share awards provide for accelerated vesting, if there is a change in control, as defined in the Equity Plan. The Equity Plan is described more fully in Note 16—Stock Options and Restricted Stock in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
At September 30, 2014, future compensation expense related to unvested stock option and unvested restricted stock grants are reflected in the table below (dollars in thousands):
Future Stock Based Compensation Expense | Stock Options | Restricted Stock | Total | |||||||||
Remainder of 2014 | $ | 1 | $ | 321 | $ | 322 | ||||||
2015 | 2 | 756 | 758 | |||||||||
2016 | — | 210 | 210 | |||||||||
2017 | — | 30 | 30 | |||||||||
2018 | — | 7 | 7 | |||||||||
Thereafter | — | — | — | |||||||||
|
|
|
|
|
| |||||||
Total | $ | 3 | $ | 1,324 | $ | 1,327 | ||||||
|
|
|
|
|
|
The estimated fair value of both incentive stock options and non-qualified stock options granted in prior years, have been calculated using the Black-Scholes option pricing model. The use of the Black-Scholes model and the variables and assumptions are described in Note 16 - Stock Options and Restricted Stock in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
Stock Options
There have been no stock options granted by the Company after 2010.
The following table summarizes the share option activity under the plans as of the date and for the period indicated:
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value (in thousands) | |||||||||||||
Outstanding stock options at December 31, 2013 | 434,740 | $ | 13.89 | 2.1 | $ | 1,913 | ||||||||||
Granted | — | — | ||||||||||||||
Exercised | 130,744 | 9.77 | ||||||||||||||
Forfeited | — | — | ||||||||||||||
Expired | — | — | ||||||||||||||
|
| |||||||||||||||
Outstanding stock options at September 30, 2014 | 303,996 | $ | 15.66 | 1.7 | $ | 1,192 | ||||||||||
|
| |||||||||||||||
Exercisable options at September 30, 2014 | 294,796 | $ | 15.76 | 1.7 | $ | 1,132 | ||||||||||
Unvested options at September 30, 2014 | 9,200 | $ | 12.30 | 2.1 | $ | 60 | ||||||||||
|
|
|
| |||||||||||||
Outstanding, vested and expected to vest at September 30, 2014 | 303,996 | $ | 15.66 | 1.7 | $ | 1,192 | ||||||||||
|
|
|
|
Page 31 of 71
Table of Contents
The Company recorded stock option compensation expense of $2,000 and $5,000 for the three month period ended September 30, 2014 and 2013, and $8,000 and $17,000 for the nine month period ended September 30, 2014 and 2013, respectively.
At December 31, 2013, there was one executive officer of the Company that had a remaining balance of 88,344 shares that were exercisable under Rule 10b5-1(c) (1) “10b5 Plan” under the Securities Exchange Act of 1934, as amended. This plan had been adopted by the executive officer in the fourth quarter of 2013. During the first quarter of 2014, all 88,344 options that remained outstanding were exercised and sold. In addition, there were an additional 42,400 options exercised by employees in the first nine months of 2014.
The total intrinsic value of options exercised during the nine months ended September 30, 2014 was $1,081,000.
Restricted Stock
The weighted-average grant-date fair value per share in the table below is calculated by taking the total aggregate cost of the restricted shares issued divided by the number of shares of restricted stock issued. The aggregate cost of the restricted stock was calculated by multiplying the number of shares granted at each of the grant dates by the closing stock price of the Company’s common stock on the date of the grant. The following table summarizes the restricted stock activity under the Equity Plan for the period indicated:
Number of Shares | Weighted-Average Grant-Date Fair Value per Share | |||||||
Restricted Stock: | ||||||||
Unvested at December 31, 2013 | 266,050 | $ | 13.49 | |||||
Granted | 46,900 | 18.19 | ||||||
Vested | (106,803 | ) | 13.19 | |||||
Cancelled and forfeited | (500 | ) | 11.75 | |||||
|
| |||||||
Unvested at September 30, 2014 | 205,647 | $ | 14.72 | |||||
|
|
Restricted stock compensation expense related to the restricted stock grants reflected in the table above was $443,000 and $236,000 for the three month period ended September 30, 2014 and 2013, and $1,324,000 and $699,000 for the nine month period ended September 30, 2014 and 2013, respectively. Restricted stock awards reflected in the table above are valued at the closing stock price on the date of grant and are expensed to stock based compensation expense over the period for which the related service is performed.
Note 12 - Common Stock
During the first nine months of 2014, the Company’s outstanding common stock increased by 150,437 shares to 11,231,801 at September 30, 2014. The components of this increase are as follows: The Company issued 130,744 shares of stock from the exercise of employee stock options for a total value of $1.3 million. The Company issued 46,900 shares of restricted stock to the Company’s employees, cancelled 500 shares of unvested restricted stock related to employee turnover and repurchased 26,207 shares of restricted stock that had a value of $246,000 related to employees electing to pay their tax obligation via the repurchase of the stock by the Company. The net issuance of restricted stock for 2014 was 20,193 shares. See Note 11 – Stock Options and Restricted Stock for additional detail related to the issuances of these shares.
During the first nine months of 2013, the Company issued 48,711 shares of stock from the exercise of employee stock options for a total value of $484,000. The Company issued 73,050 shares of restricted stock to the Company’s directors and employees, cancelled 10,600 shares of unvested restricted stock related to employee turnover and repurchased 29,863 shares of restricted stock that had a value of $422,000, when employees elected to pay their tax obligation via the repurchase of the stock by the Company. The net issuance of restricted stock for 2013 was 81,298 shares.
Page 32 of 71
Table of Contents
Note 13 - Other Comprehensive Income (Loss)
The following table presents the changes in accumulated other comprehensive income (loss) by component for the periods indicated (dollars in thousands):
Before Tax | Tax Effect | Net of Tax | ||||||||||
Three Months Ended – September 30, 2014 | ||||||||||||
Net unrealized gains (losses) on investment securities: | ||||||||||||
Beginning balance | $ | 331 | $ | 136 | $ | 195 | ||||||
|
|
|
|
|
| |||||||
Net unrealized gains arising during the period | 19 | 11 | 8 | |||||||||
Reclassification adjustment for gains realized in net income | — | — | — | |||||||||
|
|
|
|
|
| |||||||
Net other comprehensive income | 19 | 11 | 8 | |||||||||
|
|
|
|
|
| |||||||
Ending balance | $ | 350 | $ | 147 | $ | 203 | ||||||
|
|
|
|
|
|
Before Tax | Tax Effect | Net of Tax | ||||||||||
Three Months Ended – September 30, 2013 | ||||||||||||
Net unrealized gains on investment securities: | ||||||||||||
Beginning balance | $ | 996 | $ | 410 | $ | 586 | ||||||
|
|
|
|
|
| |||||||
Non-credit portion of other-than-temporary impairments arising during the period | — | — | — | |||||||||
Net unrealized losses arising during the period | (905 | ) | (372 | ) | (533 | ) | ||||||
|
|
|
|
|
| |||||||
Net other comprehensive loss | (905 | ) | (372 | ) | (533 | ) | ||||||
|
|
|
|
|
| |||||||
Ending balance | $ | 91 | $ | 38 | $ | 53 | ||||||
|
|
|
|
|
|
Before Tax | Tax Effect | Net of Tax | ||||||||||
Nine Months Ended – September 30, 2014 | ||||||||||||
Net unrealized gains (losses) on investment securities: | ||||||||||||
Beginning balance | $ | (348 | ) | $ | (143 | ) | $ | (205 | ) | |||
|
|
|
|
|
| |||||||
Net unrealized gains arising during the period | 698 | 290 | 408 | |||||||||
Reclassification adjustment for gains realized in net income | — | — | — | |||||||||
|
|
|
|
|
| |||||||
Net other comprehensive income | 698 | 290 | 408 | |||||||||
|
|
|
|
|
| |||||||
Ending balance | $ | 350 | $ | 147 | $ | 203 | ||||||
|
|
|
|
|
|
Before Tax | Tax Effect | Net of Tax | ||||||||||
Nine Months Ended – September 30, 2013 | ||||||||||||
Net unrealized gains on investment securities: | ||||||||||||
Beginning balance | $ | 2,369 | $ | 975 | $ | 1,394 | ||||||
|
|
|
|
|
| |||||||
Non-credit portion of other-than-temporary impairments arising during the period | (32 | ) | (13 | ) | (19 | ) | ||||||
Net unrealized losses arising during the period | (2,241 | ) | (922 | ) | (1,319 | ) | ||||||
|
|
|
|
|
| |||||||
Other comprehensive loss before reclassifications | (2,273 | ) | (935 | ) | (1,338 | ) | ||||||
Reclassification adjustment for gains realized in net income | (5 | ) | (2 | ) | (3 | ) | ||||||
|
|
|
|
|
| |||||||
Net other comprehensive loss | (2,278 | ) | (937 | ) | (1,341 | ) | ||||||
|
|
|
|
|
| |||||||
Ending balance | $ | 91 | $ | 38 | $ | 53 | ||||||
|
|
|
|
|
|
Page 33 of 71
Table of Contents
Note 14 - Commitments and Contingencies
Litigation
From time to time the Company is a party to claims and legal proceedings arising in the ordinary course of business. The Company accrues for any probable loss contingencies that are estimable and discloses any material losses. As of September 30, 2014, there were no legal proceedings against the Company the outcome of which are expected to have a material adverse impact on the Company’s financial position, results of operations or cash flows, as a whole.
Financial Instruments with Off Balance Sheet Risk
See Note 22 – Commitments and Contingencies in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Financial instruments with off balance sheet risk include commitments to extend credit of $419.1 million and $345.9 million at September 30, 2014 and December 31, 2013, respectively. Included in the aforementioned commitments were standby letters of credit outstanding of $43.3 million and $40.6 million at September 30, 2014 and December 31, 2013, respectively.
Note 15 - Fair Value of Assets and Liabilities
Fair Value Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The required disclosure within the financial statements of the fair value of financial assets and financial liabilities includes both those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis and those reported on a non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value, and for estimating the fair value of financial assets and financial liabilities not recorded at fair value, are discussed below.
In accordance with accounting guidance, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are as follows:
• | Level 1 – Observable unadjusted quoted market prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date. |
• | Level 2 – Significant other observable market based inputs, other than Level 1 prices such as quoted prices for similar assets or liabilities or unobservable inputs that are corroborated by market data. This includes quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, either directly or indirectly. This would include those financial instruments that are valued using models or other valuation methodologies where substantially all of the assumptions are observable in the marketplace, can be derived from observable market data or are supported by observable levels at which transactions are executed in the marketplace. |
• | Level 3 – Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. Assets measured utilizing level 3 are for positions that are not traded in active markets or are subject to transfer restrictions, and or where valuations are adjusted to reflect illiquidity and or non-transferability. These assumptions are not corroborated by market data. This is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable from objective sources. Management uses a combination of reviews of the underlying financial statements, appraisals and management’s judgment regarding credit quality to determine the value of the financial asset or liability. |
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management maximizes the use of observable inputs and attempts to minimize the use of unobservable inputs when determining fair value measurements. The following is a description of both the general and specific valuation methodologies used for certain instruments measured at fair value, as well as the general classification of these instruments pursuant to the valuation hierarchy.
Page 34 of 71
Table of Contents
Investment Securities Available-for-Sale: The fair value of securities available-for-sale may be determined by obtaining quoted prices in active markets, when available, from nationally recognized securities exchanges (Level 1 financial assets) If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique widely used in the securities industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities which are observable market inputs (Level 2 financial assets). Debt securities’ pricing is generally obtained from one of the matrix pricing models developed from one of the three national pricing agencies. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are classified as Level 3 financial assets.
Securities classified as available-for-sale are accounted for at their current fair value rather than amortized historical cost. Unrealized gains or losses are excluded from net income and reported as an amount net of taxes as a separate component of accumulated other comprehensive income included in shareholders’ equity.
The Company considers the inputs utilized to fair value the U.S. Agency and U.S. Sponsored Agency issued debt securities (callable and non-callable notes), mortgage backed securities guaranteed by those agencies, collateralized mortgage obligations issued by those agencies, corporate bond securities, and municipal securities to be observable market inputs and classified these financial assets within the Level 2 fair value hierarchy. Management bases the fair value for these investments primarily on third party price indications provided by independent pricing sources utilized by the Company’s bond accounting system to obtain market pricing on its individual securities. Vining Sparks, who provides the Company with its bond accounting system, utilizes pricing from three independent third party pricing sources for pricing of securities. These third party pricing sources utilize, quoted market prices or when quoted market prices are not available, and then fair values are estimated using nationally recognized third-party vendor pricing models of which the inputs are observable. However, the fair value reported may not be indicative of the amounts that could be realized in an actual market exchange.
The fair value of the Company’s U.S. Agency and U.S. Sponsored Agency callable and non-callable agency securities, mortgage backed securities guaranteed by those agencies, and collateralized mortgage obligations issued by those agencies, corporate bond securities, and municipal securities are calculated using an option adjusted spread model from one of the nationally recognized third-party pricing models. Depending on the assumptions used and the treasury yield curve and other interest rate assumptions, the fair value could vary significantly in the near term.
Loans: The fair value for loans is estimated by discounting the expected future cash flows using current interest rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities, adjusted for the allowance for loan loss. Loans are segregated by type such as commercial and industrial, commercial real estate, construction and other loans with similar credit characteristics and are further segmented into fixed and variable interest rate loan categories. Expected future cash flows are projected based on contractual cash flows, adjusted for estimated prepayments. The inputs utilized in determining the fair value of loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.
Impaired Loans: The fair value of impaired loans is determined based on an evaluation at the time the loan is originally identified as impaired, and periodically thereafter, at the lower of cost or fair value. Fair value on impaired loans is measured based on the value of the collateral securing these loans, less costs to sell, if the loan is collateral dependent, or based on the discounted cash flows for non-collateral dependent loans. Collateral on collateral dependent loans may be real estate and/or business assets including equipment, inventory and/or accounts receivable and is determined based on appraisals performed by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and unobservable. For unsecured loans, the estimated future discounted cash flows of the business or borrower, are used in evaluating the fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The inputs utilized in determining the fair value of impaired loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.
Interest Rate Swap Contracts: The fair value of the interest rate swap contracts are provided by an independent third party vendor that specializes in interest rate risk management and fair value analysis using a model that utilizes current market data to estimate cash flows of the interest rate swaps utilizing the future London Interbank Offered Rate (“LIBOR”) yield curve for accruing and the future Overnight Index Swap Rate (“OIS”) yield curve for discounting through the maturity date of the interest rate swap contract. The future LIBOR yield curve is the primary input in the valuation of the interest rate swap contracts. Both the LIBOR and OIS yield curves are readily observable in the marketplace. Accordingly, the interest rate swap contracts are classified within Level 2 of the fair value hierarchy.
Page 35 of 71
Table of Contents
Other Real Estate Owned: The fair value of other real estate owned is generally based on real estate appraisals (unless more current market information is available) less estimated costs of sale. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant. The inputs utilized in determining the fair value of other real estate owned are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.
SBA Servicing Asset: The Company acquired an SBA servicing asset with the PC Bancorp merger and has added to the servicing asset with the sale of SBA loans subsequent to the merger. This servicing asset was initially fair valued at the merger date based on an evaluation by a third party who specializes in fair value analysis. The fair value of this asset was based on the estimated discounted future cash flows utilizing market based discount rates and estimated prepayment speeds. The discount rate was based on the current U.S. Treasury yield curve, plus a spread for marketplace risk associated with these assets. Prepayment speeds were selected based on the historical prepayments of similar SBA pools. The prepayment speeds determine the timing of the cash flows. The SBA servicing asset is amortized over the estimated life of the loans based on an effective yield approach. In addition, the Company’s servicing asset is evaluated regularly for impairment by discounting the estimated future cash flows using market-based discount rates and prepayment speeds. If the calculated present value of the servicing asset declines below the Company’s current carrying value, the servicing asset is written down to its present value. Based on the Company’s methodology in its valuation of the SBA servicing asset, the current carrying value is estimated to approximate the fair value. The inputs utilized in determining the fair value of SBA servicing asset are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.
Non-Maturing Deposits: The fair values for non-maturing deposits (deposits with no contractual termination date), which include non-interest bearing demand deposits, interest bearing transaction accounts, money market deposits and savings accounts are equal to their carrying amounts, which represent the amounts payable on demand. Because the carrying value and fair value are by definition identical, and accordingly non-maturity deposits are classified within Level 1 of the fair value hierarchy, these balances are not listed in the following tables.
Maturing Deposits: The fair values of fixed maturity certificates of deposit (time deposits) ) “CD’s” are estimated using a discounted cash flow calculation that applies current market deposit interest rates to the Company’s current certificates of deposit interest rates for similar term certificates. The inputs utilized in determining the fair value of maturing deposits are observable from published and quoted CD rates marketed by other financial institutions and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.
Securities Sold under Agreements to Repurchase (“Repos”): The fair value of securities sold under agreements to repurchase is estimated based on the discounted value of future cash flows expected to be paid on the deposits. The carrying amounts of Repos with maturities of 90 days or less approximate their fair values. The fair value of Repos with maturities greater than 90 days is estimated based on the discounted value of the contractual future cash flows. The inputs utilized in determining the fair value of securities sold under agreements to repurchase are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.
Subordinated Debentures: The fair value of the three variable rate subordinated debentures (“debentures”) is estimated using a discounted cash flow calculation that applies the three month LIBOR plus the margin index at September 30, 2014, to the cash flows from the debentures, based on the actual interest rate the debentures were accruing at September 30, 2014. Because all three of the debentures re-priced during September 2014 based on the current three month LIBOR index rate plus the index margin at that date, and with relatively little to no change in the three month LIBOR index rate from the re-pricing date through September 30, 2014, the current face value of the debentures and their calculated fair value are approximately equal. The inputs utilized in determining the fair value of subordinated debentures are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.
Fair Value of Commitments: Loan commitments that are priced on an index plus a margin to a market rate of interest are reported at the carrying value of the loan commitment. Loan commitments on which the committed fixed interest rate is less or more than the current market rate were insignificant at September 30, 2014 and December 31, 2013.
Interest Rate Risk: The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match
Page 36 of 71
Table of Contents
maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. In addition, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall rate risk.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table summarizes the financial assets and financial liabilities measured at fair value on a recurring basis as of the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):
Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Financial Assets – September 30, 2014 | ||||||||||||||||
Investment securities available-for-sale | $ | 139,552 | $ | — | $ | 139,552 | $ | — | ||||||||
Financial Liabilities – September 30, 2014 | ||||||||||||||||
Interest Rate Swap Contracts | $ | 3,102 | $ | — | $ | 3,102 | $ | — | ||||||||
Financial Assets – December 31, 2013 | ||||||||||||||||
Investment securities available-for-sale | $ | 106,488 | $ | — | $ | 106,488 | $ | — | ||||||||
Financial Liabilities – December 31, 2013 | ||||||||||||||||
Interest Rate Swap Contracts | $ | 3,943 | $ | — | $ | 3,943 | $ | — |
Page 37 of 71
Table of Contents
At September 30, 2014 and at December 31, 2013 the Company had no financial assets or liabilities that were measured at fair value on a recurring basis that required the use of significant unobservable inputs (Level 3), and thus a table has not been provided for the nine months ended September 30, 2014. The following table presents a roll forward of all assets and liabilities and additional information about the financial assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the date and period indicated (dollars in thousands):
Financial Assets – Measured at Fair Value on a Recurring Basis using Unobservable Inputs | Balance at January 1 | Included in Earnings | Included in Other Comprehensive Income (Loss) | Purchases, Issuances, Sales, Settlements | Transfers into (out of) Level 3 | Balance at September 30 | ||||||||||||||||||
Period ended September 30, 2013 | ||||||||||||||||||||||||
Private Issue CMO Securities | $ | 2,910 | $ | (20 | ) | $ | — | $ | (2,890 | ) | $ | — | $ | — | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 2,910 | $ | (20 | ) | $ | — | $ | (2,890 | ) | $ | — | $ | — | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
There were no transfers of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a recurring basis for the period ended September 30, 2014 and 2013. The above table reflects the sale of the Company’s Private Issue CMO securities during the first quarter of 2013.
Assets Measured at Fair Value on a Non-recurring Basis
The Company may be required periodically, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of or during the period.
One loan transferred to other real estate owned “OREO” during the second quarter of 2014 and was sold in the third quarter of 2014. There were no other reclassifications of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a non-recurring basis for the nine months ended September 30, 2014 and 2013.
The following table presents the balances of assets and liabilities measured at fair value on a non-recurring basis by caption and by level within the fair value hierarchy as of the dates indicated (dollars in thousands):
Recorded Investment Carrying Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Financial Assets – September 30, 2014 | ||||||||||||||||
Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs (non-purchased credit impaired loans) | $ | 1,152 | $ | — | $ | — | $ | 1,152 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 1,152 | $ | — | $ | — | $ | 1,152 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Financial Assets – December 31, 2013 | ||||||||||||||||
Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs (non-purchased credit impaired loans) | $ | 264 | $ | — | $ | — | $ | 264 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total | $ | 264 | $ | — | $ | — | $ | 264 | ||||||||
|
|
|
|
|
|
|
|
Page 38 of 71
Table of Contents
The following table presents the significant unobservable inputs used in the fair value measurements for Level 3 assets and liabilities measured at fair value on a non-recurring basis as of the dates indicated (dollars in thousands):
Fair Value | Valuation Methodology | Valuation Model and/or Factors | Unobservable Input Values | |||||||
Financial Assets – September 30, 2014 |
| |||||||||
Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off | $ | 1,152 | Credit loss estimate of aged accounts receivable collateral | Credit loss factors on aging of accounts receivable collateral | 25%-75% | |||||
Estimated selling costs | 15% | |||||||||
|
| |||||||||
Total | $ | 1,152 | ||||||||
|
| |||||||||
Financial Assets – December 31, 2013 |
| |||||||||
Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off (1) | $ | 45 | Credit loss estimate of aged accounts receivable collateral | Credit loss factors on aging of accounts receivable collateral | 80% | |||||
219 | Commercial real estate appraisal | Sales approach (2) | ||||||||
Estimated selling costs | 8% | |||||||||
|
| |||||||||
Total | $ | 264 | ||||||||
|
|
(1) | The Company has recorded total charge-offs of $605,000 on the principal balance on two of the loans included in the balance in the above table. These charge-offs were recorded in 2013. |
(2) | For the one commercial real estate loan included in the above table at December 31, 2013, the Company established the fair value of the loan based on a recent commercial real estate appraisal. The Company selected the “sales approach” for valuing the collateral. |
Page 39 of 71
Table of Contents
Fair Value of Financial Assets and Liabilities
The required disclosure within the financial statements of the fair value of financial assets and financial liabilities, include both those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis and those reported on a non-recurring basis. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could have realized in a current market exchange as of September 30, 2014 and December 31, 2013. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The description of the valuation methodologies used for assets and liabilities measured at fair value and for estimating fair value for financial instruments not recorded at fair value has been described above.
The table below presents the carrying amounts and fair values of financial instruments based on their fair value hierarchy indicated (dollars in thousands):
Fair Value | ||||||||||||||||
Recorded Investment Carrying Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
September 30, 2014 | ||||||||||||||||
Financial Assets | ||||||||||||||||
Investment securities available-for-sale | $ | 139,552 | $ | — | $ | 139,552 | $ | — | ||||||||
Loans, net | 967,452 | — | — | 970,362 | ||||||||||||
Financial Liabilities | ||||||||||||||||
Certificates of deposit | 52,852 | — | 52,880 | — | ||||||||||||
Securities sold under agreements to repurchase | 13,618 | — | 13,618 | — | ||||||||||||
Subordinated debentures | 9,498 | — | 12,372 | — | ||||||||||||
Interest rate swap contracts | 3,102 | — | 3,102 | — | ||||||||||||
December 31, 2013 | ||||||||||||||||
Financial Assets | ||||||||||||||||
Investment securities available-for-sale | $ | 106,488 | $ | — | $ | 106,488 | $ | — | ||||||||
Loans, net | 922,591 | — | — | 926,500 | ||||||||||||
Financial Liabilities | ||||||||||||||||
Certificates of deposit | 63,581 | — | 63,680 | — | ||||||||||||
Securities sold under agreements to repurchase | 11,141 | — | 11,141 | — | ||||||||||||
Subordinated debentures | 9,379 | — | 12,372 | — | ||||||||||||
Interest rate swap contracts | 3,943 | — | 3,943 | — |
Page 40 of 71
Table of Contents
ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
See “Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” below relating to “forward-looking” statements included in this report.
The following is management’s discussion and analysis of the major factors that influenced the results of the operations and financial condition of CU Bancorp, the (“Company”) for the current period. This analysis should be read in conjunction with the audited financial statements and accompanying notes included in the Company’s 2013 Annual Report on Form 10K and with the unaudited financial statements and notes as set forth in this report.
CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
We have made forward-looking statements in this document about the Company, for which the Company claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995.
The Company’s forward-looking statements include descriptions of plans or objectives of management for future operations, products or services, and forecasts of its revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words “believe,” “expect,” “intend,” “estimate” “anticipates,” “project”, “assume”, “plan”, “predict” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”
We make forward-looking statements as set forth above and regarding projected sources of funds, availability of acquisition and growth opportunities, dividends, adequacy of our allowance for loan losses and provision for loan losses, our loan portfolio and subsequent charge-offs. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the SEC, Item 1A of our Annual Report on Form 10-K, and the following:
• | Current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth. |
• | Loss of customer checking and money-market account deposits as customers pursue other, higher-yield investments. |
• | Possible changes in business and consumer spending and saving habits and the related effect on our ability to increase assets and to attract deposits. |
• | Competitive market pricing factors. |
• | Deterioration in economic conditions that could result in increased loan losses. |
• | Risks associated with concentrations in real estate related loans. |
• | Risks associated with concentrations in deposits. |
• | Market interest rate volatility. |
• | Possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans. |
• | Changes in the speed of loan prepayments, loan origination and sale volumes, loan loss provisions, charge offs or actual loan losses. |
• | Compression of our net interest margin. |
• | Stability of funding sources and continued availability of borrowings. |
• | Changes in legal or regulatory requirements or the results of regulatory examinations that could restrict growth. |
• | The inability of our internal disclosure controls and procedures to prevent or detect all errors or fraudulent acts. |
• | Inability of our framework to manage risks associated with our business, including operational risk and credit risk, to mitigate all risk or loss to us. |
• | Our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft. |
• | The effects of man-made and natural disasters, including earthquakes, floods, droughts, brush fires, tornadoes and hurricanes. |
• | Our ability to recruit and retain key management and staff. |
Page 41 of 71
Table of Contents
• | Availability of and competition for acquisition opportunities. |
• | Risks associated with merger and acquisition integration. |
• | Significant decline in the market value of the Company that could result in an impairment of goodwill. |
• | Regulatory limits on the Bank’s ability to pay dividends to the Company. |
• | New accounting pronouncements. |
• | The impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and related rules and regulations on the Company’s business operations and competitiveness. |
• | Our ability to comply with applicable capital and liquidity requirements (including the finalized Basel III capital standards), including our ability to generate capital internally or raise capital on favorable terms. |
• | The effects of any damage to our reputation resulting from developments related to any of the items identified above. |
Merger
On June 3, 2014, the Company announced it had entered into the Agreement and Plan of Merger, dated June 2, 2014, (the “merger agreement”) by and among CU Bancorp, the (“Company”), California United Bank, the (“Bank”) and 1st Enterprise Bank (“1st Enterprise”). In connection with the execution of that merger agreement, the Company has supplemented the risk factors previously disclosed in the Company’s most recent annual report on Form 10-K as follows:
We may fail to realize all of the anticipated benefits of the merger if the combined company does not achieve certain cost savings and other benefits or if the Bank and 1st Enterprise do not successfully integrate.
The Company’s belief that the cost savings and revenue enhancements are achievable is a forward-looking statement that is inherently uncertain. The combined company’s actual cost savings and revenue enhancements, if any, cannot be quantified at this time. Actual cost savings and revenue enhancements will depend on future expense levels and operating levels, the timing of certain events and general industry, regulatory and business conditions. Many of these events will be beyond the control of the combined company.
Further, if the Company is unable to successfully integrate the businesses of the Bank and 1st Enterprise, operating results may suffer. The Bank and 1st Enterprise have operated and, until completion of the merger, will continue to operate independently of one another. It is possible that the integration process could result in the loss of key employees, disruption of their ongoing businesses, or inconsistencies in standards, controls, policies or procedures. These could negatively affect both the Bank’s and 1st Enterprise’s ability to maintain relationships with customers and employees, or achieve the anticipated benefits of the merger. As with any completed merger of financial institutions, there may also be disruptions that cause customers, both deposit and loan, to take their business to competitors.
The Company will be subject to business uncertainties while the merger is pending that could adversely affect its business.
The parties’ efforts to complete the merger could cause substantial disruptions in the Company’s business, which could have an adverse effect on its financial results. Among other things, uncertainty as to whether the merger will be completed may affect the ability of each of the parties to recruit prospective employees or to retain and motivate existing employees. Employee retention may be particularly challenging while the merger is pending because employees may experience uncertainty about their future roles with the combined Company.
Uncertainty as to the future could adversely affect the Company’s business, reputation and relationships with potential depositors, borrowers and vendors. For example, vendors, customers and others who deal with the Company could defer decisions concerning working with the Company, or seek to change existing business relationships with the Company. Further, a substantial amount of the attention and management and employees of the Company is being directed toward the completion of the merger and thus is being diverted from the Company’s day-to-day operations because matters related to the merger, (including integration planning) require substantial commitments of time and resources.
In addition the merger agreement restricts the Company from taking certain actions without 1st Enterprises’ consent while the merger is pending. These restrictions may, among other matters, prevent the Company from pursuing otherwise attractive business opportunities, selling assets, changing the capital structure, entering into other transactions or making other changes to our business prior to consummation of the merger or termination of the merger agreement. These restrictions could have a material adverse effect on the Company’s business, financial condition and results of operations.
Page 42 of 71
Table of Contents
The Company will incur significant transaction and merger-related integration costs in connection with the merger.
The Company expects to incur significant costs associated with completing the merger and integrating the operations of the Bank and 1st Enterprise. Although the Company believes that the elimination of duplicate costs and the realization of other efficiencies related to the integration of the businesses of the Bank and 1st Enterprise will offset incremental transition and merger-related costs over time, this net benefit may not be achieved in the near term, or at all.
Company shareholders will experience significant dilution as a result of the merger.
In connection with the merger, 1st Enterprise shareholders will receive 1.3450 shares of Company common stock in exchange for each share of 1st Enterprise common stock (except with respect to fractional shares) pursuant to the terms of the merger agreement. As a consequence, the shareholders of the Company will experience significant dilution in their ownership percentage and voting power in the Company following the merger. If the merger is consummated and based upon the exchange ratio of 1.3450, current 1st Enterprise common stock shareholders will own approximately 31.5% of the Company’s common stock, on a fully diluted basis. Accordingly, while the Company’s shareholders will still own a majority of the outstanding voting stock of the combined company after the merger, their interests will be diluted and would significantly reduce their ability to out vote current 1st Enterprise shareholders if such current 1st Enterprise shareholders voted together as a group.
The market price of Company common stock after the merger may be affected by factors different from those currently affecting the market price of 1st Enterprise common stock and Company common stock.
Upon completion of the merger, holders of 1st Enterprise common stock will become holders of Company common stock, and the Treasury, as the sole holder of the 1st Enterprise preferred stock, will become a holder of Company preferred stock. The Company’s business differs from that of 1st Enterprise and, accordingly, the results of operations of the combined company and the market price of Company common stock after the completion of the merger may be affected by factors different from those currently affecting the independent results of operations of each of the Company and 1st Enterprise.
The merger will not be completed unless important conditions are satisfied.
Specified conditions set forth in the merger agreement must be satisfied or waived to complete the merger. If the conditions are not satisfied or waived, to the extent permitted by law or NASDAQ rules, the merger will not occur or will be delayed, and the Company may lose some or all of the intended benefits of the merger. The following conditions must be satisfied or, with respect to conditions other than shareholder and regulatory approval, waived, if permissible, before the Company, the Bank, and 1st Enterprise are obligated to complete the merger:
• | the merger agreement must be approved by the affirmative vote of at least a majority of the shares of Company common stock outstanding as of the record date for the Company annual meeting; |
• | the merger agreement must be approved by the affirmative vote of at least a majority of the shares of 1st Enterprise common stock and by the affirmative vote of at least a majority of the shares of 1st Enterprise preferred stock outstanding as of the record date for the 1st Enterprise annual meeting; |
• | all required regulatory approvals and consents must be obtained, including approvals and/or non-objections from the FRB, the FDIC and the California Department of Business Oversight, (the “DBO”); as of September 30, 2014, all such approvals and/or non-objections have been received. |
• | the absence of any law or order by a court or regulatory authority that would prohibit, restrict or make illegal the merger; |
• | the number of shares of 1st Enterprise common stock for which dissenters’ rights have been properly asserted shall not be more than 5% of the total issued and outstanding shares of 1st Enterprise common stock; and |
• | the Treasury, as the holder of the 1st Enterprise preferred stock, does not exercise dissenters’ rights with respect to any shares of the 1st Enterprise preferred stock it holds. |
Page 43 of 71
Table of Contents
Failure to complete the merger could negatively impact the Company’s and the Bank’s business, financial condition, results of operations and / or stock price.
If the merger agreement is terminated and the merger is not completed, the ongoing businesses of the Company and the Bank may be adversely affected. For example:
• | the risk that the pursuit of the merger could lead to the Company’s failure to pursue other beneficial opportunities due to the focus of the Company’s management on completing the merger; |
• | pursuant to the merger agreement, the Company and the Bank are subject to certain restrictions on the conduct of their business prior to completing the merger, which restrictions could adversely affect their ability to realize certain of their business strategies; |
• | the market price of the Company’s common stock may decline to the extent that the current market price reflects a market assumption that the merger will be completed; |
• | the Company and the Bank may experience negative reactions to the termination of the merger from customers, depositors, investors, vendors and others who deal with the Company and the Bank; |
• | the Company would not realize any of the anticipated benefits of having completed the merger; |
• | the Company may be required to pay a termination fee of $1.0 million to 1st Enterprise and to reimburse 1st Enterprise for its merger-related expenses (up to $1.0 million) if the merger agreement is terminated under certain circumstances; and |
• | the expenses of the Company incurred in connection with the merger, such as legal and accounting fees, must be paid even if the merger is not completed and may not, except in certain circumstances, be recovered from the other party. |
In addition, any delay in the consummation of the merger, or any uncertainty about the consummation of the merger, may adversely affect the Company’s and the Bank’s future business, growth, revenue and results of operations.
The consideration to be paid in the merger is fixed and will not be adjusted for changes in the Company’s or 1st Enterprises’ business, assets, liabilities, prospects, outlook, financial condition or results of operations, or in the event of any change in the Company’s or 1st Enterprise’s stock price.
The merger consideration is fixed in the merger agreement and will not be adjusted for changes in the Company’s or 1st Enterprise’s business, assets, liabilities, prospects, outlook financial condition or results of operations, or changes in the market price of, analyst estimates of, or projections relating to, the Company’s common stock or 1st Enterprises’ common stock. For example, if the Company experienced an improvement in its business, assets, liabilities, prospects, outlook, financial condition or results of operations prior to the consummation of the merger, there would be no adjustment to the amount of the merger consideration.
Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.
For a more complete discussion of these risks and uncertainties, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and particularly, Item 1A, titled “Risk Factors.”
Page 44 of 71
Table of Contents
CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company”, as used throughout this document, refers to the consolidated balance sheets and consolidated statements of income of CU Bancorp and California United Bank.
California United Bank (the “Bank”) is a full-service commercial business bank offering a broad range of banking products and services including: deposit services, lending and cash management to small and medium-sized businesses in Los Angeles, Orange and Ventura counties, to non-profit organizations, to business principals and entrepreneurs, to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors. The Bank opened for business in 2005, with its headquarters office located in Encino, California. As a state chartered non-member bank, the Bank is subject to regulation by the California Department of Business Oversight, (the “DBO”) and the Federal Deposit Insurance Corporation (“FDIC”). The deposits of the Bank are insured by the FDIC, to the maximum amount allowed by law.
On June 3, 2014, CU Bancorp and 1st Enterprise Bank (“1st Enterprise”) announced the execution of a definitive agreement and plan of merger whereby 1st Enterprise will merge into California United Bank. The transaction combines two of the leading commercial banking franchises in Southern California with more than $2.2 billion in combined assets which operate offices in Los Angeles, Orange, Ventura and San Bernardino counties. California United Bank will survive the merger and will continue the commercial banking operations of the combined bank following the merger. The transaction is intended to qualify as a tax-free reorganization under the applicable provisions of the Internal Revenue Code and 1st Enterprise shareholders who receive shares of CU Bancorp common stock in the merger should not recognize any taxable gain on the exchange. Shareholders of 1st Enterprise will receive a fixed exchange ratio at closing of 1.3450 shares of CU Bancorp common stock for each share of 1st Enterprise common stock. Based on the CU Bancorp stock price as of June 2, 2014, the merger transaction is valued at approximately $103.4 million.
On September 25, 2014, CU Bancorp and 1st Enterprise Bank issued a joint press release announcing that they have received all bank regulatory approvals necessary to authorize the merge of 1st Enterprise Bank with California United Bank. Approvals have been received from the Federal Deposit Insurance Corporation and the California Department of Business Oversight, subject to usual and customary conditions.
Total assets increased $43.5 million or 3.1% from December 31, 2013 to $1.5 billion mainly due to deposit growth of $30.5 million, growth in securities sold under agreements to repurchase of $2.5 million and earnings of $7.6 million. Loan growth during the period was concentrated primarily in Other Nonresidential Property loans of $31.8 million and Construction, Land Development and Other Land loans of $11.4 million. Funding the loan growth of the Company for the nine months ended September 30, 2014 was an increase in non-interest bearing demand deposits of $66.1 million, partially offset by a decline in interest bearing deposits of $35.5 million. At September 30, 2014 and December 31, 2013, non-interest bearing deposits represented 55% and 51% of total deposits, respectively.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions, and other subjective assessments. We have identified several accounting policies that, due to judgments, estimates, and assumptions inherent in those policies, are essential to an understanding of our consolidated financial statements. These policies relate to the methodologies that determine our allowance for loan loss, the valuation of impaired loans, the classification and valuation of investment securities, accounting for and valuation of derivatives and hedging activities, accounting for business combinations, evaluation of goodwill for impairment, and accounting for income taxes.
Page 45 of 71
Table of Contents
Our critical accounting policies are described in greater detail in the Company’s 2013 Annual Report on Form 10-K, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations –Critical Accounting Policies and Estimates. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessment, are as follows:
Allowance for Loan Loss
We maintain an allowance for loan loss (“Allowance”) to provide for probable losses in the loan portfolio. Additions to the Allowance are made by charges to operating expense in the form of a provision for loan losses. All loans that are judged to be uncollectible are charged against the Allowance while any recoveries are credited to the Allowance. We have instituted loan policies and procedures which are designed to evaluate, analyze and monitor risk factors associated with our loan portfolio. These policies and procedures are designed to assess risk factors prior to granting new loans and to continually monitor the risk levels in the loan portfolio. We conduct a critical evaluation of the loan portfolio and the level of the Allowance quarterly. We have instituted loan policies to adequately evaluate and analyze risk factors associated with our loan portfolio and to enable us to assess such risk factors prior to granting new loans and to assess the sufficiency of the Allowance. This evaluation includes an assessment of the following factors: the results of any internal and external loan reviews and any regulatory examination, changes in management or lending policies and underwriting standards, levels of past due loans, loan loss experience, estimated probable loss exposure on each impaired credit, concentrations of credit, value of collateral and any known impairment in the borrowers’ ability to repay, and current economic conditions.
Investment Securities
The Company currently classifies its investment securities under the available-for-sale classification. Under the available-for-sale classification, securities can be sold in response to certain conditions, such as changes in interest rates, changes in the credit quality of the securities, when the credit quality of a security does not conform with current investment policy guidelines, fluctuations in deposit levels or loan demand or need to restructure the portfolio to better match the maturity or interest rate characteristics of liabilities with assets. Securities classified as available-for-sale are accounted for at their current fair value rather than amortized cost. Unrealized gains or losses are excluded from net income and reported as a separate component of accumulated other comprehensive income (loss) net of taxes included in shareholders’ equity.
At each reporting date, investment securities are assessed to determine whether there is an other-than-temporary impairment. If it is probable, based on current information, that we will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an other-than-temporary impairment shall be considered to have occurred. If it’s determined that an other-than-temporary impairment exists on a debt security, the Company then determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Company will recognize an other-than-temporary impairment in earnings equal to the difference between the security’s fair value and its adjusted cost basis, the credit portion of the loss is required to be recognized in current earnings, while the non-credit portion of the loss is recorded as a separate component of shareholders’ equity. If neither of the conditions is met, the Company determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss portion of such impairment, if any, is the portion of the other-than-temporary impairments that is recognized in current earnings rather than as a separate component of shareholders’ equity and is a reduction to the cost basis of the security. The portion of total impairment related to all other factors is included in accumulated other comprehensive income (loss). Significant judgment is required in this analysis that includes, but is not limited to assumptions regarding the collectability of principal and interest, future default rates, future prepayment speeds, the amount of current delinquencies that will result in defaults and the amount of eventual recoveries expected on these defaulted loans through the foreclosure process.
Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. For mortgage-backed securities, the amortization or accretion is based on estimated lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities.
Page 46 of 71
Table of Contents
Derivative Financial Instruments and Hedging Activities
All derivative instruments are recorded on the consolidated balance sheet at fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and hedged item related to the hedged risk are recognized in earnings. Current financial accounting and reporting standards require every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the consolidated balance sheet as either an asset or liability measured at its fair value. Accounting standards require that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
On the date a derivative contract is entered into, the Company will designate the derivative contract as either a fair value hedge (i.e. a hedge of the fair value of a recognized asset or liability), a cash flow hedge (i.e. a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability), or a stand-alone derivative (i.e. an instrument with no hedging designation). For a derivative designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as other non-interest income.
The Company will discontinue hedge accounting prospectively when: it is determined that the derivative is no longer effective in offsetting change in the fair value of the hedged item, the derivative expires or is sold, is terminated, is exercised or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company will continue to carry the derivative on the consolidated balance sheet at its fair value (if applicable), but will no longer adjust the hedged asset or liability for changes in fair value. The adjustments of the carrying amount of the hedged asset or liability will be accounted for in the same manner as other components of the carrying amount of that asset or liability, and the adjustments are amortized to interest income over the remaining life of the hedged item upon the termination of hedge accounting.
Business Combinations
The Company has a number of fair value adjustments recorded within the consolidated financial statements that were created from the business combinations with California Oaks State Bank (“COSB”) and Premier Commercial Bancorp (“PC Bancorp”) completed on December 31, 2010 and July 31, 2012, respectively. These fair value adjustments include the Company’s goodwill, fair value adjustments on loans, core deposit intangible assets, other intangible assets, fair value adjustments to acquired lease obligations, fair value adjustments to high rate certificates of deposit and fair value adjustments on derivatives. The assets and liabilities acquired through acquisition have been accounted for at fair value as of the date of the acquisition. The goodwill that was recorded on the transactions represented the excess of the purchase price over the fair value of net assets acquired. If the consideration paid would have been less than the fair value of the net assets acquired, the Company would have recorded a bargain purchase gain. Goodwill is not amortized and is reviewed for impairment on October 1st of each year. If an event occurs or circumstances change that result in the Company’s fair value declining to below its book value, the Company would perform an impairment analysis at that time.
Purchased Credit Impaired Loans (“PCI”) are acquired loans with evidence of deterioration of credit quality since origination and it is probable at the acquisition date, that the Company will not be able to collect all contractually required amounts. When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans. The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans. For non-PCI loans, loan fair value adjustments consist of a premium or discount on each individual loan and are amortized to loan interest income based on the effective yield method over the remaining life of the loans.
Income Taxes
Deferred income tax assets and liabilities are computed using the asset and liability method, which recognizes a liability or asset representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to
Page 47 of 71
Table of Contents
events that have been recognized in the financial statements. A valuation allowance may be established to the extent necessary to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax assets or benefits will be realized. Realization of tax benefits depends on having sufficient taxable income, available tax loss carrybacks or credits, the reversing of taxable temporary differences and/or tax planning strategies within the reversal period and that current legislative tax law allows for the realization of those tax benefits.
Page 48 of 71
Table of Contents
Key Profitability Measures
The following table presents key profitability measures for the periods indicated and the dollar and percentage changes between the periods (dollars in thousands, except per share data):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
Amounts | Increase (Decrease) | Amounts | Increase (Decrease) | |||||||||||||||||||||||||||||
2014 | 2013 | $ | % | 2014 | 2013 | $ | % | |||||||||||||||||||||||||
Net Income | $ | 2,549 | $ | 2,477 | $ | 72 | 2.9 | % | $ | 7,601 | $ | 6,953 | $ | 648 | 9.3 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
Earnings per share | ||||||||||||||||||||||||||||||||
Basic | $ | 0.23 | $ | 0.24 | $ | (0.01 | ) | (4.2 | )% | $ | 0.70 | $ | 0.66 | $ | 0.04 | 6.1 | % | |||||||||||||||
Diluted | $ | 0.23 | $ | 0.23 | $ | 0.00 | 0.0 | % | $ | 0.68 | $ | 0.65 | $ | 0.03 | 4.6 | % | ||||||||||||||||
Return on average equity | 6.85 | % | 7.47 | % | (0.62 | )% | (8.2 | )% | 7.05 | % | 7.17 | % | (0.12 | )% | (1.7 | )% | ||||||||||||||||
Return on average assets | 0.69 | % | 0.74 | % | (0.05 | )% | (6.9 | )% | 0.72 | % | 0.73 | % | (0.01 | )% | (0.08 | )% | ||||||||||||||||
Net interest rate spread | 3.53 | % | 3.77 | % | (0.24 | )% | (6.4 | )% | 3.62 | % | 3.88 | % | (0.26 | )% | (6.7 | )% | ||||||||||||||||
Net interest margin | 3.70 | % | 3.95 | % | (0.25 | )% | (6.3 | )% | 3.80 | % | 4.07 | % | (0.27 | )% | (6.6 | )% | ||||||||||||||||
Efficiency ratio (1) | 67.91 | % | 68.45 | % | (0.54 | )% | (0.8 | )% | 67.95 | % | 68.32 | % | (0.37 | )% | (0.5 | )% |
(1) | Efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net. |
Operations Performance Summary
Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
Net income for the three months ended September 30, 2014 was $2.55 million, or $0.23 per diluted share, compared to $2.48 million, or $0.23 per diluted share for the three months ended September 30, 2013. The $72,000 increase, or 2.9%, was primarily due to a $462,000 increase in net interest income, a $533,000 increase in non-interest income, a $596,000 decrease in provision for loan losses, offset by a $601,000 increase in non-interest expense, primarily due to merger related expenses of $631,000, and a $918,000 increase in the provision for income taxes. There were no merger related expenses for the three months ended September 30, 2013. The increase in the tax provision is related to the non-deductibility of certain merger costs for tax purposes which has resulted in a higher effective tax rate for the third quarter of 2014 compared to 2013. Each of these increases and or decreases is more fully described below.
Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Net income for the nine months ended September 30, 2014 was $7.60 million, or $0.68 per diluted share, compared to $6.95 million, or $0.65 per diluted share for the nine months ended September 30, 2013. The $648,000 increase, or 9.3%, was primarily due to $1.1 million increase in net interest income, a $990,000 increase in non-interest income, a $1.4 million decrease in provision for loan losses, offset by a $1.3 million increase in non-interest expense, primarily due to merger related expenses of $1.1 million, and a $1.6 million increase in the provision for income taxes. There were merger related expenses of $43,000 for the nine months ended September 30, 2013. The increase in the tax provision is related to the non-deductibility of certain merger costs for tax purposes which has resulted in a higher effective tax rate for the third quarter of 2014 compared to 2013. Each of these increases and or decreases is more fully described below.
Page 49 of 71
Table of Contents
Average Balances, Interest Income and Expense, Yields and Rates
The following tables present the Company’s average balance sheets, together with the total dollar amounts of interest income and interest expense and the weighted average interest yield/rate for the periods presented. All average balances are daily average balances (dollars in thousands).
Three Months Ended | ||||||||||||||||||||||||
September 30, 2014 | September 30, 2013 | |||||||||||||||||||||||
Average Balance | Interest | Average Yield/Rate (5) | Average Balance | Interest | Average Yield/Rate (5) | |||||||||||||||||||
Interest Earning Assets: | ||||||||||||||||||||||||
Deposits in other financial institutions | $ | 278,623 | $ | 248 | 0.35 | % | $ | 241,088 | $ | 178 | 0.29 | % | ||||||||||||
Investment securities (2) | 121,124 | 589 | 1.95 | % | 106,744 | 441 | 1.65 | % | ||||||||||||||||
Loans (1) | 969,668 | 12,401 | 5.07 | % | 888,024 | 12,203 | 5.45 | % | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||||||
Total interest-earning assets | 1,369,415 | 13,238 | 3.84 | % | 1,235,856 | 12.822 | 4.12 | % | ||||||||||||||||
Non-interest-earning assets | 91,123 | 90,347 | ||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Total Assets | $ | 1,460,538 | $ | 1,326,203 | ||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Interest Bearing Liabilities: | ||||||||||||||||||||||||
Interest bearing transaction accounts | $ | 150,160 | $ | 70 | 0.18 | % | $ | 125,991 | $ | 57 | 0.18 | % | ||||||||||||
Money market and savings deposits | 363,693 | 225 | 0.25 | % | 370,725 | 263 | 0.28 | % | ||||||||||||||||
Certificates of deposit | 59,362 | 58 | 0.39 | % | 55,556 | 47 | 0.34 | % | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||||||
Total Interest Bearing Deposits | 573,215 | 353 | 0.24 | % | 552,272 | 367 | 0.26 | % | ||||||||||||||||
Securities sold under agreements to repurchase | 14,210 | 8 | 0.22 | % | 28,202 | 23 | 0.32 | % | ||||||||||||||||
Subordinated debentures | 9,740 | 109 | 4.38 | % | 9,312 | 126 | 5.29 | % | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||||||
Total Interest Bearing Liabilities | 597,165 | 470 | 0.31 | % | 589,786 | 516 | 0.35 | % | ||||||||||||||||
Non-interest bearing demand deposits | 699,592 | 593,252 | ||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Total funding sources | 1,296,757 | 1,183,038 | ||||||||||||||||||||||
Non-interest bearing liabilities | 16,041 | 11,523 | ||||||||||||||||||||||
Shareholders’ Equity | 147,740 | 131,642 | ||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Total Liabilities and Shareholders’ Equity | $ | 1,460,538 | $ | 1,326,203 | ||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Net interest income | $ | 12,768 | $ | 12,306 | ||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Net interest rate spread (3) | 3.53 | % | 3.77 | % | ||||||||||||||||||||
Net interest margin (4) | 3.70 | % | 3.95 | % | ||||||||||||||||||||
Core net interest margin (6) | 3.58 | % | 3.77 | % |
(1) | Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield. |
(2) | Average balances of investment securities are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities. |
(3) | Net interest rate spread represents the yield earned on average total interest-earning assets less the rate paid on average total interest bearing liabilities. |
(4) | Net interest margin is computed by dividing annualized net interest income by average total interest-earning assets. |
(5) | Annualized |
(6) | Core net interest margin is computed by dividing annualized net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans, by average total interest-earning assets. See the reconciliation table for core net interest margin. |
Page 50 of 71
Table of Contents
Nine Months Ended | ||||||||||||||||||||||||
September 30, 2014 | September 30, 2013 | |||||||||||||||||||||||
Average Balance | Interest | Average Yield/Rate (5) | Average Balance | Interest | Average Yield/Rate (5) | |||||||||||||||||||
Interest Earning Assets: | ||||||||||||||||||||||||
Deposits in other financial institutions | $ | 261,617 | $ | 665 | 0.34 | % | $ | 221,484 | $ | 495 | 0.29 | % | ||||||||||||
Investment securities (2) | 109,160 | 1,557 | 1.90 | % | 108,596 | 1,420 | 1.74 | % | ||||||||||||||||
Loans (1) | 950,427 | 36,691 | 5.16 | % | 867,603 | 36,090 | 5.56 | % | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||||||
Total interest-earning assets | 1,321,204 | 38,913 | 3.94 | % | 1,197,683 | 38,005 | 4.24 | % | ||||||||||||||||
Non-interest-earning assets | 91,283 | 91,958 | ||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Total Assets | $ | 1,412,487 | $ | 1,289,641 | ||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Interest Bearing Liabilities: | ||||||||||||||||||||||||
Interest bearing transaction accounts | $ | 142,575 | $ | 194 | 0.18 | % | $ | 125,609 | $ | 173 | 0.18 | % | ||||||||||||
Money market and savings deposits | 363,603 | 681 | 0.25 | % | 352,013 | 772 | 0.29 | % | ||||||||||||||||
Certificates of deposit | 61,013 | 169 | 0.37 | % | 66,496 | 197 | 0.40 | % | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||||||
Total Interest Bearing Deposits | 567,191 | 1,044 | 0.25 | % | 544,118 | 1,142 | 0.28 | % | ||||||||||||||||
Securities sold under agreements to repurchase | 13,870 | 27 | 0.26 | % | 27,331 | 63 | 0.31 | % | ||||||||||||||||
Subordinated debentures | 9,527 | 323 | 4.47 | % | 9,370 | 376 | 5.29 | % | ||||||||||||||||
|
|
|
|
|
|
|
| |||||||||||||||||
Total Interest Bearing Liabilities | 590,588 | 1,394 | 0.32 | % | 580,819 | 1,581 | 0.36 | % | ||||||||||||||||
Non-interest bearing demand deposits | 661,883 | 567,100 | ||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Total funding sources | 1,252,471 | 1,147,919 | ||||||||||||||||||||||
Non-interest bearing liabilities | 15,787 | 12,059 | ||||||||||||||||||||||
Shareholders’ Equity | 144,229 | 129,663 | ||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Total Liabilities and Shareholders’ Equity | $ | 1,412,487 | $ | 1,289,641 | ||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Net interest income | $ | 37,519 | $ | 36,424 | ||||||||||||||||||||
|
|
|
| |||||||||||||||||||||
Net interest rate spread (3) | 3.62 | % | 3.88 | % | ||||||||||||||||||||
Net interest margin (4) | 3.80 | % | 4.07 | % | ||||||||||||||||||||
Core net interest margin (6) | 3.65 | % | 3.88 | % |
(1) | Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield. |
(2) | Average balances of investment securities are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities. |
(3) | Net interest rate spread represents the yield earned on average total interest-earning assets less the rate paid on average total interest bearing liabilities. |
(4) | Net interest margin is computed by dividing annualized net interest income by average total interest-earning assets. |
(5) | Annualized |
(6) | Core net interest margin is computed by dividing annualized net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans, by average total interest-earning assets. See the reconciliation table for core net interest margin. |
Page 51 of 71
Table of Contents
The following table represents a reconciliation of GAAP net interest margin to core net interest margin used by the Company. The table presents the information for the periods indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net Interest Income | $ | 12,768 | $ | 12,306 | $ | 37,519 | $ | 36,424 | ||||||||
Less: Interest recovered (reversed) on non-accrual loans | — | (167 | ) | — | (5 | ) | ||||||||||
Accelerated accretion of fair value adjustment on early loan payoffs | 403 | 735 | 1,405 | 1,663 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Core Net Interest Income | $ | 12,365 | $ | 11,738 | $ | 36,114 | $ | 34,766 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net interest margin | 3.70 | % | 3.95 | % | 3.80 | % | 4.07 | % | ||||||||
Core net interest margin | 3.58 | % | 3.77 | % | 3.65 | % | 3.88 | % |
The following table reflects the composition of the net deferred loan fees, costs and fair value discounts at September 30, 2014 and December 31, 2013 (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||
Accreting loan discount | $ | 5,941 | $ | 7,912 | ||||
Non-accreting loan discount | 902 | 2,683 | ||||||
|
|
|
| |||||
Acquired loans remaining discount | 6,843 | 10,595 | ||||||
Organic loans net deferred fees | 2,883 | 2,014 | ||||||
|
|
|
| |||||
Total | $ | 9,726 | $ | 12,609 | ||||
|
|
|
|
Page 52 of 71
Table of Contents
Net Changes in Average Balances, Composition, Yields and Rates
The following tables set forth the composition of average interest-earning assets and average interest-bearing liabilities by category and by the percentage of each category to the total for the periods indicated, including the change in average balance, composition, and yield/rate between these respective periods (dollars in thousands):
Three Months Ended September 30, | ||||||||||||||||||||||||||||||||||||
2014 | 2013 | Increase (Decrease) | ||||||||||||||||||||||||||||||||||
Average Balance | % of Total | Average Yield/ Rate | Average Balance | % of Total | Average Yield/ Rate | Average Balance | % of Total | Average Yield/ Rate | ||||||||||||||||||||||||||||
Interest-Earning Assets: | ||||||||||||||||||||||||||||||||||||
Deposits in other financial institutions | $ | 278,623 | 20.3 | % | 0.35 | % | $ | 241,088 | 19.5 | % | 0.29 | % | $ | 37,535 | 0.8 | % | 0.06 | % | ||||||||||||||||||
Investment securities | 121,124 | 8.8 | % | 1.95 | % | 106,744 | 8.6 | % | 1.65 | % | 14,380 | 0.2 | % | 0.30 | % | |||||||||||||||||||||
Loans | 969,668 | 70.8 | % | 5.07 | % | 888,024 | 71.9 | % | 5.45 | % | 81,644 | (1.0 | )% | (0.38 | )% | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total interest-earning assets | $ | 1,369,415 | 100.0 | % | 3.84 | % | $ | 1,235,856 | 100.0 | % | 4.12 | % | $ | 133,559 | 0.0 | % | (0.28 | )% | ||||||||||||||||||
Interest-Bearing Liabilities: | ||||||||||||||||||||||||||||||||||||
Non-interest bearing demand deposits | $ | 699,592 | 53.9 | % | $ | 593,252 | 50.1 | % | $ | 106,340 | 3.8 | % | ||||||||||||||||||||||||
Interest-bearing transaction accounts | 150,160 | 11.6 | % | 0.18 | % | 125,991 | 10.6 | % | 0.18 | % | 24,169 | 0.9 | % | 0.00 | % | |||||||||||||||||||||
Money market and savings deposits | 363,693 | 28.0 | % | 0.25 | % | 370,725 | 31.3 | % | 0.28 | % | (7,032 | ) | (3.3 | )% | (0.03 | )% | ||||||||||||||||||||
Certificates of deposit | 59,362 | 4.6 | % | 0.39 | % | 55,556 | 4.7 | % | 0.34 | % | 3,806 | (0.1 | )% | 0.05 | % | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total deposits | 1,272,807 | 98.2 | % | 0.11 | % | 1,145,524 | 96.8 | % | 0.13 | % | 127,283 | 1.3 | % | (0.02 | )% | |||||||||||||||||||||
Securities sold under agreements to repurchase | 14,210 | 1.1 | % | 0.22 | % | 28,202 | 2.4 | % | 0.32 | % | (13,992 | ) | (1.3 | )% | (0.10 | )% | ||||||||||||||||||||
Subordinated debentures | 9,740 | 0.8 | % | 4.38 | % | 9,312 | 0.8 | % | 5.29 | % | 428 | (0.0 | )% | (0.91 | )% | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total borrowings | 23,950 | 1.8 | % | 1.94 | % | 37,514 | 3.2 | % | 1.58 | % | (13,564 | ) | (1.3 | )% | 0.36 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total funding sources | $ | 1,296,757 | 100.0 | % | 0.14 | % | $ | 1,183,038 | 100.0 | % | 0.17 | % | $ | 113,719 | 0.0 | % | (0.03 | )% | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page 53 of 71
Table of Contents
Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||||||
2014 | 2013 | Increase (Decrease) | ||||||||||||||||||||||||||||||||||
Average Balance | % of Total | Average Yield/ Rate | Average Balance | % of Total | Average Yield/ Rate | Average Balance | % of Total | Average Yield/ Rate | ||||||||||||||||||||||||||||
Interest-Earning Assets: | ||||||||||||||||||||||||||||||||||||
Deposits in other financial institutions | $ | 261,617 | 19.8 | % | 0.34 | % | $ | 221,484 | 18.5 | % | 0.29 | % | $ | 40,133 | 1.3 | % | 0.05 | % | ||||||||||||||||||
Investment securities | 109,160 | 8.3 | % | 1.90 | % | 108,596 | 9.1 | % | 1.74 | % | 564 | (0.8 | )% | 0.16 | % | |||||||||||||||||||||
Loans | 950,427 | 71.9 | % | 5.16 | % | 867,603 | 72.4 | % | 5.56 | % | 82,824 | (0.5 | )% | (0.40 | )% | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total interest-earning assets | $ | 1,321,204 | 100.0 | % | 3.94 | % | $ | 1,197,683 | 100.0 | % | 4.24 | % | $ | 123,521 | 0.0 | % | (0.30 | )% | ||||||||||||||||||
Interest-Bearing Liabilities: | ||||||||||||||||||||||||||||||||||||
Non-interest bearing demand deposits | $ | 661,883 | 52.8 | % | $ | 567,100 | 49.4 | % | $ | 94,783 | 3.4 | % | ||||||||||||||||||||||||
Interest-bearing transaction accounts | 142,575 | 11.4 | % | 0.18 | % | 125,609 | 10.9 | % | 0.18 | % | 16,966 | 0.4 | % | (0.00 | )% | |||||||||||||||||||||
Money market and savings deposits | 363,603 | 29.0 | % | 0.25 | % | 352,013 | 30.7 | % | 0.29 | % | 11,590 | (1.6 | )% | (0.04 | )% | |||||||||||||||||||||
Certificates of deposit | 61,013 | 4.9 | % | 0.37 | % | 66,496 | 5.8 | % | 0.40 | % | (5,483 | ) | (0.9 | )% | (0.03 | )% | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total deposits | 1,229,074 | 98.1 | % | 0.11 | % | 1,111,218 | 96.8 | % | 0.14 | % | 117,856 | 1.3 | % | (0.03 | )% | |||||||||||||||||||||
Securities sold under agreements to repurchase | 13,870 | 1.1 | % | 0.26 | % | 27,331 | 2.4 | % | 0.31 | % | (13,461 | ) | (1.3 | )% | (0.05 | )% | ||||||||||||||||||||
Subordinated debentures | 9,527 | 0.8 | % | 4.47 | % | 9,370 | 0.8 | % | 5.29 | % | 157 | (0.1 | )% | (0.82 | )% | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total borrowings | 23,397 | 1.9 | % | 2.00 | % | 36,701 | 3.2 | % | 1.60 | % | (13,304 | ) | (1.3 | )% | 0.40 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||
Total funding sources | $ | 1,252,471 | 100.0 | % | 0.15 | % | $ | 1,147,919 | 100.0 | % | 0.18 | % | $ | 104,552 | 0.0 | % | (0.03 | )% | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page 54 of 71
Table of Contents
Volume and Rate Variance Analysis of Net Interest Income
The following table presents the dollar amount of changes in interest income and interest expense due to changes in average balances of interest-earning assets and interest bearing liabilities and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (i) changes in volume (i.e. changes in average balance multiplied by prior period rate) and (ii) changes in rate (i.e. changes in rate multiplied by prior period average balance). For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately based on the absolute dollar amounts of the changes due to volume and rate (dollars in thousands):
Three Months Ended September 30, 2014 vs. 2013 | ||||||||||||
Increase (Decrease) Due To | ||||||||||||
Volume | Rate | Total | ||||||||||
Interest Income | ||||||||||||
Loans | $ | 1,120 | $ | (922 | ) | $ | 198 | |||||
Deposits in other financial institutions | 28 | 42 | 70 | |||||||||
Investment securities | 58 | 90 | 148 | |||||||||
|
|
|
|
|
| |||||||
Total interest income | 1,206 | (790 | ) | 416 | ||||||||
|
|
|
|
|
| |||||||
Interest Expense | ||||||||||||
Interest-bearing transaction accounts | 13 | — | 13 | |||||||||
Money market and savings deposits | (8 | ) | (30 | ) | (38 | ) | ||||||
Certificates of deposit | 3 | 8 | 11 | |||||||||
|
|
|
|
|
| |||||||
Total deposits | 8 | (22 | ) | (14 | ) | |||||||
Securities sold under agreements to repurchase | (11 | ) | (4 | ) | (15 | ) | ||||||
Subordinated debentures | 5 | (22 | ) | (17 | ) | |||||||
|
|
|
|
|
| |||||||
Total borrowings | (6 | ) | (26 | ) | (32 | ) | ||||||
|
|
|
|
|
| |||||||
Total interest expense | 3 | (49 | ) | (46 | ) | |||||||
|
|
|
|
|
| |||||||
Net Interest Income | $ | 1,203 | $ | (741 | ) | $ | 462 | |||||
|
|
|
|
|
|
Nine Months Ended 2014 vs. 2013 | ||||||||||||
Increase (Decrease) Due To | ||||||||||||
Volume | Rate | Total | ||||||||||
Interest Income | ||||||||||||
Loans | $ | 3,444 | $ | (2,843 | ) | $ | 601 | |||||
Deposits in other financial institutions | 77 | 93 | 170 | |||||||||
Investment securities | 7 | 130 | 137 | |||||||||
|
|
|
|
|
| |||||||
Total interest income | 3,528 | (2,620 | ) | 908 | ||||||||
|
|
|
|
|
| |||||||
Interest Expense | ||||||||||||
Interest-bearing transaction accounts | 21 | — | 21 | |||||||||
Money market and savings deposits | 22 | (113 | ) | (91 | ) | |||||||
Certificates of deposit | (15 | ) | (13 | ) | (28 | ) | ||||||
|
|
|
|
|
| |||||||
Total deposits | 28 | (126 | ) | (98 | ) | |||||||
Securities sold under agreements to repurchase | (31 | ) | (5 | ) | (36 | ) | ||||||
Subordinated debentures | 6 | (59 | ) | (53 | ) | |||||||
|
|
|
|
|
| |||||||
Total borrowings | (25 | ) | (64 | ) | (89 | ) | ||||||
|
|
|
|
|
| |||||||
Total interest expense | 3 | (190 | ) | (187 | ) | |||||||
|
|
|
|
|
| |||||||
Net Interest Income | $ | 3,525 | $ | (2,430 | ) | $ | 1,095 | |||||
|
|
|
|
|
|
Page 55 of 71
Table of Contents
Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
The net interest margin declined 25 basis points to 3.70% for the three months ended September 30, 2014, compared to 3.95% for the three months ended September 30, 2013. The decline in net interest margin is primarily due to a 38 basis point decrease in the quarterly loan yield, offset by a 2 basis point decline in the interest bearing deposit rate. The lower net interest margin in 2014 is attributable to the continued low interest rate environment, as new loans have been originated at lower interest rates than those loans that have been paid off. This is in addition to a lower level of fair value discounts earned on early payoffs of acquired loans in 2014 compared to 2013. Fair value discounts earned on early payoffs of acquired loans were $403,000 compared to $735,000 for the three months ended September 30, 2014 and 2013, respectively. Despite a decline in the net interest margin, net interest income increased $462,000 mainly due to a higher average loan balance. However, net interest income also included the reversal of $167,000 of interest income on an acquired loan that was put on non-accrual status during the quarter ended September 30, 2013. The impact to the Company’s net interest margin from the accelerated accretion of fair value discounts on early payoffs of acquired loans and the reversal of interest on a loan that was put on nonaccrual status during the quarters ending September 30, 2014 and 2013 was 12 basis points and 19 basis points, respectively.
Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
The net interest margin declined 27 basis points to 3.80% for the nine months ended September 30, 2014 compared to 4.07% for the nine months ended September 30, 2013. The decline in net interest margin is primarily due to a 40 basis point decrease in loan yield, offset by a 3 basis point decline in the interest bearing deposit rate. The lower net interest margin in 2014 is attributable to the continued low interest rate environment, as new loans have been originated at lower interest rates than loans that have been paid off. Despite a decline in the net interest margin, net interest income increased $1.1 million mainly due to a higher average loan balance. During the nine months ended September 30, 2014 and 2013, the Company has experienced $1.4 million and $1.7 million, respectively, of accelerated accretion of fair value discounts on early payoffs of acquired loans. Net interest income for the nine months ended September 30, 2013 was slightly impacted by the recovery of $162,000 of interest income from the payoff of a nonaccrual loan during the quarter ended June 30, 2013, offset by the reversal of $167,000 of interest income on an acquired loan that was put on non-accrual status during the quarter ended September 30, 2013. The impact to the Company’s net interest margin from the accelerated accretion of fair value discounts on early payoffs of acquired loans and the net reversal of interest on nonaccrual loans during the nine months ending September 30, 2014 and 2013 was 19 basis points for both periods.
Provision for Loan Losses
The Company maintains an allowance for loan loss (“Allowance”) to provide for probable losses in the loan portfolio. Additions to the Allowance are made by charges to operating expense in the form of a provision for loan losses. All loans that are judged to be uncollectible are charged against the Allowance, while any recoveries are credited to the Allowance.
Provision for loan losses for the three months ended September 30, 2014 was $35,000 compared to $631,000 for the three months ended September 30, 2013. The Company had $15.5 million of net organic loan growth for the quarter ended September 30, 2014, compared to $42.5 million for the same quarter a year ago. Net recoveries for the three months ended September 30, 2014 were $29,000 compared to net charge-offs of $5,000 in 2013. Provision for loan losses for the nine months ended September 30, 2014 was $518,000 compared to $1.9 million for the nine months ended September 30, 2013. The Company had $87.5 million of net organic loan growth for the nine months ended September 30, 2014, compared to $99.4 million for the same period a year ago. Net recoveries for the nine months ended September 30, 2014 were $227,000, compared to net charge-offs of $683,000 in 2013. See further discussion inBalance Sheet Analysis, Allowance for Loan Loss.
Page 56 of 71
Table of Contents
Non-interest Income
Three Months Ended September 30, | Increase (Decrease) | Nine Months Ended September 30, | Increase (Decrease) | |||||||||||||||||||||||||||||
2014 | 2013 | $ | % | 2014 | 2013 | $ | % | |||||||||||||||||||||||||
Gain on sale of securities, net | $ | — | $ | — | $ | — | — | % | $ | — | $ | 5 | $ | (5 | ) | (100.0 | )% | |||||||||||||||
Gain on sale of SBA loans, net | 331 | 263 | 68 | 25.9 | % | 936 | 673 | 263 | 39.1 | % | ||||||||||||||||||||||
Deposit account service charge income | 631 | 598 | 33 | 5.5 | % | 1,891 | 1,749 | 142 | 8.1 | % | ||||||||||||||||||||||
Other non-interest income | 1,042 | 610 | 432 | 70.8 | % | 2,750 | 2,160 | 590 | 27.3 | % | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
Total Non-Interest Income | $ | 2,004 | $ | 1,471 | $ | 533 | 36.2 | % | $ | 5,577 | $ | 4,587 | $ | 990 | 21.6 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
Non-interest income increased $533,000 or 36.2% to $2.0 million for the three months ended September 30, 2014 compared to $1.5 million for the three months ended September 30, 2013. This change was mainly due to a $68,000 increase in the gain on sale of SBA loans, $204,000 in transaction referral income in the third quarter of 2014 compared to none in the year-ago quarter, a $92,000 increase in lending-related fees, a $57,000 increase in dividend income and a positive swing of $61,000 in an unhedged swap.
Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Non-interest income increased $990,000 or 21.6% to $5.6 million for the nine months ended September 30, 2014 compared to $4.6 million for the nine months ended September 30, 2013. The change was mainly due to a $263,000 increase in gain on sale of SBA loans, a $142,000 increase in deposit account service charge income, a $216,000 increase in lending-related fees, a $290,000 increase in transaction referral income and a $90,000 increase in dividend income. The growth in deposit accounts by the Company resulted in the increase in deposit account service charge income between the periods. Included in other non-interest income for the nine months ending September 30, 2014 was a $225,000 settlement related to an other real estate owned property sold in 2013. Included in other non-interest income for the nine months ending September 30, 2013 was a $250,000 insurance settlement.
Page 57 of 71
Table of Contents
Non-interest Expense
The following table sets forth certain information with respect to the Company’s non-interest expense for the periods indicated (dollars in thousands):
Three Months Ended | Increase | Nine Months Ended | Increase | |||||||||||||||||||||||||||||
September 30, | (Decrease) | September 30, | (Decrease) | |||||||||||||||||||||||||||||
2014 | 2013 | $ | % | 2014 | 2013 | $ | % | |||||||||||||||||||||||||
Salaries and employee benefits | $ | 5,621 | $ | 5,432 | $ | 189 | 3.5 | % | $ | 16,554 | $ | 16,287 | $ | 267 | 1.6 | % | ||||||||||||||||
Stock based compensation expense | 445 | 241 | 204 | 84.6 | % | 1,332 | 716 | 616 | 86.0 | % | ||||||||||||||||||||||
Occupancy | 999 | 1,074 | (75 | ) | (7.0 | )% | 2,970 | 3,157 | (187 | ) | (5.9 | )% | ||||||||||||||||||||
Data processing | 472 | 452 | 20 | 4.4 | % | 1,423 | 1,413 | 10 | 0.7 | % | ||||||||||||||||||||||
Legal and professional | 456 | 530 | (74 | ) | (14.0 | )% | 1,390 | 1,609 | (219 | ) | (13.6 | )% | ||||||||||||||||||||
FDIC deposit assessment | 195 | 219 | (24 | ) | (11.0 | )% | 596 | 654 | (58 | ) | (8.9 | )% | ||||||||||||||||||||
Merger related expenses | 631 | — | 631 | — | % | 1,128 | 43 | 1,085 | 2,523.3 | % | ||||||||||||||||||||||
OREO valuation write-downs and expenses | 8 | 39 | (31 | ) | (79.5 | )% | 14 | 88 | (74 | ) | (84.1 | )% | ||||||||||||||||||||
Office services expense | 219 | 261 | (42 | ) | (16.1 | )% | 721 | 786 | (65 | ) | (8.3 | )% | ||||||||||||||||||||
Other operating expenses | 985 | 1,182 | (197 | ) | (16.7 | )% | 3,150 | 3,267 | (117 | ) | (3.6 | )% | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
Total Non-Interest Expense | $ | 10,031 | $ | 9,430 | $ | 601 | 6.4 | % | $ | 29,278 | $ | 28,020 | $ | 1,258 | 4.5 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
Non-interest expense increased $601,000 or 6.4% to $10.0 million for the three months ended September 30, 2014 compared to $9.4 million for the three months ended September 30, 2013. The overall increase between the quarters was primarily due to a $189,000 increase in salaries and employee benefits, a $204,000 increase in stock based compensation expense and a $631,000 increase in merger related expenses associated with the current pending merger. The increase in salary expense was attributable to the accrual of bonus incentives related to work performed on the upcoming merger, as well as a modest increase in the number of full time employees. The increase in stock-based compensation reflects the delay in the annual granting of stock-based compensation in 2013 which resulted in dampened expense in the third quarter of that year. Merger expenses during the quarter were primarily due to legal fees associated with the upcoming merger with 1st Enterprise Bank and the related Registration Statement and Proxy/Prospectus.
Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Non-interest expense increased $1.3 million or 4.5% to $29.3 million for the nine months ended September 30, 2014 compared to $28.0 million for the nine months ended September 30, 2013. The overall increase between the nine month periods was primarily due to a $267,000 increase in salaries and employee benefits, a $616,000 increase in stock based compensation expense and a $1.1 million increase in merger related expenses associated with the current pending merger. The increase in stock-based compensation reflects the delay in the annual granting of stock-based compensation in 2013 which resulted in dampened expense in the comparative period in 2013.
Income Taxes
The effective tax rate for the three months ended September 30, 2014 was 45.8% compared to 33.3% for the three months ended September 30, 2013. The effective tax rate for the nine months ended September 30, 2014 was 42.9% compared to 37.2% for the nine months ended September 30, 2013. The increase in the effective tax rates for these periods was due to the non-deductibility of certain merger related expenses incurred in 2014 and the discontinuance of the California net interest deduction on loans within designated enterprise zones. The Company’s effective tax rate is impacted by the increase in cash surrender value of bank owned life insurance policies which is excluded from taxable income and the Company has invested in Qualified Affordable Housing Projects “LIHTC” that generate tax credits and benefits for the Company. The Company operates in the Federal and California jurisdictions and the blended statutory tax rate for Federal and California income taxes is 42.05%.
Page 58 of 71
Table of Contents
Balance Sheet Analysis
Total assets increased $43.5 million for the nine months ending September 30, 2014 to $1.5 billion with net loan growth of $45.6 million, an increase of $33.1 million in investment securities available-for-sale, at fair value, offset by a net decrease of $31.4 million of cash and cash equivalents and certificates of deposits in other financial institutions. Net organic loan growth during the period was $87.5 million, partially offset by $42.4 million in runoff of purchased loans from the COSB and PC Bancorp acquisitions. Loan growth for the nine months of 2014 was concentrated in Other Nonresidential Properties of $31.8 million, Construction, Land Development and Other Land categories of $11.4 million, and 1-4 Family Residential Properties of $2.4 million.
Funding the asset growth for the Company for the first nine months of 2014 was the growth in deposits of $30.5 million, growth in securities sold under agreements to repurchase of $2.5 million and earnings of $7.6 million. Non-interest bearing demand deposits increased by $66.1 million to $698.3 million at September 30, 2014. The increase in non-interest bearing deposits was partially offset by a $35.5 million decrease in interest-bearing deposits. At September 30, 2014 and December 31, 2013, non-interest bearing deposits represented 55% and 51% of total deposits, respectively.
Lending
The following table presents the composition of the loan portfolio at the dates indicated (dollars in thousands):
September 30, | December 31, | |||||||||||||||
2014 | 2013 | |||||||||||||||
Amount | % of Total | Amount | % of Total | |||||||||||||
Commercial and Industrial Loans: | $ | 297,853 | 30 | % | $ | 299,473 | 32 | % | ||||||||
Loans Secured by Real Estate: | ||||||||||||||||
Owner-Occupied Nonresidential Properties | 198,406 | 20 | % | 197,605 | 21 | % | ||||||||||
Other Nonresidential Properties | 303,605 | 31 | % | 271,818 | 29 | % | ||||||||||
Construction, Land Development and Other Land | 58,474 | 6 | % | 47,074 | 5 | % | ||||||||||
1-4 Family Residential Properties | 68,134 | 7 | % | 65,711 | 7 | % | ||||||||||
Multifamily Residential Properties | 27,937 | 3 | % | 33,780 | 4 | % | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Loans Secured by Real Estate | 656,556 | 67 | % | 615,988 | 66 | % | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Other Loans: | 24,391 | 2 | % | 17,733 | 2 | % | ||||||||||
|
|
|
|
|
|
|
| |||||||||
|
|
|
|
|
|
|
| |||||||||
Total Loans | $ | 978,800 | 100 | % | $ | 933,194 | 100 | % | ||||||||
|
|
|
|
|
|
|
|
Page 59 of 71
Table of Contents
The following table is a breakout of the Company’s gross loans stratified by the industry concentration of the borrower by their respective NAICS code at the dates indicated (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||||||||||
Amount | % of Total | Amount | % of Total | |||||||||||||
Real Estate | $ | 422,509 | 43 | % | $ | 381,830 | 41 | % | ||||||||
Manufacturing | 87,140 | 9 | % | 83,319 | 9 | % | ||||||||||
Hotel/Lodging | 82,728 | 8 | % | 76,143 | 8 | % | ||||||||||
Construction | 67,189 | 7 | % | 62,835 | 7 | % | ||||||||||
Wholesale | 59,563 | 6 | % | 60,291 | 6 | % | ||||||||||
Finance | 63,496 | 7 | % | 46,393 | 5 | % | ||||||||||
Professional Services | 45,745 | 5 | % | 49,739 | 5 | % | ||||||||||
Healthcare | 44,346 | 3 | % | 38,662 | 4 | % | ||||||||||
Other Services | 23,467 | 2 | % | 21,448 | 2 | % | ||||||||||
Restaurant/Food Service | 24,187 | 2 | % | 35,244 | 4 | % | ||||||||||
Administrative Services | 19,085 | 2 | % | 15,218 | 2 | % | ||||||||||
Retail | 16,891 | 2 | % | 23,157 | 2 | % | ||||||||||
Information | 11,327 | 1 | % | 11,709 | 1 | % | ||||||||||
Transportation | 10,393 | 1 | % | 9,531 | 1 | % | ||||||||||
Education | 9,625 | 1 | % | 10,270 | 1 | % | ||||||||||
Entertainment | 5,382 | 1 | % | 6,207 | 1 | % | ||||||||||
Other | 1,347 | 0 | % | 1,198 | 0 | % | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Total Loans | $ | 978,800 | 100 | % | $ | 933,194 | 100 | % | ||||||||
|
|
|
|
|
|
|
|
The Company’s loan origination and lending activities continue to be focused primarily on direct contact with its borrowers through the Company’s relationship managers and/or executive officers. Total loans were $978.8 million at September 30, 2014, an increase of $45.6 million or 4.9% from $933.2 million at December 31, 2013. The Company had approximately $87.5 million of net organic loan growth, which was partially offset by approximately $41.9 million in loan run-off from the acquired loan portfolios.
The net growth in the Company’s other nonresidential real estate properties portfolio of approximately $31.8 million during the nine months ending September 30, 2014, included two large loans. The first loan was originated to refinance a retail center in the Company’s footprint and has a balance that represents a loan-to-value of less than fifty percent. The second loan represents a new customer relationship for the Company with a borrower to facilitate the purchase of a hotel near an Orange County entertainment center, with plans to redevelop the property.
The increase in the construction, land development and other land portfolio of $11.4 million is primarily related to a $9.6 million loan for the development of a property located in Los Angeles by a real estate developer who is a well-known and long-time customer of the Bank.
The Commercial and Industrial Loans portfolio was flat for the nine month period ending September 30, 2014. A large commercial line of credit was paid off in the third quarter of 2014, as the Company maintained its firm commitment to its disciplined underwriting standards and declined to match the more aggressive structure offered by another bank. This payoff was offset by outstandings in commercial lines of credit.
We continue to establish new relationships and expand our current business, as evidenced by our increased commercial line of credit commitments, which are up 8.5% from December 31, 2013; however due to the dynamic nature of commercial and industrial lending, actual credit utilization does experience ebbs and flows. The Company’s commercial and industrial line of credit utilization was approximately 46% as of September 30, 2014 and 49% as of December 31, 2013. The Company experienced a spike in line utilization at December 31, 2013 as a result of several of its smaller businesses drawing on their lines of credit at year end and then paying down their lines during the first nine months of the year. This occurs around year-end and appears to be a recurring trend.
Page 60 of 71
Table of Contents
The Company had 35 commercial banking relationship managers and 5 commercial real estate relationship managers at September 30, 2014 and December 31, 2013. The Company’s credit approval process includes an examination of the collateral, cash flow, and debt service coverage of the loan, as well as the financial condition and credit references of the borrower. The Company’s senior management is actively involved in its lending activities and collateral valuation. The Company obtains independent third party appraisals of real property securing commercial real estate loans, as required by applicable federal and state laws and regulations. There is also a loan committee comprised of senior management that reviews problem loans.
The Company believes that it carefully manages credit risk in its loan portfolio and uses a variety of policy guidelines and analytical tools to achieve its asset quality objectives.
Allowance for Loan Loss
The Allowance increased by $745,000, to $11.3 million at September 30, 2014 from $10.6 million at December 31, 2014 due to a provision for loan losses of $518,000 and net recoveries of $227,000. The Allowance as a percentage of total loans was 1.16% and 1.14% at September 30, 2014 and December 31, 2013, respectively. The Allowance as a percentage of loans (excluding loan balances and the related Allowance on loans acquired through acquisition) was 1.43% and 1.50% at September 30, 2014 and December 31, 2013, respectively. The decrease in the allowance ratio related to organic loans was directly attributable to improvements in the economic conditions within the Company’s markets, a reduction in non-accrual loans, as well as the level of charge-offs.
The Company’s management considered the following factors in evaluating the allowance for loan loss at September 30, 2014:
• | During the nine months ended September, 2014 there were net loan recoveries of $227,000 |
• | There were eighteen nonaccrual loans totaling $4.4 million at September 30, 2014 |
• | The overall growth and composition of the loan portfolio |
• | Changes to the overall economic conditions within the markets in which the Company makes loans |
• | Concentrations within the loan portfolio, as well as risk conditions within its commercial and industrial loan portfolio |
• | The remaining fair value adjustments on loans acquired through acquisition, with special attention to the fair value adjustments associated with the purchased credit impaired loans. |
Management has considered various material elements of potential risk within the loan portfolio, including classified credits, pools of loans with similar characteristics, economic factors, trends in the loan portfolio and modifications and changes in the Company’s lending policies, procedures and underwriting criteria. In addition, management recognized the potential for unforeseen events to occur when evaluating the qualitative factors in all categories of its analysis.
The Company analyzes historical net charge-offs in various loan portfolio segments when evaluating the reserves. For loan segments without previous loss experience, the analysis is adjusted to reflect regulatory peer group loss experience in those loan segments. The loss analysis is then adjusted for qualitative factors that may have an impact on loss experience in the particular loan segments.
The Allowance and the reserve for unfunded loan commitments are significant estimates that can and do change based on management’s process in analyzing the loan portfolio and on management’s assumptions about specific borrowers and applicable economic and environmental conditions, among other factors. In considering all of the above factors, management believes that the Allowance at September 30, 2014 is adequate. Although the Company maintains its Allowance at a level which it considers adequate to provide for probable charge-offs, there can be no assurance that such charge-offs will not exceed the estimated amounts, thereby adversely affecting future results of operations.
Loans acquired through acquisition are recorded at estimated fair value on their purchase date without a carryover of the related Allowance. Loans acquired with deteriorated credit quality are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect principal and interest payments according to contractual terms. These loans are accounted for under ASC Subtopic 310-30Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality. Evidence of credit quality deterioration as of the purchase date may include factors such as past due and non-accrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the credit loss or non accretable yield. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield
Page 61 of 71
Table of Contents
and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses.
The following table is a summary of the activity for the Allowance as of the dates and for the periods indicated (dollars in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Allowance for loan loss at beginning of period | $ | 11,284 | $ | 9,412 | $ | 10,603 | $ | 8,803 | ||||||||
Provision for loan losses | 35 | 631 | 518 | 1,918 | ||||||||||||
Net (charge-offs) recoveries: | ||||||||||||||||
Charge-offs | (8 | ) | (786 | ) | (165 | ) | (1,523 | ) | ||||||||
Recoveries | 37 | 781 | 392 | 840 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net (charge-offs) recoveries | 29 | (5 | ) | 227 | (683 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Allowance for loan loss at end of period | $ | 11,348 | $ | 10,038 | $ | 11,348 | $ | 10,038 | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net (charge-offs) recoveries to average loans | 0.00 | % | 0.00 | % | (0.02 | )% | (0.08 | )% |
The following is a summary of our asset quality data and key ratios at the dates indicated (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||
Loans originated by the Bank on non-accrual | $ | 2,018 | $ | 1,657 | ||||
Loans acquired through acquisition that are on non-accrual | 2,336 | 7,899 | ||||||
|
|
|
| |||||
Total nonaccrual loans | 4,354 | 9,556 | ||||||
Other Real Estate Owned | — | — | ||||||
|
|
|
| |||||
Total non-performing assets | $ | 4,354 | $ | 9,556 | ||||
|
|
|
| |||||
Nonaccrual loans to total loans | 0.44 | % | 1.02 | % | ||||
Total non-performing assets to total assets | 0.30 | % | 0.68 | % | ||||
Allowance for loan losses to total loans | 1.16 | % | 1.14 | % | ||||
Allowance for loan losses to total loans accounted at historical cost, which excludes acquired loans and related allowance | 1.43 | % | 1.50 | % | ||||
Allowance for loan losses to nonaccrual loans accounted at historical cost, which excludes nonaccrual acquired loans and related allowance | 562.2 | % | 639.8 | % | ||||
Allowance for loan losses to total non-accrual loans | 260.6 | % | 111.0 | % |
Page 62 of 71
Table of Contents
Deposits
The following table presents the balance of each major category of deposits at the dates indicated (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||||||||||
Amount | % of Total | Amount | % of Total | |||||||||||||
Non-interest bearing demand deposits | $ | 698,251 | 55 | % | $ | 632,192 | 51 | % | ||||||||
Interest bearing transaction accounts | 145,899 | 12 | % | 155,735 | 13 | % | ||||||||||
Money market and savings deposits | 365,945 | 29 | % | 380,915 | 31 | % | ||||||||||
Certificates of deposit | 52,852 | 4 | % | 63,581 | 5 | % | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Total deposits | $ | 1,262,947 | 100 | % | $ | 1,232,423 | 100 | % | ||||||||
|
|
|
|
|
|
|
|
Total deposits increased $30.5 million to $1.3 billion at September 30, 2014 mainly due to a $66.1 million increase in non-interest bearing demand deposits, offset by a $35.5 million decrease in total interest bearing deposits. At September 30, 2014 and December 31, 2013, non-interest bearing deposits represented 55% and 51% of total deposits, respectively.
Page 63 of 71
Table of Contents
The following table provides a summary of the Bank’s primary and secondary liquidity levels at the dates indicated (dollars in thousands):
September 30, 2014 | December 31, 2013 | |||||||
Amount | Amount | |||||||
Primary Liquidity- On Balance Sheet: | ||||||||
Cash and due from banks | $ | 27,882 | $ | 23,156 | ||||
Interest-earning deposits in other financial institutions | 167,859 | 218,131 | ||||||
Investment securities available-for-sale | 139,552 | 106,488 | ||||||
Less: pledged cash and due from banks | (1,500 | ) | (1,500 | ) | ||||
Less: pledged investment securities | (104,027 | ) | (92,800 | ) | ||||
|
|
|
| |||||
Total primary liquidity | $ | 229,766 | $ | 253,475 | ||||
|
|
|
| |||||
Ratio of primary liquidity to total deposits | 18.2 | % | 21.5 | % | ||||
Additional Liquidity Not Included In Primary Liquidity: | ||||||||
Certificates of deposit in other financial institutions | $ | 74,473 | $ | 60,307 | ||||
Less: Certificate of deposits pledged | (2,731 | ) | (4,341 | ) | ||||
|
|
|
| |||||
Total additional liquidity | $ | 71,742 | $ | 55,966 | ||||
|
|
|
| |||||
Secondary Liquidity- Off-Balance Sheet: | ||||||||
Available Borrowing Capacity: | ||||||||
Total secured borrowing capacity with FHLB | $ | 259,227 | $ | 292,000 | ||||
Fed Funds borrowing lines | 47,000 | 54,500 | ||||||
Secured credit line with the FRBSF | 19,736 | 5,245 | ||||||
|
|
|
| |||||
Total secondary liquidity | $ | 325,963 | $ | 351,745 | ||||
|
|
|
|
As of September 30, 2014, the Company’s primary overnight source of liquidity consisted of the balances reflected in the table above. The Company’s primary liquidity consisted of cash and due from banks and interest-earning deposits at financial institutions. The amount of funds maintained directly with the Federal Reserve included in interest-earning deposits in other financial institutions was $132.5 million and $203.0 million, at September 30, 2014 and December 31, 2013, respectively. The next source of liquidity is the Company’s collateralized borrowings and unsecured borrowing facilities. In addition, the Company has $74.5 million of Certificates of deposits in other financial institutions where the average maturity is approximately 6.0 months that could be utilized over time to supplement the liquidity needs of the Company.
The Company’s primary long term source of funding has come from the liability side of the balance sheet and has historically been through the growth in non-interest bearing and interest bearing core deposits from its customers. Additional sources of funds from the Company’s asset side of the balance sheet have included Federal Funds sold, interest-earning deposits with other financial institutions, balances maintained with the Federal Reserve Bank, certificates of deposit in other financial institutions and payments of principal and interest on loans and investment securities. While maturities and scheduled principal amortization on loans are a reasonably predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition.
As an additional source of liquidity, the Company maintains credit facilities, “Fed Funds Borrowing Lines,” of $47.0 million and $54.5 million at September 30, 2014 and December 31, 2013, respectively, with its primary correspondent banks for the purchase of overnight Federal funds. The lines are subject to availability of funds and have restrictions as to the number of days and length used during a month. At September 30, 2014 and December 31, 2014, $5 million of these credit facilities required the pledging of investment securities collateral.
The Company has established a secured credit facility with the FHLB of San Francisco which allows the Bank to borrow up to 25% of the Bank’s total assets, which equates to a credit line of approximately $357 million at September 30, 2014. The Company currently has no outstanding borrowings with the FHLB. As of September 30, 2014, the Company had $606 million of loan collateral pledged with the FHLB. This level of loan collateral would provide the Company with $259 million in borrowing capacity. Any amount of borrowings in excess of the $259 million would require the Company to pledge additional collateral. In addition, the Company must maintain a certain investment level in the common stock of the
Page 64 of 71
Table of Contents
FHLB. The Company’s investment in the common stock of the FHLB is $4.2 million at September 30, 2014. This level of capital would allow the Company to borrow up to $89 million. Any advances from the FHLB in excess of the $89 million would require additional purchases of FHLB common stock. The Company had no securities pledged with the FHLB at September 30, 2014.
The Company maintains a secured credit facility with the Federal Reserve Bank of San Francisco (“FRBSF”) which is collateralized by investment securities pledged with the FRB. At September 30, 2014, the Company’s available borrowing capacity was $19.7 million.
The Company maintains investments in certificates of deposit with other financial institutions, with various balances maturing monthly. The Company had balances of $74.5 million and $60.3 million at September 30, 2014 and December 31, 2013, respectively. At September 30, 2014, $2.7 million of the Company’s certificates of deposit with other financial institutions were pledged as collateral as credit support for the interest rate swap contracts and are not available as a source of liquidity.
At September 30, 2014 and December 31, 2013, $1.5 million of the Company’s due from bank balances was pledged as collateral as credit support for the interest rate swap contracts and is not available as a source of liquidity.
The Company’s commitments to extend credit (off-balance sheet liquidity risk) are agreements to lend funds to customers as long as there are no violations as established in the loan agreement. Many of the commitments are expected to expire without being drawn upon, and as such, the total commitment amounts do not necessarily represent future cash requirements. Financial instruments with off-balance sheet risk for the Company include both undisbursed loan commitments, as well as undisbursed letters of credit. The Company’s exposure to extend credit was $419 million and $346 million at September 30, 2014 and December 31, 2013, respectively.
CU Bancorp’s liquidity on a stand-alone basis was $3.7 million and $4.3 million, in cash on deposit at the Bank, at September 30, 2014 and December 31, 2013, respectively. Management believes this amount of cash is currently sufficient to fund the holding company’s cash flow needs over at least the next twelve to twenty-four months.
To date, the Company has not paid any cash dividends. Payment of stock or cash dividends in the future will depend upon earnings, liquidity, financial condition and other factors deemed relevant by our Board of Directors. Notification to the FRB is required prior to declaring and paying a dividend to shareholders that exceeds earnings for the period for which the dividend is being paid. This notification requirement is included in regulatory guidance regarding safety and soundness surrounding capital and includes other non-financial measures such as asset quality, financial condition, capital adequacy, liquidity, future earnings projections, capital planning and credit concentrations. Should the FRB object to dividend payments, the Company would be precluded from declaring and paying dividends, until approval is received or the Company no longer needs to provide notice under applicable guidance.
California law also limits the Company’s ability to pay dividends. A corporation may make a distribution/dividend from retained earnings to the extent that the retained earnings exceed (a) the amount of the distribution plus (b) the amount if any, of dividends in arrears on shares with preferential dividend rights. Alternatively, a corporation may make a distribution/dividend, if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution/dividend.
The Bank is subject to certain restrictions on the amount of dividends that may be declared without regulatory approval. Such dividends shall not exceed the lesser of the Bank’s retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). In addition, the Bank may not pay dividends that would result in its capital being reduced below the minimum requirements shown above for capital adequacy purposes.
As of September 30, 2014, both CU Bancorp and the Bank had positive retained earnings and positive net income that would allow either of them to declare and pay a dividend as of September 30, 2014. However, neither CU Bancorp nor the Bank has plans to declare and pay a cash dividend at the current time.
The Company has a program to repurchase a portion of an employee’s outstanding restricted stock upon the vesting of this restricted stock, but only in amounts necessary to cover the employee tax withholding obligations at the option of the
Page 65 of 71
Table of Contents
restricted stockholder (employee). The Company had this program in place during all of 2013 and through the nine months ending September 30, 2014. This program was designed to provide the Bank’s employees with the financial ability to cover their tax liability obligation associated with the vesting of their restricted stock at the date of vesting. These transactions under the State of California Corporations Code are defined as distributions to shareholders.
Capital Resources
The Company’s objective is to maintain a level of capital that will support sustained asset and loan growth, provide for anticipated credit risks, and ensure that regulatory guidelines and industry standards are met. The Company and the Bank are subject to certain minimum capital adequacy and minimum well capitalized category guidelines adopted by the FRB and the FDIC. These guidelines relate primarily to the Tier 1 leverage ratio, the Tier 1 risk-based capital ratio, and the Total risk-based capital ratio. The minimum well capitalized required ratios are 5.00% Tier 1 leverage, 6.00% Tier 1 risk-based capital and 10.00% total risk-based capital.
At September 30, 2014, the respective capital ratios of the Company and the Bank exceeded the minimum percentage requirements to be deemed “well-capitalized” under the current capital guidelines. The following tables present the regulatory capital ratios requirements and the actual capitalization levels of the Company and the Bank as of the dates indicated (dollars in thousands):
CU Bancorp | September 30, 2014 | December 31, 2013 | Adequately Capitalized | Well Capitalized | ||||||||||||
Amount | Amount | (greater than or equal to) | ||||||||||||||
Regulatory Capital Ratios: | ||||||||||||||||
Tier 1 leverage ratio | 10.12 | % | 9.57 | % | 4.0 | % | 5.0 | % | ||||||||
Tier 1 risk-based capital ratio | 11.88 | % | 11.84 | % | 4.0 | % | 6.0 | % | ||||||||
Total risk-based capital ratio | 12.83 | % | 12.80 | % | 8.0 | % | 10.0 | % | ||||||||
Regulatory Capital Data: | ||||||||||||||||
Tier 1 capital | $ | 146,277 | $ | 134,440 | ||||||||||||
Total risk-based capital | 158,030 | 145,372 | ||||||||||||||
Average total assets | 1,445,873 | 1,404,293 | ||||||||||||||
Risk-weighted assets | 1,231,336 | 1,135,552 |
California United Bank | September 30, 2014 | December 31, 2013 | Adequately Capitalized | Well Capitalized | ||||||||||||
Amount | Amount | (greater than or equal to) | ||||||||||||||
Regulatory Capital Ratios: | ||||||||||||||||
Tier 1 leverage ratio | 9.42 | % | 8.90 | % | 4.0 | % | 5.0 | % | ||||||||
Tier 1 risk-based capital ratio | 11.06 | % | 10.99 | % | 4.0 | % | 6.0 | % | ||||||||
Total risk-based capital ratio | 12.02 | % | 11.96 | % | 8.0 | % | 10.0 | % | ||||||||
Regulatory Capital Data: | ||||||||||||||||
Tier 1 capital | $ | 136,154 | $ | 124,750 | ||||||||||||
Total risk-based capital | 147,957 | 135,682 | ||||||||||||||
Average total assets | 1,444,845 | 1,402,041 | ||||||||||||||
Risk-weighted assets | 1,230,725 | 1,134,653 |
Total Tier 1 capital of the Company increased by $11.9 million or 8.8% to $146.3 million during the nine month period ending September 30, 2014. The increase in the Company’s Tier 1 leverage ratio during the nine months ended September 30, 2014, was primarily the result of the following increases to capital: nine months of earnings of $7.6 million, the exercise of employee stock options of $1.3 million, stock based compensation expense of $1.3 million, excess tax benefits related to stock based compensation of $477,000, an increase in other comprehensive income (the increase in unrealized gains or the decrease in unrealized losses on investment securities) of $408,000 and a decrease in the amount of
Page 66 of 71
Table of Contents
disallowed deferred tax that is subtracted from regulatory capital increased capital by approximately $1.1 million. For regulatory capital calculations, a portion of the Company’s deferred tax asset may be disallowed based on the regulatory capital disallowance calculation. There was no disallowed deferred tax asset that was subtracted from regulatory capital at September 30, 2014.
Total risk-based capital of the Company increased by $12.7 million or 8.7% to $158 million during the nine months ended September 30, 2014. The major component elements that resulted in the increase in the Company’s Tier 1 risk-based capital, as described above were the same components that lead to the increases in the Total risk-based capital during the nine months ended September 30, 2014. The Company’s Risk-weighted assets used in the calculation of Total risk-based capital ratio increased by $95.8 million or 8.4%.
Total Tier 1 capital at the Bank increased by $11.4 million or 9.1% to $136.2 million during the nine month period ending September 30, 2014. The increase in the Bank’s Tier 1 leverage ratio during the nine months ended September 30, 2014 was primarily the result of the following increases to capital: nine months earnings of $8.2 million, stock based compensation expense of $1.3 million, excess tax benefits related to stock based compensation of $477,000, an increase in other comprehensive income (the increase in unrealized gains or the decrease in unrealized losses on investment securities) of $408,000 and a decrease in the amount of disallowed deferred tax that is subtracted from regulatory capital increased capital by approximately $1.1 million. For regulatory capital calculations, a portion of the Company’s deferred tax asset may be disallowed based on the regulatory capital disallowance calculation. There was no disallowed deferred tax asset that was subtracted from regulatory capital as of September 30, 2014. The Bank’s Average total assets used in the calculation of Tier 1 leverage ratio increased by $42.8 million or 3.1%.
Basel III Capital Standards
For a discussion regarding the phase in of the new Basel III capital requirements see the Company’s December 31, 2013 Form 10K, Part I, Item 1 – Business – Recent Legislation and Regulation –New Financial Institution Capital Rules.
Management has evaluated the final rules and their expected impact on the Company. Based upon that assessment, management believes the Company’s and Bank’s current capital levels at September 30, 2014 would equal or exceed the minimum capital requirements, including the capital conservation buffer, if they were in effect on that date.
Dodd-Frank Wall Street Reform and Consumer Protection Act
For a discussion regarding the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, see the Company’s December 31, 2013 Form 10K, Part I, Item 1 – Business – Supervision and Regulation – Recent Legislation and Regulation –Dodd-Frank Wall Street Reform and Consumer Protection Act, Final Volker Rule, and Bureau of Consumer Financial Protection.
Corporate Governance
The following are some of the key corporate governance practices at both the Company and the Bank, which are oriented to ensure that there are no conflicts of interest and that the Company operates in the best interests of shareholders:
• | Eight of the Company’s and Bank’s eleven directors at September 30, 2014 are independent outside directors. |
• | A new independent director was appointed effective April 1, 2014. |
• | None of the Company’s senior officers and directors have received loans from the Bank. |
• | There are no loans by the Bank to outside companies controlled by, or affiliated with officers or directors. |
• | The Company’s Board of Directors has Audit and Risk, and Compensation, Nomination and Governance committees comprised solely of independent outside directors. |
Number of Employees
The number of active full-time equivalent employees increased from 176 at December 31, 2013 to 178 at September 30, 2014.
Page 67 of 71
Table of Contents
ITEM 3. | Quantitative and Qualitative Disclosures about Market Risk |
The Company’s primary market risk is interest rate risk. Interest rate risk is the potential for economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. To mitigate interest rate risk, the structure of the Company’s balance sheet is managed with the objective of correlating the movements of interest rates on loans and investments with those of deposits and borrowings.
The Company’s exposure to interest rate risk is reviewed by the Company’s management Asset/Liability Committee formally on a quarterly basis and on an ongoing basis. The main tool used to monitor interest rate risk is a dynamic simulation model that quantifies the estimated exposure of net interest income to sustained interest rate changes. The simulation model estimates the impact of changing interest rates on the interest income from all interest-earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company’s balance sheet. This sensitivity analysis is compared to the Company’s policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 100 and 400 basis point upward and 200 basis point downward shift in interest rates.
An additional tool used by management to monitor interest rate risk includes the standard GAP report, which measures the estimated difference between the amount of interest-sensitive assets and interest-sensitive liabilities anticipated to mature or reprice during future periods, based on certain assumptions. In general, the GAP report presents the carrying amounts of these assets and liabilities in a particular period based on either the date that they first reprice, for variable rate products, or the maturity date, for fixed rate products.
At September 30, 2014, the Company had twenty three pay-fixed, receive-variable interest rate contracts that were designed to convert fixed rate loans into variable rate loans. Twenty one of these swap contacts are designated as fair value hedges. For additional information on these interest rate contracts, see Note 9 – Derivative Financial Instruments located in Part I, Item 1.—Notes to the Consolidated Financial Statements.
The Company has no market risk sensitive instruments held for trading purposes. Management believes that the Company’s market risk is reasonable at this time.
The following depicts the Company’s net interest income sensitivity analysis as of September 30, 2014 (dollars in thousands):
Simulated Rate Changes | Estimated Net Interest Income Sensitivity | |||||||
+ 400 basis points | 37.7 | % | $ | 16,549 | ||||
+ 100 basis points | 8.8 | % | $ | 3,870 | ||||
- 200 basis points (1) | (4.0 | )% | $ | (1,743 | ) |
The Company is currently asset sensitive. The estimated sensitivity does not necessarily represent our forecast and the results may not be indicative of actual changes to our net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, pricing strategies on loans and deposits and replacement of asset and liability cash flows. The duration of the Company’s investment securities portfolio at September 30, 2014 is approximately 2.7. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.
Variable rate loans make up 70% of the loan portfolio. However, the Company has floors on some of its loans. At September 30, 2014, 50% of variable rate loans are at their floor, and thus an increase in the underlying index may not necessarily result in an increase in the coupon until the loan index plus margin exceeds that floor.
The Company’s static GAP as of September 30, 2014, is not materially different from that reported at December 31, 2013 and is thus not included in this 10Q. See the Company’s Static Gap reports under “Item7A-Quantitative and Qualitative Disclosures about Market Risk” in the Company’s 2013 Annual Report on Form 10-K.
(1) | The simulated rate change under the -200 basis points reflected above actually reflects only a maximum negative 25 basis points or less decline in actual rates based on the current targeted Fed Funds target rate by the government of 0% to 0.25%. The -200 simulation model reflects repricing of liabilities of less than 0.25% due to the Company paying significantly less than 25 basis points on its deposit accounts, and higher downward repricing of the Company’s interest-earning assets in the -200 simulation model. |
Page 68 of 71
Table of Contents
ITEM 4. | Controls and Procedures |
(a) | As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s principal executive officer (“CEO”) and principal financial officer (“CFO”) have evaluated the effectiveness of the Company’s “disclosure controls and procedures” (“Disclosure Controls”). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) (as adopted by the FDIC), are procedures that are designed with the objective of ensuring that information required to be disclosed in the Company’s reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. |
The Company’s management, including the CEO and CFO, does not expect that the Company’s Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based upon their controls evaluation, the CEO and CFO have concluded that the Company’s Disclosure Controls are effective at a reasonable assurance level.
(b) | There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. |
Page 69 of 71
Table of Contents
ITEM 1. | Legal Proceedings |
None.
ITEM 1A. | Risk Factors |
See “Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” relating to “forward-looking” statements included in this report for a discussion of additional risk factors related to the Company’s proposed acquisition of 1st Enterprise Bank through the merger of 1st Enterprise with and into the Company’s subsidiary California United Bank which will be the surviving bank in the merger transaction.
ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
ITEM 3. | Defaults upon Senior Securities |
None.
ITEM 4. | Mine Safety Disclosures |
Not applicable.
ITEM 5. | Other Information |
(a) | None. |
(b) | None. |
ITEM 6. | Exhibits |
(a) | Index to Exhibits |
Exhibit | Description | |
10.1* | CU Bancorp 2007 Equity and Incentive Plan as amended and restated July 31, 2014, incorporated by reference to Exhibit 10.6 to the Registration Statement on Form S-4, as filed with the Securities and Exchange Commission on August 20, 2014 | |
31.1⌂ | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2⌂ | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1⌂ | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2⌂ | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
101.INS⌂ | XBRL Instance Document | |
101.SCH⌂ | XBRL Taxonomy Extension Schema Document | |
101.CAL⌂ | XBRL Taxonomy Calculation Linkbase Document | |
101.LAB⌂ | XBRL Taxonomy Label Linkbase Document | |
101 DEF⌂ | XBRL Taxonomy Extension Definition Linkbase Document | |
101.PRE⌂ | XBRL Taxonomy Presentation Linkbase Document |
* | Refers to management contracts or compensatory plans or arrangements |
⌂ | Attached hereto |
Page 70 of 71
Table of Contents
Pursuant to the requirements of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CU BANCORP
Date: | November 7, 2014 | /s/ DAVID I. RAINER | ||||||
David I. Rainer | ||||||||
President and Chief Executive Officer | ||||||||
Date: | November 7, 2014 | /s/ KAREN A. SCHOENBAUM | ||||||
Karen A. Schoenbaum | ||||||||
Executive Vice President and Chief Financial Officer |
Page 71 of 71