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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
/X/ For the Quarterly Period Ended March 31, 1994, or
Transition Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from _________ to _________.
-------------------------------
Commission File Number 0-11008
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CU BANCORP
(Exact name of registrant as specified in its charter)
California 95-3657044
---------- ----------
(State or other Jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
818-907-9122
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address, and former
fiscal year if changes 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 / /
As of March 31, 1994, the Registrant has outstanding 4,437,312 shares
of its Common Stock, no par value.
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CU Bancorp
Quarter Ended March 31, 1994
Table of Contents - Form 10-Q
Page
Part I. Financial Information ----
Item 1. Financial Statements
Management's Discussion and Analysis of Financial
Condition and Results of Operation. 3
Consolidated Statements of Financial Condition:
-March 31, 1994, and December 31, 1993. 17
Consolidated Statements of Income:
-Three Month Periods Ended March 31, 1994, and
March 31, 1993. 18
Consolidated Statements of Cash Flows:
-Three Month Periods Ended March 31, 1994, and
March 31, 1993. 19
Notes to Consolidated Financial Statements 20
Signatures 24
Part II. Other Information
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Filings on Form 8-K 25
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MANAGMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
The Company earned $578 thousand, or $0.13 per share, during the first
quarter of 1994, compared to $384 thousand, or $0.09 per share, during
the same period in 1993. This represented the fifth consecutive
quarter of increased profits. First quarter 1994 earnings included
profitable performance by the bank and a gain on the sale of a portion
of the mortgage servicing rights retained by the Bank when its
mortgage origination network was sold in 1993.
The Bank's asset quality ratios continue to be exceptionally strong.
At March 31, 1994, nonperforming assets were $1.1 million, down $1.2
million, or 52%, from the prior quarter, and nearly $9.9 million, or
90% from the first quarter of 1993. By March 31, 1994, the Bank did
not have any real estate acquired through foreclosure. The
improvement in asset quality over the past year is illustrated by
Graph 1: Nonperforming Assets. The Bank's allowance for loan losses
as a percent of both nonperforming loans and nonperforming assets at
the end of the first quarter of 1994 was 652%, compared to first
quarter 1993 levels of 164% and 98%, respectively. This trend can be
seen in Graph 2: Ratio of Allowance for Loan Losses to Nonperforming
Assets.
Graph 1: Nonperforming Assets
[GRAPH 1]
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Graph 1 Data: Nonperforming Assets
March 31, 1993 June 30, 1993 September 30, 1993 December 31, 1993 March 31, 1994
-------------- ------------- ------------------ ----------------- --------------
Nonperforming Loans $6,602 $6,530 $1,065 $1,378 $1,108
Nonperforming Assets 11,034 9,988 4,034 2,298 $1,108
The allowance for loan losses as a percentage of nonperforming loans
and assets has increased as both nonperforming categories were
reduced. During the first quarter of 1994, the Bank enjoyed a net
recovery as recoveries exceeded chargeoffs for the second consecutive
quarter. Net recoveries further increase the allowance's coverage of
the nonperforming loans and assets.
Graph 2: Allowance for Loan Losses to Nonperforming Assets
[GRAPH 2]
Graph 2 Data: Allowance for Loan Losses to Nonperforming Assets
March 31, June 30, September 30, December 31, March 31,
1993 1993 1993 1993 1994
Allowance to: ---- ---- ---- ---- ----
Nonperforming Loans 164% 118% 536% 473% 652%
Nonperforming Assets 98% 77% 142% 283% 652%
Capital ratios are strong, substantially exceeding levels required to
be in the "well capitalized" category established by bank regulators.
The Total Risk-Based Capital Ratio was 17.0%, the Tier 1 Risk-Based
Capital Ratio was 15.7%, and the Leverage Ratio was 10.7% at March 31,
1994, compared to 16.7%, 15.4%, and 9.2%, respectively, at year-end
1993. Regulatory requirements for Total Risk-Based, Tier 1 Risk-
Based, and Leverage capital ratios are a minimum of 8%, 4%,
5
and 3%, respectively, and for classification as well capitalized, 10%, 6%, and
5%, respectively.
The successful results in 1993 concerning asset quality, regulatory
relations, growth of middle market lending and strategic focus make
expansion and growth possible in 1994. Two new loan production offices
were opened in January 1994. These offices will allow expanded market
penetration and commercial portfolio diversification. Subsequent to
the end of the first quarter of 1994, the Bank acquired the deposits
of the Encino branch of Mechanics National Bank from the FDIC, to
expand and improve deposit mix.
Balance Sheet Analysis
LOAN PORTFOLIO COMPOSITION AND CREDIT RISK
Loan portfolio quality has been a focal point of management's
attention since June 1992. As a result, considerable improvements have
been made. Credit policies have been established to promote quality
production. Further, target markets have been redefined to emphasize
middle market commercial lending and reduce real estate
concentrations.
The Bank's focus on middle market lending, in its infancy at year-end
1992, gained momentum in 1993 and 1994. While total loans decreased
from year-end 1993 to March 31, 1994 the assets of the core commercial
bank increased. Offsetting this, the remaining Held for Sale mortgages
of $10.4 million at December 31, 1993 were sold in the first quarter
of 1994. Excluding this planned liquidation, loans increased by $6.9
million, or 5%, for the quarter ended March 31, 1994.
Table 1 Loan Portfolio Composition
Amounts in thousands of dollars March 31, December 31, March 31,
1994 1993 1993
---- ---- ----
Commercial & Industrial Loans $126,885 $120,513 $111,181
Real Estate Loans:
Held for Sale 0 10,426 58,576
Mortgages 9,166 8,496 39,081
Construction 1,010 1,226 261
Other Loans 0 0 494
------- ------- -------
Total loans net of unearned fees $137,061 $140,661 $209,593
======= ======= =======
The Bank's credit policy limits concentrations of loans in any
industry or collateral. Efforts to reduce any remaining concentrations
continue.
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Historically, the Bank's real estate loans secured by single family
residences were principally mortgages held for sale that were
originated by the Mortgage Banking Operation. These were sold to
investors through firm commitments, generally in less than 90 days.
The loans amounted to $10.4 million, or 7.4% of the December 31, 1993,
loan portfolio. This part of the loan portfolio historically presents
almost no credit risk. The mortgage origination operation sale
eliminated this loan concentration. The remainder of real estate loans
are generally collateralized by a first or second trust deed position.
Lending efforts have been directed away from commercial real estate,
as well as construction and multifamily lending. The Bank is now
focused on business lending to middle market customers. Current credit
policy now permits commercial real estate lending generally only as
part of a complete commercial banking relationship with a middle
market customer. Existing commercial real estate loans, 19% of the
loan portfolio, or $26 million at March 31, 1994, compared to $27
million at year-end 1993, are secured by first or second liens on
office buildings and other structures. The loans are secured by real
estate that had appraisals in excess of loan amounts at origination.
Monitoring and controlling the Bank's allowance for loan losses is a
continuous process. All loans are assigned a risk grade, as defined by
credit policies, at origination and are monitored to identify changing
circumstances that could modify their inherent risks. These
classifications are one of the criteria considered in determining the
adequacy of the allowance for loan losses.
The amount and composition of the allowance for loan losses is as follows:
Table 2 Allocation of Allowance for Loan Losses
Amounts in thousands of dollars March 31, December 31, March 31,
1994 1993 1993
---- ---- ----
Commercial & Industrial Loans $6,392 $5,699 $9,783
Real estate loans - Held for Sale 0 67 128
Real estate loans - Mortgages 277 225 324
Real estate loans - Construction 5 10 45
Other loans 0 0 12
Loans 6,674 6,001 10,292
Unfunded commitments and letters of credit 551 512 531
------ ------ -------
Total Allowance for loan losses $7,225 $6,513 $10,823
====== ====== =======
Adequacy of the allowance is determined using management's estimates
of the risk of loss for the portfolio and individual loans. Included
in the criteria used to evaluate credit risk are, wherever
appropriate, the borrower's cash flow, financial condition, management
capabilities, and collateral valuations, as well as industry
conditions. A portion of the allowance is established to address the
risk inherent in
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general loan categories, historic loss experience,
portfolio trends, economic conditions, and other factors. Based on
this assessment a provision for loan losses may be charged against
earnings to maintain the adequacy of the allowance. The allocation of
the allowance based upon the risks by type of loan, as shown in Table
2, implies a degree of precision that is not possible when using
judgments. While the systematic approach used does consider a variety
of segmentations of the portfolio, management considers the allowance
a general reserve available to address risks throughout the entire
loan portfolio.
Activity in the allowance, classified by type of loan, is as follows:
Table 3 Analysis of the Changes in the Allowance for Loan Loss
Amounts in thousands of dollars For the Periods Ended
March 31, December 31, March 31,
1994 1993 1993
---- ---- ----
Balance at January 1 $6,513 $12,986 $12,986
Loans charged off:
Real estate secured loans 200 3,266 568
Commercial loans secured and unsecured 464 6,582 2,520
Loans to individuals, installment and other loans 0 901 209
Total charge-offs 664 10,749 3,297
Recoveries of loans previously charged off:
Real estate secured loans 493 393 2
Commercial loans secured and unsecured 882 3,189 949
Loans to individuals, installment and other loans 0 244 33
Total recoveries of loans previously charged off 1,377 3,826 984
Net charge-off (recovery) (713) 6,923 2,313
Provision for loan losses 0 450 150
------ ------ -------
Balance at end of period $7,226 $6,513 $10,823
====== ====== =======
Net loan charge-offs (recoveries) as a percentage of
average gross loans outstanding during the period ended (0.52)% 3.49% 1.15%
==== ==== ====
The Bank's policy concerning nonperforming loans is more conservative
than is generally required. It defines nonperforming assets as all
loans ninety days or more delinquent, loans classified nonaccrual, and
foreclosed, or in substance foreclosed real estate. Nonaccrual loans
are those whose interest accrual has been discontinued because the
loan has become ninety days or more past due or there exists
reasonable doubt as to the full and timely collection of principal or
interest. When a loan is placed on nonaccrual status, all interest
previously accrued but uncollected is reversed against operating
results. Subsequent payments on nonaccrual loans are treated as
principal reductions. At March 31, 1994, nonperforming loans amounted
to $1.1 million, down 20% from $1.4 million at December 31, 1993.
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Table 4: Nonperforming Assets
Amounts in thousands of dollars March 31, December 31, March 31,
1994 1993 1993
---- ---- ----
Loans not performing (1) $308 $378 $3,067
Insubstance foreclosures 800 1,000 3,535
----- ----- -----
Total nonperforming loans 1,108 1,378 6,602
Other real estate owned 0 920 4,432
----- ----- -----
Total nonperforming assets $1,108 $2,298 $11,034
===== ===== ======
Allowance for loan losses as a percent of:
Nonperforming loans 652% 473% 164%
Nonperforming assets 652% 283% 98%
Nonperforming assets as a percent of total assets 0.8% 0.8% 3.3%
Nonperforming loans as a percent of total loans 0.8% 1.0% 3.1%
Note 1:
Loans not performing
Performing as agreed $271 $9 $2,034
Partial performance 0 369 1,162
Not performing 37 0 3,406
------ ------ ------
$308 $378 $6,602
====== ====== ======
Nonaccrual:
Loans $308 $378 $5,595
Troubled debt restructurings 0 0 1,007
(a) Past due with respect to principal and/or interest and continuing to accrue interest.
SECURITIES
The securities portfolio at March 31, 1994, totaled $68.8 million,
compared to $88.0 million at year-end 1993. The securities are all
held in a Held for Investment portfolio. There was no held for sale
portfolio at March 31, 1994 or year-end 1993. This portfolio is
recorded at amortized cost. It is the Bank's intention to hold these
securities to their individual maturity dates.
There have been no realized gains or losses on securities in the first
quarter of 1994. Gains of $77 thousand were realized in the
comparable quarter of 1993. At March 31, 1994, there were unrealized
gains of $28 thousand and losses of $961 thousand in the securities
portfolio.
Additional information concerning securities is provided in the
footnotes to the accompanying financial statements.
OTHER REAL ESTATE OWNED
At March 31, 1994, there was no Other Real Estate Owned on the Bank's
balance sheet, compared with $920 thousand at December 31, 1994. The
carrying values of these properties are at fair value, which is
determined using recent appraisal values adjusted, if necessary, for
other market conditions. Loan balances in
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excess of fair value are charged to the allowance for loan losses when the loan
is reclassified to other real estate. Subsequent declines in fair value are
charged against an allowance for real estate owned losses created by charging
a provision to other operating expenses. Expenses related to Other
Real Estate Owned were $8 thousand in the quarter ended March 31, 1994
and $22 thousand in the first quarter of 1993.
DEPOSIT CONCENTRATION
Due to its historic focus on real estate-related activities, the Bank
developed a concentration of deposit accounts from title insurance and
escrow companies. These deposits are generally noninterest bearing
transaction accounts that contribute to the Bank's interest margin.
Noninterest expense related to these deposits is included in other
operating expense. The Bank monitors the profitability of these
accounts through an account analysis procedure.
The Bank offers products and services allowing these customers to
operate with increased efficiency. A substantial portion of the
services, provided through third party vendors, are automated data
processing and accounting for trust balances maintained on deposit at
the Bank. These and other banking related services, such as messenger
and deposit courier services, will be limited or charged back to the
customer if the deposit relationship profitability does not meet the
Bank's expectations.
Noninterest bearing deposits represent nearly the entire title and
escrow relationship. These balances have been reduced substantially
as the Bank focused on middle market business loans. The balance at
March 31, 1994, was $49.2 million compared to $58.1 million at
December 31, 1993. Costs relative to servicing the above
relationships are the significant portion of the Bank's customer data
processing and messenger and courier costs. Part of the decrease in
these expenses is related to lower general market interest rates, but
the majority is due to the reduced amount of this deposit
concentration.
The Bank had $17.0 million in certificates of deposit larger than $100
thousand dollars at March 31, 1994. The maturity distribution of these
deposits is relatively short term, with $11.2 million maturing within
3 months and the balance maturing within 12 months.
LIQUIDITY AND INTEREST RATE SENSITIVITY
The objective of liquidity management is to ensure the Bank's ability
to meet cash requirements. The liquidity position is managed giving
consideration to both on and off-balance sheet sources and demands for
funds.
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Sources of liquidity include cash and cash equivalents (net of Federal
Reserve requirements to maintain reserves against deposit
liabilities), securities eligible for pledging to secure borrowings
from dealers pursuant to repurchase agreements, loan repayments,
deposits, and borrowings from a $20 million overnight federal funds
line available from a correspondent bank. Potential significant
liquidity requirements are withdrawals from noninterest bearing demand
deposits and funding of commitments to loan customers.
During 1993, the Bank maintained a $20 million line of credit with a
major purchaser of the mortgage loans originated by the mortgage
origination operation. This warehouse line was terminated in
conjunction with the sale of that operation.
From time to time the Bank may experience liquidity shortfalls ranging
from one to several days. In these instances, the Bank will either
purchase federal funds, and/or sell securities under repurchase
agreements. These actions are intended to bridge mismatches between
funding sources and requirements, and are designed to maintain the
minimum required balances. Liquidity volatility was significantly
reduced by the sale of the mortgage origination operation which
created volatility with production volume fluctuations.
The Bank's historical portfolio of large certificates of deposit
(those of $100 thousand or more) has not been significant relative to
the total deposit base. At March 31, 1994 this funding source was
7.8% of average deposits, compared to 7.3% at December 31, 1993. This
funding source has traditionally been used to manage liquidity needs
within the deposit portfolio.
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Table 5 Interest Rate Maturities of Earning Assets and Funding Liabilities
at March 31, 1994
Amounts in thousands of dollars Amounts Maturing or Repricing in
---------------------------------------------------------------------
More Than 3 More Than 6 More Than 9
Months But Months But Months But
Less Than 3 Less Than 6 Less Than 9 Less than 12 12 Months &
Months Months Months Months Over
----------- ----------- ----------- ------------ -----------
Earning Assets
Gross Loans (1) $128,971 $348 $886 $838 $5,018
Securities 20,999 4,053 3,416 3,000 38,750
Federal funds sold & other 17,000 --- --- --- ---
-------- ------ ------ ------ ------
Total earning assets 166,970 4,401 4,302 3,838 43,768
-------- ------ ------ ------ ------
Interest-bearing deposits:
Now and money market 62,913 --- --- --- ---
Savings 6,964 --- --- --- ---
Time certificates of deposit:
Under $100 6,479 5,071 3,089 623 1,375
$100 or more 11,193 3,108 1,770 500 425
Non interest-bearing demand deposits 46,080 --- --- --- ---
-------- ------ ------ ------ ------
Total interest-bearing liabilities 133,629 8,179 4,859 1,123 1,800
-------- ------ ------ ------ ------
Interest rate sensitivity gap 33,341 (3,778) (557) 2,715 41,968
-------- ------ ------ ------ ------
Cumulative interest rate sensitivity gap 33,341 29,563 29,006 31,721 73,689
Off balance sheet financial instruments 750 750 --- --- ---
-------- ------ ------ ------ ------
Net cumulative gap $34,091 $30,313 $29,006 $31,721 $73,689
======== ====== ====== ====== ======
Adjusted cumulative ratio of rate sensitive assets
to rate sensitive liabilities (2) 1.25% 1.21% 1.20% 1.21% 1.49%
======== ====== ====== ====== ======
(1) Included in loans are mortgages in the process of being sold.
(2) Ratios greater than 1.0 indicate a net asset sensitive position.
Ratios less than 1.0 indicate a liability sensitive position. A
ratio of 1.0 indicates a risk neutral position.
Assets and liabilities shown on Table 6 are categorized based on
contractual maturity dates. Maturities for those accounts without
contractual maturities are estimated based on the Bank's experience
with these customers. Noninterest bearing deposits of title and escrow
companies, having no contractual maturity dates, are considered
subject to more volatility than similar deposits from commercial
customers. The net cumulative gap position shown in the table above
indicates that the Bank does not have a significant exposure to
interest rate fluctuations during the next twelve months.
CAPITAL
Total shareholders' equity was $27.6 million at March 31, 1994,
compared to $27.0 million at year-end 1993. This increase was due to
earnings, plus the exercise of stock options. The Bank is guided by
statutory capital requirements, which are measured with three ratios,
two of which are sensitive to the risk inherent in various assets and
which consider off-balance sheet activities in assessing capital
adequacy. During 1994 and 1993, the Bank's capital levels exceeded
the "well capitalized" standards, the highest classification
established by bank regulators.
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Table 6 Capital Ratios
Regulatory Standards
---------------------------
March 31, December 31, Well
1994 1993 Minimum Capitalized
---- ---- ------- -----------
Total Risk Based Capital 17.0% 16.7% 8.0% 10.0%
Tier 1 Risk Base Capital 15.7 15.4 4.0 6.0
Leveraged Capital 10.7 9.2 3.0 5.0
No dividends have been paid in 1994 or 1993. Capital being generated
by current earnings are currently expected to be used to support
anticipated growth of the Bank.
The common stock of the Company is listed on the National Association
of Securities Dealers Automated Quotation (NASDAQ) National Market
Systems where it trades under the symbol CUBN.
EARNINGS BY LINE OF BUSINESS
Prior to the sale of the mortgage origination network in November,
1993, the Bank operated a commercial bank and a mortgage bank as two
distinct business segments. In 1994, real estate lending is generally
only done as part of a commercial banking relationship. For 1994,
therefore, the Bank consists of only a single segment, the commercial
banking operation. Table 7 shows the pre-tax operating contributions
by the Commercial Banking and Mortgage Banking divisions.
Table 7 Pre-tax operating contribution by line of business (i)
Amounts in thousands of dollars
March 31, 1994 March 31, 1993
-------------- -------------------------------------------
Commercial Mortgage
Consolidated Consolidated Banking Banking
------------- ------------- ----------- ---------
Net interest income $2,752 $3,814 $3,527 $287
Provisions for loan losses 0 150 150 0
2,752 3,664 3,377 287
Noninterest revenue 903 4,349 284 4,065
Total revenues 3,655 8,013 3,661 4,352
Salaries and related benefits 1,543 2,439 1,553 886
Other operating expenses 1,942 4,932 1,978 2,954
Total operating expenses 3,485 7,371 3,531 3,840
Operating income 170 642 130 512
Gain on sale of mortgage servicing portfolio 838 --- --- ---
------ ------ ------ -----
Income before taxes $1,008 $642 $130 $512
====== ====== ====== =====
(i) Inter-divisional transactions have been eliminated at the
division level.
The Bank changed its strategic direction during the second half of
1992 when the new management team committed its focus to southern
California's middle market commercial business. Historically, it had
concentrated on commercial real estate and related businesses. The
portfolios of loans and deposits that resulted
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from past operations have been substantially replaced by new middle market
commercial customer relationships.
Steps taken to facilitate the expansion and market penetration of the
commercial bank include the creation of loan production offices,
establishment of a Small Business Administration ("SBA") loan
production group, and development of an international trade services
group.
Loan production offices have been established in two strategic
locations in southern California. These will serve the San Gabriel
Valley area and the South Bay area. The offices are staffed with
seasoned commercial lenders whose primary focus is business
development. Such offices are cost effective approaches to business
development and allow the Bank access to wider market exposure. While
these offices are primarily staffed with existing personnel, when
appropriate, key people with specific market knowledge and experience
have been hired.
The Bank has established a group of lenders to focus on the production
of commercial loans that can be participated with the SBA. These loans
are subject to the same credit quality policies and procedures as all
commercial loan production. Fees generated from the sale of the
guaranteed portion of the loans will be an important new source of
noninterest income.
Another new product was added with the creation of an international
trade services group. Many of the Bank's existing commercial customers
and prospects are involved in import and/or export. This product line
includes letters of credit, foreign exchange, and foreign collections,
and is another important element in the total banking relationship
offered to our business customers.
NET INTEREST INCOME AND INTEREST RATE RISK
Net interest income is the difference between interest and fees earned
on earning assets and interest paid on funding liabilities. Net
interest income for the first quarter of 1994 was $2.8 million,
compared to $3.6 million for the same period in 1993. The change is
primarily attributable to changes in volume. As a result of efforts to
deal with credit quality issues and refocus the Bank on middle market
business customers, loans outside target markets have been motivated
to leave the Bank. Initially this has an adverse affect on net
interest margin but subsequent growth of the middle market loan
portfolio replaces these assets and provides a more reliable and
valuable source of interest margin.
Yields on earning assets were approximately 6.5% in the first quarter
of 1994, compared to a 7.6% yield for the same period in 1993. The
lower average yield
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on earning assets in 1994 is largely due to the
higher mix of Fed Funds and government securities held in 1994
compared with higher concentrations of mortgage loans in 1993.
Through October 8, 1993, net interest income continued to benefit from
an interest rate swap agreement, discussed below. Rates on interest-
bearing liabilities resulted in an average cost of funds of 3.0% in
1994, compared to 3.1% for 1993.
Shrinkage in the Bank's earning asset and funding liability portfolios
contributed to the reduction in net interest income. Average loans
during the first quarter of 1994 decreased $63 million from $200
million in the first quarter of 1993. As previously discussed, this
resulted from the sale of the held for sale mortgage loans, discussed
below, and management's efforts to improve the quality of the loan
portfolio and redirect production to middle market commercial loans.
Earning assets averaged $226 million in 1994, down $31 million from
$257 million in the same period of 1993
Following the sale of the mortgage origination operation, the Bank's
funded warehouse inventory was sold in the normal course of business.
The liquidation of this mortgage loan portfolio is being used to
increase the Bank's investment portfolio and liquidity position. This
liquidity will fund the expected growth of the Bank's core commercial
loan portfolio. While this transition will have a temporary adverse
impact on net interest margin, it facilitates the commercial loan
growth planned for 1994.
Expressing net interest income as a percent of average earning assets
is referred to as margin. Margin for 1994 was 4.91%, compared to 6.01%
for the same period in 1993. The Bank's margin is strong because it
has funded itself with a significant amount of noninterest bearing
deposits. The lower margin in 1994 is largely due to the maturing of
the interest rate swap discussed below.
Through October 8, 1993, the Bank continued to benefit from an
interest rate swap agreement entered into October 8, 1991, which had a
notional value of $100 million. Under this arrangement, the Bank
received a fixed rate of 8.18% and paid interest at prime rate, which
was 6.0% during 1993. The income earned from the interest rate swap
agreement was $0.5 million in the first quarter of 1993.
OTHER OPERATING INCOME
The majority of other operating income in prior years was earned as
the Mortgage Banking Operation originated and sold mortgage loans. The
trends and composition of other operating income are shown in the
following table.
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Table 8 Other operating income
Amounts in thousands of dollars
For the Periods Ended
March 31, 1994 March 31, 1993
--------------- ---------------------------------------------------
Commercial Mortgage
Consolidated Consolidated Banking Banking
------------ ------------ ---------- --------
Processing fees $225 $225
Capitalization of excess servicing rights 71 71
Fees on loans sold 396 396
Premium on sales of mortgage loans $68 2,625 2,625
Service income 466 480 480
Documentation fees 22 208 $33 175
Other service fees and charges 347 267 196 71
Securities & other nonoperating gains 0 77 77 0
Gain on sale of mortgage servicing portfolio 838 --- --- ---
--- --- --- ---
Total $1,741 $4,349 $306 $4,043
====== ====== ==== ======
The Mortgage Banking Operation earned fee income on loans originated,
and gains as loans were sold to permanent investors. Loans for which
servicing was retained are conventional mortgages under approximately
$200 thousand which were sold to the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, and other
institutional investors. Excess servicing rights were capitalized,
and related gains recognized, based on the present value of the
servicing cash flows discounted over a period of seven years. When
loan prepayments occur within this period, the remaining capitalized
cost associated with the loan is written off.
The servicing rights were retained by the bank following sale of the
mortgage origination operation. The Bank has entered into an agreement
with the Federal National Mortgage Association and the Federal Home
Loan Mortgage Corporation to dispose of any remaining portion of this
portfolio by the end of 1994 because, with the sale of the mortgage
origination operation, the Bank is no longer a qualified
seller/servicer of such loans. In the first quarter of 1994, the bank
sold a portion of the retained servicing rights at a gain of $838
thousand.
OPERATING EXPENSE
Total operating expense for the commercial bank was $1.9 million in
the first quarter of 1994, compared to $2.0 million for the same
period in 1993. Refocusing productive resources toward commercial
banking activities and eliminating historic inefficiencies allowed
this reduction. The current level of operating expense is deemed to be
adequate and will be leveraged further as the core middle market
business is expanded.
PROVISION FOR LOAN LOSSES
The Bank's made no provision for loan losses in 1994 compared with
$150 thousand in the first quarter of 1993. This change in provision
was made possible
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by the significant reduction of nonperforming loans.
The relationship between the level and trend of the allowance for loan
losses and nonperforming assets, combined with the results of the
ongoing review of credit quality, determine the level of provisions.
LEGAL AND REGULATORY MATTERS
In June 1992, the Bank entered into an agreement with the Office of
the Comptroller of the Currency (OCC), the Bank's primary federal
regulator, which required the implementation of certain policies and
procedures for the operation of the bank to improve lending operations
and management of the loan portfolio. In November 1993, after
completion of its annual examination, the OCC released the Bank from
the Formal Agreement. Following this, the Federal Reserve Bank of San
Francisco ("Fed") notified the Company on November 29, 1993, that the
Memorandum of Understanding, which it had signed, was terminated
because the requirements of the agreement were satisfied.
17
Consolidated Statements of Financial Condition CU Bancorp and Subsidiary
Amounts in thousands of dollars March 31, December 31,
1994 1993
---- ----
ASSETS
Cash and due from banks $37,511 $18,440
Federal funds sold 17,000 28,000
------ ------
Total cash and cash equivalents 54,511 46,440
Time deposits with other financial institutions 1,377 1,377
Investment securities (Market value of $67,908 and $87,889 at March 31,
1994 and December 31, 1993, respectively) 68,842 88,034
Loans, (Net of allowance for loan losses of $7,226 and $6,513 at March
31, 1994, and December 31, 1993, respectively) 129,835 134,148
Premises and equipment, net 872 924
Other real estate owned, net --- 920
Accrued interest receivable and other assets 7,111 7,363
-------- --------
Total Assets $262,548 $279,206
======== ========
LIABILITIES AND SHAREHOLDERS'EQUITY
Deposits:
Demand deposits $123,782 $125,665
Savings deposits 69,505 66,214
Time deposits under $100 16,637 27,753
Time deposits of $100 or more 16,996 19,296
------- -------
Total deposits 226,920 238,928
Accrued interest payable and other liabilities 8,006 13,288
------- -------
Total liabilities 234,926 252,216
------- -------
Shareholders' equity:
Preferred stock, no par value:
Authorized -- 10,000,000 shares
No shares issued or outstanding in 1994 or 1993 --- ---
Common stock, no par value:
Authorized - 20,000,000 shares
Issued and outstanding - 4,437,312 in 1994, and 4,424,306 in 1993. 26,304 26,250
Retained earnings 1,318 740
------ ------
Total Shareholders' equity 27,622 26,990
------ ------
Total Liabilities and Shareholders' equity $262,548 $279,206
The accompanying notes are an integral part of these consolidated financial statements.
18
Consolidated Statements of Income CU Bancorp and Subsidiary
Amounts in thousands of dollars, except per share data For the three months ended March 31,
------------------------------------
1994 1993
---- ----
Revenue from earning assets:
Interest and fees on loans $2,831 $3,773
Benefits of interest rate hedge transactions --- 538
Interest on taxable investment securities 641 462
Interest on tax exempt investment securities 1 10
Interest on time deposits with other financial institutions 16 37
Interest on federal funds sold 147 46
----- -----
Total revenue from earning assets 3,637 4,866
----- -----
Cost of funds:
Interest on interest-bearing demand deposits 361 419
Interest on savings deposits 45 92
Interest on time deposits under $100 214 162
Interest on time deposits of $100 or more 143 200
Interest on federal funds purchased & securities sold under agreements to repurchase 23 27
Interest on other borrowings 99 152
----- -----
Total cost of funds 885 1,052
----- -----
Net revenue from earning assets before provision for loan losses 2,752 3,814
Provision for loan losses 0 150
----- -----
Net revenue from earning assets 2,752 3,664
----- -----
Other operating revenue:
Capitalization of excess servicing rights --- 71
Servicing income - mortgage loans sold 466 480
Other fees & charges - commercial 229 206
Fees on loans sold 0 396
Premium on sales of mortgage loans 68 2,625
Other fees and charges - mortgage 140 494
Gain on sale of mortgage servicing portfolio 838 ---
Gain on sale of investment securities (before taxes of $0, and $11, in 1994, 1993, respectively) --- 28
Gain on sale of securities held for sale (before taxes of $0 and $20 in 1994 and
1993, respectively) --- 49
----- -----
Total other operating revenue 1,741 4,349
----- -----
Other operating expenses:
Salaries and related benefits 1,543 2,439
Selling expenses - mortgage loans 126 2,088
Other operating expenses 1,816 2,844
----- -----
Total operating expenses 3,485 7,371
----- -----
Income before provision for income taxes 1,008 642
Provision for income taxes 430 258
----- -----
Net income $578 $384
===== =====
Earnings per share $0.13 $0.09
===== =====
The accompanying notes are an integral part of these consolidated financial statements.
19
CU BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS OF DOLLARS)
For the three months
ended March 31,
---------------------
1994 1993
---- ----
Cash flows from operating activities:
Net income $578 $384
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses --- 150
Increase (decrease) in cash provided by other operating activities (4,004) 1,307
------ ------
Total adjustments (4,004) 1,457
------ ------
Net cash (used) by operating activities (3,426) 1,841
------ ------
Cash flows from investing activities:
Net (increase) decrease in investment securities 19,192 46,880
Net (increase) decrease in loans 4,313 (11,269)
(Increase) in other investing activities (54) (129)
------ ------
Net cash provided by investing activities 23,451 35,482
Cash flows from financing activities:
Net increase (decrease) in demand and savings deposits 1,408 (35,409)
Net increase (decrease) in time certificates of deposit (13,416) 19,002
Net increase in other financing activities 54 0
------ ------
Net cash (used) by financing activities (11,954) (16,407)
------ ------
Net increase in cash and cash equivalents 8,071 20,916
Cash and cash equivalents at beginning of year 46,440 55,989
------- -------
Cash and cash equivalents at end of year $54,511 $76,905
======= =======
The accompanying notes are an integral part of these consolidated financial statements.
20
Notes to Consolidated Financial Statements
March 31, 1994
UNAUDITED
Note A. BASIS OF PRESENTATION
The accounting and reporting policies of CU Bancorp ("the Company")
and its wholly owned subsidiary, California United Bank, N.A. ("the
Bank"), are prepared in accordance with generally accepted accounting
principles used in the banking industry. All material inter company
balances have been eliminated and all material interim period
adjustments which, in the opinion of management, are necessary for a
fair presentation of financial condition, results of operations, and
cash flow have been made.
Note B. EARNINGS PER SHARE
Net income per share is computed using the weighted average number of
shares of common stock and common stock equivalents outstanding during
the periods presented, except when the effect of the latter would be
anti-dilutive.
NOTE C. SECURITIES
The Bank has the intent and ability to hold its investment securities
until maturity. Accordingly, investment securities are carried at
cost, adjusted for amortization of premiums and accretion of discounts
on a straight-line basis, which approximates the effective interest
method. Gains and losses recognized on the sale of investment
securities are based upon the adjusted cost and determined using the
specific identification method.
The Bank has no securities classified as "held for sale", indicating
the willingness to sell these securities under certain conditions.
These securities would be carried at current market value with
unrealized gains or losses not recognized as current income but
reported as an increase or decrease to capital in the statements of
financial condition and in the statements of shareholders' equity.
The following tables set forth the book value and market value, of
investment securities at March 31, 1994.
Gross Unrealized Gross Unrealized
(Thousands of dollars) Book Value Gains Losses Market Value
---------- ----- ------ ------------
U.S. Treasury Securities $57,516 $(961) $56,555
U.S. Government Agency Securities 10,143 10,143
State and Municipal Securities 750 $28 778
Other 0 0
Federal Reserve Bank Stock 433 433
------- --- ----- -------
Total $68,842 $28 $(961) $67,909
======= === ===== =======
At March 31, 1994, investment securities with a book value of $20.8
million were pledged to secure U.S. District Court deposits and for
other purposes as required or permitted by law. Included in interest
on investment securities is $1.0 thousand of interest from tax-exempt
securities.
21
Note D. AVERAGE FEDERAL RESERVE BALANCES
The average cash reserve required to be maintained at the Federal
Reserve Bank was approximately $6 million, $9 million, and $8 million
for the periods ending March 31, 1994 and December 31 and March 31,
1993, respectively.
Note E. PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated
depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets.
Amortization of leasehold improvements is also computed using the
straight-line method over the shorter of the useful life of the
improvement or the term of the lease.
Note F. OTHER REAL ESTATE OWNED
Real estate owned, acquired either through foreclosure or deed in lieu
of foreclosure, is carried at the lower of cost or fair value. When
acquired, any excess of the loan amount over the fair value is charged
to the allowance for loan losses. Subsequent write-downs, if any, are
charged to operation expenses in the periods that they become known.
There was no other real estate owned as of March 31, 1994. Other real
estate owned at December 31, and March 31, 1993 was $.9 million and
$4.4 million, respectively.
Note G. INCOME TAXES
Effective January 1, 1993, the Bank implemented the provisions of
Financial Accounting Standards (SFAS) No. 109, "Accounting for Income
Taxes." The implementation had no significant impact on the financial
condition or operations of the Bank. SFAS No. 109 utilizes the
liability method and deferred taxes are determined based on the
estimated future tax effects of differences between the financial
statement and tax bases of assets and liabilities given the provisions
of the enacted tax laws.
Note H. LOANS
Loans are carried at face amount, less payments collected, allowance
for loan losses, and unamortized deferred fees. Interest on loans is
accrued monthly on a simple interest basis. The general policy of the
Bank is to discontinue the accrual of interest and transfer loans to
nonaccrual (cash basis) status where reasonable doubt exists with
respect to the timely collectibility of such interest. Payments on
nonaccrual loans are accounted for using a cost recovery method.
Loan origination fees and commitment fees, offset by certain direct
loan origination costs, are deferred and recognized over the
contractual life of the loan as a yield adjustment.
The allowance for loan losses is maintained at a level considered
adequate to provide for losses that can reasonably be anticipated.
Management considers current economic conditions, historical loan loss
experience, and other factors in determining the adequacy of the
allowance. The allowance is based on estimates and ultimate losses may
differ from current estimates. These estimates are reviewed
periodically and as adjustments become necessary, they are charged to
earnings in the period in which they become known. The allowance is
increased by provisions charged to operating expenses, increased for
recoveries of loans previously charged-off, and reduced by charge-
offs.
Note I. RECLASSIFICATIONS
Certain items have been reclassified in the prior period financial
statements presented herein, in order to conform to classifications
followed for March 31, 1994.
22
Note J. LEGAL MATTERS
In the normal course of business the Bank occasionally becomes a party
to litigation. In the opinion of management, based upon consultation
with legal counsel, other than as set forth below, pending or
threatened litigation involving the Bank will have no adverse material
effect upon its financial condition, or results of operations.
The Bank is a defendant in multiple lawsuits related to the failure of
two real estate investment companies, Property Mortgage Company, Inc.,
("PMC") and S.L.G.H., Inc. ("SLGH"). The lawsuits, consist of a
federal action by investors in PMC and SLGH (the "Federal Investor
Action"), at least three state court actions by groups of Investors
(the "State Investor Actions"), and an action filed by the Resolution
Agent for the combined and reorganized bankruptcy estate of PMC and
SLGH (the "Neilson" Action). An additional action was filed by an
individual investor and his related pension and profit sharing plans
(the "Individual Investor Action").
Other defendants in these multiple actions and in related actions
include financial institutions, title companies, professionals,
business entities and individuals, including the principals of PMC and
SLGH. The Bank was a depositary bank for PMC, SLGH and related
companies and was a lender to certain principals of PMC. The Bank
denies any participation in the sale of the interests which are the
principal gravamen of the complaints.
Plaintiffs allege that PMC/SLGH was or purported to be engaged in the
business of raising money from investors by the sale and issuance of
interests in promissory notes secured by trust deed and real property
notes secured, or purported to be secured, by real property.
Plaintiffs allege that false representations were made, and the
investment merely constituted a "Ponzi" scheme. Other charges relate
to the Bank's conduct with regard to the depositary accounts, the
lending relationship with the principals and certain collateral taken
in conjunction with these loans. The lawsuits allege inter alia
violations of federal and state securities laws, fraud, negligence,
breach of fiduciary duty, and conversion as well as conspiracy and
aiding and abetting counts with regard to these violations. The Bank
denies the allegations of wrongdoing.
Damages in excess of $100 million have been alleged, and compensatory
and punitive damages have been sought generally against all
defendants, although no specific damages have been prayed for with
regard to the Bank, nor has there been any apportioning of liability
among defendants or attributable to the various claims asserted. A
former officer and director of the Bank has also been named as a
defendant.
Despite the complexity of the case and the length of time the actions
have been on file, very little discovery has been taken. The Federal
Investor and the Neilson Actions are proceeding slowly. The Federal
Court in that case denied the plaintiff's request for class
certification for litigation purposes but granted such certification
for settlement purposes, at least as to one unrelated defendant. As a
result of the denial of the class action status, the plaintiffs filed
the State Investor Actions in the Los Angeles County Superior Court.
The Neilson Action remains in the United States District Court for the
Central District of California.
During 1993, the Bank filed a motion to dismiss racketeering ("RICO")
claims in the Federal Investor Action, originally stated, which motion
was granted.
In early 1994, the Bank's motion for a summary judgment in the
Individual Investor Action was granted, thereby dismissing the case as
to the Bank, subject to appeals of that decision. That case primarily
included allegations regarding the Bank's aiding and abetting the sale
of securities by PMC and SLGH and state securities claims with regard
thereto. It did not make claims with regard to the Bank's depositary
or lending relationships with PMC, SLGH or the principal thereof. No
officer or director of the Bank was named in that case.
The Bank and its former officer have filed claims with insurance
carriers for coverage regarding the remaining litigation. The
attorneys for the Investor and Neilson Actions have made a settlement
demand on the Bank and its former officer for payment of full policy
limits by certain insurance carriers.
On the basis of the current pleadings, no carriers have accepted or
acknowledged coverage, but are continuing to monitor the cases. It is
anticipated that further pleadings and supplemental presentations will
clarify the plaintiffs' claims and the applicability of insurance
coverage. The Bank believes that should insurance be available to its
officers and directors, that the applicable deductible will be between
$500,000 and $1,000,000, and that the maximum coverage available will
be $10,000,000. The applicable policies are reimbursement policies
and do not provide any defense or legal fees coverage at this time.
Notwithstanding this, one of the
23
insurers has indicated its intention to take over (and assume the cost of) the
defense of the director/officer named in the litigation, subject to a
reservation of rights, and subject to a statement that it is not obligated to
do so.
Based on the limited discovery to date, the Bank is not aware of any
factual basis for the plaintiffs' allegations of intentional
wrongdoing by the Bank or its former officer. The Bank officers
involved in the subject matter deny these allegations. The Bank
believes that the litigation is an attempt to recover from solvent
defendants and their insurers for the alleged wrongdoing of the
PMC/SLGH entities.
Settlement negotiations are ongoing among all the parties to the
lawsuits. In the event of a failure of these negotiations, the Bank
intends to vigorously contest the charges, and believes it has
meritorious legal and factual defenses assertable in connection with
the same.
Note K. REGULATORY MATTERS
On November 2, 1993, the Office of the Comptroller of the Currency
("OCC"), after completion of their annual examination of the Bank,
terminated the Formal Agreement entered into in June, 1992. In
December 1993, the Fed terminated the Memo of Understanding entered
into in August, 1992.
The Formal Agreement had been entered into in June 1992 and required
the implementation of certain policies and procedures for the
operation of the Bank to improve lending operations and management of
the loan portfolio. The Formal Agreement required the Bank to
maintain a Tier 1 Risk Weighted Capital ratio of 10.5% and a 6.0% Tier
1 Leverage Ratio. The Formal Agreement mandated the adoption of a
written program to essentially reduce criticized assets, maintain
adequate loan loss reserves and improve bank administration, real
estate appraisal, asset review management and liquidity policies, and
restricted the payment of dividends.
The agreement specifically required the Bank to: 1) create a
compliance committee; 2) have a competent chief executive officer and
senior loan officer, satisfactory to the OCC, at all times; 3) develop
a plan for supervision of management; 4) create and implement policies
and procedures for loan administration; 5) create a written loan
policy; 6) develop and implement an asset review program; 7) develop
and implement a written program for the maintenance of an adequate
Allowance for Loan and Lease Losses, and review the adequacy of the
Allowance; 8) eliminate criticized assets; 9) develop and implement a
written real estate appraisal policy; 10) obtain and improve
procedures regarding credit and collateral documentation; 11) develop
a strategic plan; 12) develop a capital program to maintain adequate
capital (this provision also restricts the payment of dividends by the
Bank unless (a) the Bank is in compliance with its capital program;
(b) the Bank is in compliance with 12 U.S.C. 55 and 60 and (c) the
Bank receives the prior written approval of the OCC District
Administrator); 13) develop and implement a written liquidity, asset
and liability management policy; 14) document and support the
reasonableness of any management and other fees to any director or
other party; 15) correct violations of law; and 16) provide reports to
the OCC regarding compliance.
The Memorandum of Understanding was executed in August 1992 and
required 1) a plan to improve the financial condition of CU Bancorp
and the Bank; 2) development of a formal policy regarding the
relationship of CU Bancorp and the Bank, with regard to dividends,
inter-company transactions, tax allocation and management or service
fees; 3) a plan to assure that CU Bancorp has sufficient cash to pay
its expenses; 4) ensure that regulatory reporting is accurate and
submitted on a timely basis; 5) prior approval of the Federal Reserve
Bank prior to the payment of dividends; 6) prior approval of the
Federal Reserve Bank prior to CU Bancorp incurring any debt and 7)
quarterly reporting regarding the condition of the Company and steps
taken regarding the Memorandum of Understanding.
24
SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Registrant
has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CU BANCORP
May 12, 1994
By: PATRICK HARTMAN
---------------
Patrick Hartman
Chief Financial Officer
25
Part II - Other Information
Item 1. Legal Proceedings
Please refer to Notes J and K, on pages 22 and 23 above, for a
complete discussion of both legal and regulatory matters.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Filings on Form 8-K
(a) Exhibits:
(10) Material Contracts
(i) Mortgage Servicing Purchase and Sale Agreement
Dated March 31, 1994 pg. 26
(b) Reports on Form 8-K:
None.