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EX-32.2 - EXHIBIT 32.2 SECTION 906 CERTIFICATION - SQUARE 1 FINANCIAL INCsqbk6302015exhibit322.htm
EX-31.2 - EXHIBIT 31.2 SECTION 302 CERTIFICATION - SQUARE 1 FINANCIAL INCsqbk6302015exhibit312.htm
EX-32.1 - EXHIBIT 32.1 SECTION 906 CERTIFICATION - SQUARE 1 FINANCIAL INCsqbk6302015exhibit321.htm
EX-31.1 - EXHIBIT 31.1 SECTION 302 CERTIFICATION - SQUARE 1 FINANCIAL INCsqbk6302015exhibit311.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q


x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015

or
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from______ to ______

 Commission File Number: 001-36372
SQUARE 1 FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
 
Delaware                 
 
 
 
20-1872698           
(State or other jurisdiction of
incorporation or organization)
 
 
 
(IRS Employer
Identification Number)
 
 
 
 
 
406 Blackwell Street, Suite 240
Durham, North Carolina
 
 
 
27701
(Address of principal executive offices)
 
 
 
(Zip Code)
 
 
 
 
 
(866) 355-0468
(Registrant’s telephone number, including area code)
 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
Non-accelerated filer
 
x  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨    No  x
At July 31, 2015, 29,913,520 shares of the registrant’s common stock ($0.01 par value) were outstanding.



TABLE OF CONTENTS
 
 
 
 
 
 
Page
 
 
 
PART I.
FINANCIAL INFORMATION
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
 
 
 
PART II.
OTHER INFORMATION
 
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 5.
 
 
 
ITEM 6.
 
 
 




PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Square 1 Financial, Inc.
Interim Consolidated Balance Sheets
(in thousands, except share and per share data)
 
June 30, 2015
 
December 31, 2014
Assets
 
(Unaudited)
 

Cash and due from banks
 
$
39,579

 
$
13,650

Interest-bearing deposits in other banks
 
347,768

 
72,292

Total cash and cash equivalents
 
387,347

 
85,942

Investment in time deposits
 
1,002

 
1,251

Investment securities—available for sale, at fair value
 
1,541,342

 
1,294,533

Investment securities—held to maturity, at amortized cost
 
392,872

 
300,425

Loans, net of unearned income of $8.8 million and $7.9 million
 
1,516,032

 
1,346,449

Less allowance for loan losses
 
(25,037
)
 
(22,906
)
Net loans
 
1,490,995

 
1,323,543

Premises and equipment, net
 
4,015

 
4,026

Deferred income tax assets, net
 
10,666

 
9,672

Bank owned life insurance
 
51,582

 
50,723

Intangible assets
 
1,745

 
1,615

Other receivables
 
3,500

 
3,226

Warrant valuation
 
5,125

 
4,304

Prepaid expenses
 
1,779

 
2,063

Accrued interest receivable and other assets
 
20,533

 
13,543

Total assets
 
$
3,912,503

 
$
3,094,866

Liabilities and Shareholders’ Equity
 

 

Deposits:
 

 

Demand, noninterest-bearing
 
$
2,372,673

 
$
1,851,004

Demand, interest-bearing
 
100,496

 
71,598

Money market deposit accounts
 
1,081,211

 
837,630

Time deposits
 
9,384

 
16,320

Total deposits
 
3,563,764

 
2,776,552

Accrued interest payable and other liabilities
 
22,093

 
15,610

Total liabilities
 
3,585,857

 
2,792,162

Commitments and contingencies (Notes 11 and 16)
 

 

Shareholders’ equity:
 

 

Common stock, $.01 par value; 70,000,000 and 45,000,000 shares authorized, respectively (Note 9):
 
 
 
 
Class A common stock, $.01 par value; 26,485,682 shares and 25,487,568 shares issued and outstanding, respectively
 
265

 
255

Class B convertible common stock, $.01 par value; 3,395,110 shares issued and outstanding
 
34

 
34

Additional paid in capital
 
256,382

 
251,597

Accumulated other comprehensive income
 
8,479

 
7,404

Retained earnings
 
61,486

 
43,414

Total shareholders’ equity
 
326,646

 
302,704

Total liabilities and shareholders’ equity
 
$
3,912,503

 
$
3,094,866

The accompanying notes are an integral part of these consolidated financial statements.

3


Square 1 Financial, Inc.
Interim Consolidated Statements of Income (Unaudited)
(in thousands, except per share data)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2015
 
2014
 
2015
 
2014
Interest income:
 

 

 
 
 
 
Loans including fees on loans
 
$
22,207

 
$
17,720

 
$
42,341

 
$
34,123

Investment securities:
 
 
 
 
 
 
 
 
Taxable
 
6,795

 
5,382

 
13,693

 
9,943

Non-taxable
 
2,463

 
1,836

 
4,792

 
3,608

Federal funds and other short-term investments
 
128

 
137

 
168

 
201

Total interest income
 
31,593

 
25,075

 
60,994

 
47,875

Interest expense:
 

 

 
 
 
 
Deposits
 
193

 
143

 
404

 
273

Borrowings and repurchase agreements
 
1

 

 
46

 
4

Junior subordinated debt
 

 
56

 

 
215

Total interest expense
 
194

 
199

 
450

 
492

Net interest income
 
31,399

 
24,876

 
60,544

 
47,383

Provision for loan losses
 
3,758

 
3,150

 
9,205

 
6,114

Net interest income after provision for loan losses
 
27,641

 
21,726

 
51,339

 
41,269

Noninterest income:
 

 

 
 
 
 
Service charges and fees
 
1,325

 
1,126

 
2,583

 
2,194

Foreign exchange fees
 
1,620

 
1,363

 
3,338

 
3,004

Credit card and merchant income
 
1,100

 
765

 
2,121

 
1,401

Investment impairment
 

 

 

 
(43
)
Net gain on securities
 
1,025

 
38

 
821

 
47

Letter of credit fees
 
455

 
297

 
697

 
812

Warrant income
 
239

 
21

 
701

 
2,216

Gain on sale of loans
 
592

 
249

 
1,398

 
502

Bank owned life insurance
 
424

 
317

 
859

 
607

Other
 
852

 
2,196

 
1,326

 
2,771

Total noninterest income
 
7,632

 
6,372

 
13,844

 
13,511

Noninterest expense:
 

 

 
 
 
 
Personnel
 
12,541

 
10,725

 
24,768

 
21,359

Occupancy
 
880

 
773

 
1,703

 
1,513

Data processing
 
1,049

 
918

 
1,986

 
1,740

Furniture and equipment
 
793

 
660

 
1,558

 
1,362

Advertising and promotions
 
383

 
342

 
624

 
617

Professional fees
 
1,089

 
786

 
1,901

 
1,387

Telecommunications
 
286

 
285

 
577

 
545

Travel
 
285

 
292

 
482

 
458

FDIC assessment
 
497

 
347

 
916

 
752

Merger-related expenses
 
792

 

 
1,004

 

Other
 
1,712

 
1,472

 
3,125

 
2,450

Total noninterest expense
 
20,307

 
16,600

 
38,644

 
32,183

Income before income tax expense
 
14,966

 
11,498

 
26,539

 
22,597

Income tax expense
 
5,047

 
3,447

 
8,467

 
6,698

Net income
 
9,919

 
8,051

 
18,072

 
15,899

Dividends on preferred stock
 

 
1

 

 
63

Net income available to common shareholders
 
$
9,919

 
$
8,050

 
$
18,072

 
$
15,836

Earnings per share—basic
 
$
0.33

 
$
0.28

 
$
0.61

 
$
0.61

Earnings per share—diluted
 
$
0.33

 
$
0.27

 
$
0.60

 
$
0.58

The accompanying notes are an integral part of these consolidated financial statements.

4


Square 1 Financial, Inc.
Interim Consolidated Statements of Comprehensive Income (Unaudited)
(in thousands)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
2015
 
2014
 
2015
 
2014
Net income
 
$
9,919

 
$
8,051

 
$
18,072

 
$
15,899

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
Unrealized (losses) gains on securities:
 
 
 
 
 
 
 
 
Unrealized holding (losses) gains arising during period
 
(2,924
)
 
6,135

 
1,713

 
11,454

Less: reclassification adjustment for gains included in net income
 
(873
)
 
(50
)
 
(638
)
 
(50
)
Other comprehensive (loss) income
 
(3,797
)
 
6,085

 
1,075

 
11,404

Comprehensive income
 
6,122

 
14,136

 
19,147

 
27,303

Dividends on preferred stock
 

 
1

 

 
63

Comprehensive income available to common shareholders
 
$
6,122

 
$
14,135

 
$
19,147

 
$
27,240

The accompanying notes are an integral part of these consolidated financial statements.

5


Square 1 Financial, Inc.
Interim Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
(dollars in thousands)
 
 
Common Stock
 
Additional
Paid in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
Total
 
Preferred Stock
 
Class A
 
Class B
 
 
 
 

Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2013
5,000

 
$

 
19,699,136

 
$
197

 
3,912,610

 
$
39

 
$
183,716

 
$
(4,096
)
 
$
9,294

 
$
189,150

Issuance of common stock, net issuance costs of $2.3 million

 

 
3,786,810

 
38

 

 

 
59,531

 

 

 
59,569

Stock-based compensation

 

 

 

 

 

 
1,707

 

 

 
1,707

Conversion of preferred stock
(5,000
)
 

 
500,070

 
5

 

 

 
(4
)
 

 

 
1

Conversion of trust preferred securities

 

 
741,500

 
7

 

 

 
6,023

 

 

 
6,030

Dividends on preferred stock

 

 

 

 

 

 

 

 
(63
)
 
(63
)
Net income

 

 

 

 

 

 

 

 
15,899

 
15,899

Unrealized gain on securities net of tax of $3.2 million

 

 

 

 

 

 

 
11,404

 

 
11,404

Balance at June 30, 2014

 
$

 
24,727,516

 
$
247

 
3,912,610

 
$
39

 
$
250,973

 
$
7,308

 
$
25,130

 
$
283,697

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2014

 
$

 
25,487,568

 
$
255

 
3,395,110

 
$
34

 
$
251,597

 
$
7,404

 
$
43,414

 
$
302,704

Issuance of common stock

 

 
998,114

 
10

 

 

 
2,564

 

 

 
2,574

Stock-based compensation

 

 

 

 

 

 
2,221

 

 

 
2,221

Conversion of preferred stock

 

 

 

 

 

 

 

 

 

Conversion of trust preferred securities

 

 

 

 

 

 

 

 

 

Dividends on preferred stock

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 
18,072

 
18,072

Unrealized gain on securities net of tax of $0.7 million

 

 

 

 

 

 

 
1,075

 

 
1,075

Balance at June 30, 2015

 
$

 
26,485,682

 
$
265

 
3,395,110

 
$
34

 
$
256,382

 
$
8,479

 
$
61,486

 
$
326,646

The accompanying notes are an integral part of these consolidated financial statements.

6


Square 1 Financial, Inc.
Interim Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
Six Months Ended 
 June 30,
 
2015
 
2014
Net income
$
18,072

 
$
15,899

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
631

 
465

Amortization on investment securities, net
11,900

 
8,211

Provision for loan losses
9,205

 
6,114

Stock-based compensation
2,221

 
1,707

Gain on sale of securities available for sale
(821
)
 
(47
)
Investment impairment

 
43

Deferred income tax provision
(1,674
)
 
(2,299
)
Earnings on bank owned life insurance
(859
)
 
(607
)
Changes in assets and liabilities:
 
 
 
Accrued interest receivable and other assets
(7,946
)
 
(630
)
Accrued interest payable and other liabilities
6,483

 
1,056

Net cash provided by operating activities
37,212

 
29,912

Cash flows from investing activities:
 
 
 
Net increase in investment in time deposits
249

 

Purchase of securities available for sale
(411,900
)
 
(229,866
)
Purchase of securities held to maturity
(103,951
)
 
(57,373
)
Proceeds from calls/maturities of securities available for sale
102,423

 
69,177

Proceeds from sales of securities available for sale
55,322

 
2,586

Proceeds from paydowns of securities held to maturity
9,539

 

Net increase in loans
(176,656
)
 
(72,017
)
Purchase of bank owned life insurance

 
(2,635
)
Purchases of premises and equipment
(619
)
 
(907
)
Net cash used in investing activities
(525,593
)
 
(291,035
)
Cash flows from financing activities:
 
 
 
Net increase in deposits
787,212

 
338,438

Net decrease in repurchase agreements

 
(12,737
)
Preferred dividends paid

 
(63
)
Proceeds from issuance of common stock, net of issuance costs
260

 
58,758

Issuance of shares under stock-based compensation plan
2,314

 
635

Net cash provided by financing activities
789,786

 
385,031

Net change in cash and cash equivalents
301,405

 
123,908

Cash and cash equivalents at beginning of period
85,942

 
105,730

Cash and cash equivalents at end of period
$
387,347

 
$
229,638

Supplemental statement of cash flow disclosures
 
 
 
Interest paid
$
449

 
$
293

Income taxes paid
$
7,285

 
$
4,268

Schedule of noncash investing transactions
 
 
 
Conversion of trust preferred securities to common stock
$

 
$
7,415

The accompanying notes are an integral part of these consolidated financial statements.

7


Notes to the Interim Consolidated Financial Statements (Unaudited)

1.
ORGANIZATION AND BASIS OF PRESENTATION
Organization and Nature of Operations
Square 1 Financial, Inc. (the “Company”) is a bank holding company incorporated under the laws of Delaware on October 6, 2004. The Company closed on its initial public offering ("IPO") on March 31, 2014. The Company’s primary function is to serve as the holding company for its wholly owned subsidiary, Square 1 Bank. Square 1 Bank (the “Bank”) was incorporated under the laws of North Carolina on July 11, 2005 and commenced banking operations on August 8, 2005. The Bank is not a member of the Federal Reserve System. The Bank provides a full range of commercial banking services primarily to companies that have received institutional investment, typically from venture capital and private equity sources. The Bank also provides a full range of services to venture capital and private equity firms. The Bank’s primary source of revenue is interest earned from loans to customers and from invested cash and securities and non-interest income derived from various fees. During 2007, the Company formed Square 1 Ventures, LLC (a Delaware limited liability company), a wholly owned subsidiary established to sponsor a fund of funds. Square 1 Ventures, LLC is consolidated into the Company’s financial statements. In 2013, the Bank formed Square 1 Asset Management, a wholly owned subsidiary of the Bank and SEC-registered investment adviser, to provide an investment alternative for clients. The Bank also acquired the business operations and key employees of Sand Hill Finance LLC, a factoring company, as part of the Bank's strategy to continue to grow its asset-based lending portfolio and has integrated the factoring product into its existing suite of asset-based lending products.
The Bank operates one branch in Durham, NC and loan production offices in Menlo Park, San Francisco, San Diego, Campbell, and Los Angeles and Orange County, CA; and Austin, Boston, Chicago, Denver, Minneapolis, New York, Seattle and the District of Columbia area. The Company’s corporate headquarters are located in Durham, NC.
Proposed Merger with PacWest Bancorp
On March 1, 2015, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with PacWest Bancorp ("PacWest"), pursuant to which the Company will merge with and into PacWest, with PacWest as the surviving corporation (the “Merger”). The Merger Agreement also provides that immediately following the Merger, the Bank will merge with and into Pacific Western Bank, a California state-chartered bank and wholly owned subsidiary of PacWest, with Pacific Western Bank as the surviving bank. Under the terms and subject to the conditions of the Merger Agreement, each issued and outstanding share of common stock of the Company will be converted into the right to receive 0.5997 of a share of PacWest common stock. The transaction is currently valued at approximately $867 million. Completion of the Merger is subject to certain customary conditions, including approval by the Company’s shareholders and the receipt of certain required regulatory approvals. The Merger was approved by the Company's shareholders on July 29, 2015. PacWest and Square 1 expect that the Merger will be completed during the fourth quarter of 2015. However, it is possible that factors outside the control of both companies, including whether or when the required regulatory approvals will be received, could result in the Merger being completed at a different time or not at all. The Company recorded $0.8 million and $1.0 million, respectively, in merger-related expenses during the three and six months ended June 30, 2015.
Basis of Presentation
These unaudited interim consolidated financial statements have been prepared on a consistent basis with the accounting policies described in the notes to the audited financial statements for the fiscal year ended December 31, 2014 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 Form 10-K”), as filed with the Securities and Exchange Commission ("SEC") on March 20, 2015. These unaudited interim consolidated financial statements have also been prepared in accordance with the instructions for Form 10-Q pursuant to the rules and regulations of the SEC, and as such certain footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted. Because the accompanying interim financial statements do not include all of the information and footnotes required by GAAP for annual financial statements, they should be read in conjunction with the audited financial statements for the fiscal year ended December 31, 2014 and notes thereto included in the 2014 Form 10-K. Certain prior year amounts have been reclassified to conform to current year presentation. Credit card and merchant income, previously included in service charges and fees, is presented separately and income from loan documentation fees, previously presented separately, is included in other noninterest income. The amount of foreign exchange clearing, previously presented in other assets, changes daily based on transactions and is presented in cash and due from banks. Merger-related expenses previously included in Other noninterest expenses in the quarterly report for the period ending March 31, 2015 is presented separately.

8


The amounts included in these financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary to fairly present the Company’s financial position and results of operations for the interim periods. Unless otherwise noted, all adjustments are normal and recurring in nature. In preparing financial statements that conform to GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses and the disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of amounts expected for the entire year or future periods.
Principles of Consolidation
The consolidated financial statements include the financial statements of Square 1 Financial and its consolidated subsidiaries and other entities in which it has a controlling financial interest. All significant intercompany balances and transactions have been eliminated in consolidation. In addition, the Company evaluates its relationships with other entities to identify whether they are variable interest entities ("VIEs") and to assess whether it is the primary beneficiary of such entities. If the determination was made that the Company is the primary beneficiary, then that entity would be included in the consolidated financial statements. If an entity is not a VIE, the Company also evaluates arrangements in which there is a general partner or managing member to determine whether consolidation is appropriate.
Square 1 Venture 1, L.P.-The Company owns approximately a 2% partnership interest in Square 1 Venture 1, L.P., which was formed for the primary purpose of sponsoring a fund of funds. The Company has determined that Square 1 Venture 1, L.P. is not a VIE for all periods presented; accordingly, Square 1 Venture 1, L.P. is not consolidated with the Company. The Company accounts for the investment in Square 1 Venture 1, L.P. using the equity method of accounting. For the three and six months ended June 30, 2015, gains of $0.1 million were recognized. For the three and six months ended June 30, 2014, gains of $0.7 million were recognized. The fair value of the investment at June 30, 2015 and December 31, 2014 was $1.6 million and $1.5 million, respectively, and is included in other assets on the balance sheet.
On April 1, 2014, Square 1 Ventures, LLC transferred the contract for the management of Square 1 Venture 1, L.P. to Industry Ventures, a fund-of-funds manager in San Francisco, CA. In connection with this transfer, the Company recorded a gain of $0.5 million. The impact of the sale of the management contract has not had an ongoing material impact to the Company's results of operations or financial condition.
Use of Estimates in the Preparation of Financial Statements
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The more significant estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, the valuation of investment securities, recognition and measurement of income tax assets and liabilities and the valuation of equity warrant assets and foreclosed assets.
Cash and Cash Equivalents
Cash and cash equivalents include noninterest-earning and interest-earning deposits at other institutions, federal funds sold and other short term investments. Generally, federal funds are purchased and sold for one-day periods. At times, the Bank places deposits with high credit-quality financial institutions in amounts which may be in excess of federally insured limits. The Bank is required to maintain reserve and clearing balances with the Federal Reserve Bank. Accordingly, the Bank has amounts restricted for this purpose of $24.2 million and $19.8 million in the consolidated balance sheet at June 30, 2015 and December 31, 2014, respectively.

2.
NEW ACCOUNTING STANDARDS
In May 2015, the FASB issued Accounting Standards Update (ASU) 2015-07, Fair Value Measurement (Topic 820), Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). Under the guidance in ASU 2015-07, investments for which fair value is measured using the net asset value per share practical expedient will no longer be categorized within the fair value hierarchy levels, but will be presented as a reconciling line item. Investments that calculate net asset value per share (or its equivalent), but for which the practical expedient is not applied will continue to be included in the fair value hierarchy. ASU 2015-07 also eliminates the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value by limiting

9


those disclosure requirements to investments for which the entity has elected to measure the fair value using that practical expedient. ASU 2015-07 is effective for the Company for annual and interim periods beginning after December 15, 2015. Early adoption is permitted. ASU 2015-07 must be applied retrospectively for all periods presented. The Company is currently assessing the impacts of adopting ASU 2015-07.
In April 2015, the FASB issued ASU No. 2015-05, Intangibles—Goodwill and Other— Internal-Use Software (Subtopic 350-40), Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. ASU 2015-05 provides guidance to customers to determine whether a cloud computing arrangement includes a software license. When a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses and when a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance in ASC 350-40 applies to hosting contracts where the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and it is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software. Otherwise, the arrangement should be considered a service contract. ASU 2015-05 is effective for the Company for annual and interim periods beginning after December 15, 2015. Early adoption is permitted. ASU 2015-05 may be adopted prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company is currently assessing the impacts of adopting ASU 2015-05.
In April 2015, the FASB issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 simplifies the presentation of debt issuance costs whereby debt issuance costs related to a recognized debt liability shall be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for the Company for annual and interim periods beginning after December 15, 2015. Early adoption is permitted. ASU 2015-03 should be applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, an entity is required to comply with the applicable disclosures for a change in an accounting principle. The Company does not expect the adoption of ASU 2015-03 to have a material effect on the Company's balance sheet presentation.

3.
INVESTMENT SECURITIES
Investments in securities are classified into three categories and accounted for as follows:
Securities Held to Maturity—Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost; or
Trading Securities—Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; or
Securities Available for Sale—Debt and equity securities not classified as either held to maturity securities or trading securities are classified as available for sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, a separate component of shareholders’ equity.
The Company intends to hold its securities classified as available for sale securities for an indefinite period of time but may sell them prior to maturity. All other securities, which the Company has the positive intent and ability to hold to maturity, are classified as held to maturity securities. The initial classification of securities is determined at the date of purchase. Gains and losses on sales of securities, computed based on specific identification of the adjusted cost of each security, are included in noninterest income at the time of the sales. The Company's investments include agency direct obligations, Small Business Administration ("SBA") pools, agency and non-agency mortgage backed securities ("MBS"), corporate securities, municipal bonds, and asset backed securities ("ABS"). Equity securities include securities obtained from the exercise of equity warrants and required to be held until the expiration of their respective lock-up periods, which expire within one year. The Company intends to monetize these securities upon removal of all sale restrictions (see Note 14).

10


The following tables summarize the amortized cost and fair value of securities available for sale and securities held to maturity at June 30, 2015 and December 31, 2014:
(in thousands)
 
June 30, 2015
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Available for sale securities:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
159,264

 
$
243

 
$
(6
)
 
$
159,501

Agency direct obligations
 
30,323

 
112

 

 
30,435

SBA pools
 
162,014

 
2,606

 
(46
)
 
164,574

Agency MBS
 
666,405

 
9,871

 
(1,991
)
 
674,285

Municipal bonds
 
97,417

 
1,782

 
(268
)
 
98,931

Corporates
 
117,397

 
3,243

 
(15
)
 
120,625

Non-agency MBS
 
185,662

 
1,018

 
(1,567
)
 
185,113

Other ABS
 
107,495

 
233

 
(754
)
 
106,974

Equity securities
 
1,099

 

 
(195
)
 
904

Total
 
$
1,527,076

 
$
19,108

 
$
(4,842
)
 
$
1,541,342

Held to maturity securities:
 
 
 
 
 
 
 
 
Agency MBS
 
$
102,368

 
$
1,991

 
$
(2,481
)
 
$
101,878

Municipal bonds
 
230,582

 
5,752

 
(2,540
)
 
233,794

Corporates
 
59,922

 
341

 
(3,120
)
 
57,143

Total
 
$
392,872

 
$
8,084

 
$
(8,141
)
 
$
392,815

(in thousands)
 
December 31, 2014
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Available for sale securities:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
29,604

 
$
44

 
$
(7
)
 
$
29,641

Agency direct obligations
 
30,536

 
95

 

 
30,631

SBA pools
 
177,982

 
2,145

 
(305
)
 
179,822

Agency MBS
 
606,677

 
9,360

 
(1,115
)
 
614,922

Municipal bonds
 
96,016

 
2,477

 
(3
)
 
98,490

Corporates
 
117,025

 
1,732

 
(398
)
 
118,359

Non-agency MBS
 
173,322

 
1,237

 
(1,460
)
 
173,099

Other ABS
 
48,450

 
25

 
(854
)
 
47,621

Equity securities
 
2,422

 
17

 
(491
)
 
1,948

Total
 
$
1,282,034

 
$
17,132

 
$
(4,633
)
 
$
1,294,533

Held to maturity securities:
 
 
 
 
 
 
 
 
Agency MBS
 
$
58,851

 
$
1,015

 
$
(107
)
 
$
59,759

Municipal bonds
 
181,567

 
9,187

 
(445
)
 
190,309

Corporates
 
60,007

 
32

 
(3,701
)
 
56,338

Total
 
$
300,425

 
$
10,234

 
$
(4,253
)
 
$
306,406

Investment securities with a fair value of $335.5 million and $285.7 million at June 30, 2015 and December 31, 2014, respectively, were pledged to secure customer repurchase agreements and to secure prospective borrowing capacities at the Company's correspondent banks, the Federal Reserve Bank, and the Federal Home Loan Bank of Atlanta.
At June 30, 2015 and December 31, 2014, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholder's equity.

11


The proceeds from sales and calls of securities and the associated gains and losses were as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
Proceeds
 
$
95,671

 
$
41,554

 
$
157,745

 
71,763

Gross gains
 
1,184

 
100

 
1,296

 
109

Gross losses
 
159

 
62

 
475

 
62

The following tables show the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired. Investment securities contained in the table are aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2015 and December 31, 2014:
(in thousands)
 
June 30, 2015
 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Available for sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
19,522

 
$
(6
)
 
$

 
$

 
$
19,522

 
$
(6
)
SBA pools
 
8,167

 
(46
)
 
$
3,483

 

 
11,650

 
(46
)
Agency MBS
 
120,677

 
(1,523
)
 
21,699

 
(468
)
 
142,376

 
(1,991
)
Municipal bonds
 
15,410

 
(268
)
 

 

 
15,410

 
(268
)
Corporates
 

 

 
5,005

 
(15
)
 
5,005

 
(15
)
Non-agency MBS
 
71,196

 
(888
)
 
26,823

 
(679
)
 
98,019

 
(1,567
)
Other ABS
 
35,830

 
(232
)
 
3,349

 
(522
)
 
39,179

 
(754
)
Equity securities
 
904

 
(195
)
 

 

 
904

 
(195
)
Total
 
$
271,706

 
$
(3,158
)
 
$
60,359

 
$
(1,684
)
 
$
332,065

 
$
(4,842
)
Held to maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Agency MBS
 
$
49,421

 
$
(2,346
)
 
$
2,401

 
$
(135
)
 
$
51,822

 
$
(2,481
)
Municipal bonds
 
84,251

 
(2,176
)
 
8,755

 
(364
)
 
93,006

 
(2,540
)
Corporates
 
29,436

 
(1,254
)
 
6,420

 
(1,866
)
 
35,856

 
(3,120
)
Total
 
$
163,108

 
$
(5,776
)
 
$
17,576

 
$
(2,365
)
 
$
180,684

 
$
(8,141
)

12


(in thousands)
 
December 31, 2014
 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Available for sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
9,895

 
$
(7
)
 
$

 
$

 
$
9,895

 
$
(7
)
SBA pools
 
34,287

 
(296
)
 
4,186

 
(9
)
 
38,473

 
(305
)
Agency MBS
 
128,717

 
(889
)
 
17,935

 
(226
)
 
146,652

 
(1,115
)
Municipal bonds
 
1,671

 
(3
)
 

 

 
1,671

 
(3
)
Corporates
 
24,140

 
(398
)
 

 

 
24,140

 
(398
)
Non-agency MBS
 
61,284

 
(637
)
 
21,558

 
(823
)
 
82,842

 
(1,460
)
Other ABS
 
37,527

 
(146
)
 
4,708

 
(708
)
 
42,235

 
(854
)
Equity securities
 
1,859

 
(491
)
 

 

 
1,859

 
(491
)
Total
 
$
299,380

 
$
(2,867
)
 
$
48,387

 
$
(1,766
)
 
$
347,767

 
$
(4,633
)
Held to maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Agency MBS
 
$

 
$

 
$
5,856

 
$
(107
)
 
$
5,856

 
$
(107
)
Municipal bonds
 
10,657

 
(116
)
 
12,688

 
(329
)
 
23,345

 
(445
)
Corporates
 
40,959

 
(1,846
)
 
6,420

 
(1,855
)
 
47,379

 
(3,701
)
Total
 
$
51,616

 
$
(1,962
)
 
$
24,964

 
$
(2,291
)
 
$
76,580

 
$
(4,253
)
At June 30, 2015, there were a total of 52 available for sale securities that were in an unrealized loss position, of which 24 investments had fair values less than their amortized cost for a period of time greater than 12 months. At December 31, 2014, there were a total of 78 available for sale securities that were in an unrealized loss position, of which 24 investments had fair values less than their amortized cost for a period of time greater than 12 months. At June 30, 2015, the fair value of equity securities included $0.1 million in equity securities obtained from the exercise of equity warrants, which the Company intends to monetize upon removal of all sale restrictions, and $0.8 million in other equity securities. At December 31, 2014, the fair value of equity securities included $0.9 million in equity securities obtained from the exercise of equity warrants, which the Company intends to monetize upon removal of all sale restrictions, and $1.0 million in other equity securities.
The Company performs extensive ongoing evaluations of the investment portfolio at the individual security level, including market valuations and impairment analyses. The Company had recorded no impairment for the three months ended June 30, 2015 and 2014. The Company had recorded no impairment for the six months ended June 30, 2015 and $43 thousand of impairment on certain mortgage-related securities for the six months ended June 30, 2014. The Company deemed these securities permanently impaired and unlikely to receive full principal, even if the investments were held to maturity. The Company believes the remainder of the investment portfolio, based on the evaluation performed, will be paid in full and that any temporary impairment will be fully recoverable prior to or at maturity. The Company has the ability and intent to hold the investment securities until forecasted recovery of fair value or until maturity.

13


The amortized cost of debt securities at June 30, 2015, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(in thousands)
 
June 30, 2015
 
 
Total
Amortized
Cost
 
Less than
One Year
Amortized
Cost
 
After One
Year to
Five Years
Amortized
Cost
 
After Five
Years to
Ten Years
Amortized
Cost
 
After Ten
Years
Amortized
Cost
Available for sale securities:
 
 
 
 
 
 
 
 
 
 
Contractual maturity
 
 
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
159,264

 
$

 
$
159,264

 
$

 
$

Agency direct obligations
 
30,323

 
20,272

 
10,051

 

 

SBA pools
 
162,014

 

 
4,136

 
82,765

 
75,113

Agency MBS
 
666,405

 

 
2,398

 
29,622

 
634,385

Municipal bonds
 
97,417

 

 

 
15,185

 
82,232

Corporates
 
117,397

 
13,928

 
41,843

 
12,954

 
48,672

Non-agency MBS
 
185,662

 

 
701

 
7,417

 
177,544

Other ABS
 
107,495

 
3,516

 
36,755

 
26,387

 
40,837

Total
 
$
1,525,977

 
$
37,716

 
$
255,148

 
$
174,330

 
$
1,058,783

Held to maturity securities:
 
 
 
 
 
 
 
 
 
 
Contractual maturity
 
 
 
 
 
 
 
 
 
 
Agency MBS
 
$
102,368

 
$

 
$

 
$

 
$
102,368

Municipal bonds
 
230,582

 

 

 
18,295

 
212,287

Corporates
 
59,922

 

 

 

 
59,922

Total
 
$
392,872

 
$

 
$

 
$
18,295

 
$
374,577

There were no transfers between the available for sale portfolio and the held to maturity portfolio for the three and six months ended June 30, 2015 and 2014.


14


4.
LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans
The composition of loans, net of unearned income, broken out by portfolio segment at June 30, 2015 and December 31, 2014, are as follows:
(in thousands)
 
June 30, 2015
 
December 31, 2014
Commercial loans:
 
 
 
 
Technology
 
$
739,016

 
$
631,979

Life sciences
 
307,240

 
274,057

Asset-based loans
 
143,204

 
177,701

Venture capital/private equity
 
216,268

 
169,143

SBA and USDA
 
36,926

 
35,609

Other
 
14,062

 
6,854

Total commercial loans
 
1,456,716

 
1,295,343

Real estate loans:
 
 
 
 
SBA and USDA
 
37,995

 
36,978

Total real estate loans
 
37,995

 
36,978

Construction loans:
 
 
 
 
SBA and USDA
 
6,752

 
4,035

Total construction loans
 
6,752

 
4,035

Credit cards
 
23,379

 
17,980

Less unearned income, net
 
(8,810
)
 
(7,887
)
Total loans, net of unearned income
 
$
1,516,032

 
$
1,346,449

The Bank makes loans under the Small Business Administration (SBA) and United States Department of Agriculture (USDA) programs. At June 30, 2015 and December 31, 2014, the outstanding balances of these loans being serviced were $142.5 million and $135.3 million, respectively. The SBA/USDA guaranteed portions of five and seven of these loans were sold to the secondary market during the six months ended June 30, 2015 and 2014, respectively. The cumulative outstanding sold balance at June 30, 2015 and December 31, 2014, was $57.5 million and $57.2 million, respectively.
The Company accounts for loan servicing rights or liabilities under Accounting Standards Codification (ASC) 860, “Transfers and Servicing.” ASC 860 requires the Company to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset. Changes in the fair value of the servicing asset are recognized in other noninterest income. The valuation methodology estimates the present value of future cash flows based on the unique characteristics of the loan, market-based assumptions for prepayment speeds, and discount rate assumptions. The servicing asset is recorded in intangible assets in the financial statements.
See Note 15 for a summary of the activity for the Company's servicing assets.

15


Allowance for Loan Losses
The following tables summarize the activity in the allowance for loan losses during the three and six months ended June 30, 2015 and 2014, broken out by portfolio segment:
(in thousands)
 
Three Months Ended June 30, 2015
 
 
Beginning
Balance
 
Charge
Offs
 
Recoveries
 
Provision
(Benefit)
 
Ending
Balance
Commercial loans
 
 
 
 
 
 
 
 
 
 
Technology
 
$
12,714

 
$
1,630

 
$
6

 
$
3,369

 
$
14,459

Life sciences
 
4,581

 
600

 

 
(73
)
 
3,908

Asset-based loans
 
3,025

 
938

 

 
74

 
2,161

Venture capital/private equity
 
331

 

 

 
43

 
374

SBA and USDA
 
534

 
26

 
1

 
113

 
622

Other
 
2,474

 
246

 

 
291

 
2,519

Total commercial loans
 
23,659

 
3,440

 
7

 
3,817

 
24,043

Real estate loans:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
826

 
27

 

 
(100
)
 
699

Total real estate loans
 
826

 
27

 

 
(100
)
 
699

Construction:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
49

 

 

 
12

 
61

Total construction loans
 
49

 

 

 
12

 
61

Credit cards
 
205

 

 

 
29

 
234

Total loans
 
$
24,739

 
$
3,467

 
$
7

 
$
3,758

 
$
25,037

(in thousands)
 
Three Months Ended June 30, 2014
 
 
Beginning
Balance
 
Charge
Offs
 
Recoveries
 
Provision
(Benefit)
 
Ending
Balance
Commercial loans
 
 
 
 
 
 
 
 
 
 
Technology
 
$
13,233

 
$
332

 
$
53

 
$
426

 
$
13,380

Life sciences
 
3,403

 
409

 

 
2,180

 
5,174

Asset-based loans
 
877

 

 

 
486

 
1,363

Venture capital/private equity
 
106

 

 

 
37

 
143

SBA and USDA
 
557

 

 

 
57

 
614

Other
 
9

 

 

 
2

 
11

Total commercial loans
 
18,185

 
741

 
53

 
3,188

 
20,685

Real estate loans:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
703

 

 

 
(1
)
 
702

Total real estate loans
 
703

 

 

 
(1
)
 
702

Construction:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
57

 

 

 
(38
)
 
19

Total construction loans
 
57

 

 

 
(38
)
 
19

Credit cards
 
149

 

 

 
1

 
150

Total loans
 
$
19,094

 
$
741

 
$
53

 
$
3,150

 
$
21,556


16


(in thousands)
 
Six Months Ended June 30, 2015
 
 
Beginning
Balance
 
Charge
Offs
 
Recoveries
 
Provision
(Benefit)
 
Ending
Balance
Commercial loans
 
 
 
 
 
 
 
 
 
 
Technology
 
$
11,904

 
$
3,691

 
$
392

 
$
5,854

 
$
14,459

Life sciences
 
3,657

 
1,961

 

 
2,212

 
3,908

Asset based loans
 
3,364

 
938

 

 
(265
)
 
2,161

Venture capital/private equity
 
250

 

 

 
124

 
374

SBA and USDA
 
622

 
64

 
1

 
63

 
622

Other
 
1,576

 
246

 

 
1,189

 
2,519

Total commercial loans
 
21,373

 
6,900

 
393

 
9,177

 
24,043

Real estate loans:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
1,310

 
567

 

 
(44
)
 
699

Total real estate loans
 
1,310

 
567

 

 
(44
)
 
699

Construction:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
43

 

 

 
18

 
61

Total construction loans
 
43

 

 

 
18

 
61

Credit cards
 
180

 

 

 
54

 
234

Total loans
 
$
22,906

 
$
7,467

 
$
393

 
$
9,205

 
$
25,037

 
 
 
 
 
 
 
 
 
 
 
(in thousands)
 
Six Months Ended June 30, 2014
 
 
Beginning
Balance
 
Charge
Offs
 
Recoveries
 
Provision
(Benefit)
 
Ending
Balance
Commercial loans
 
 
 
 
 
 
 
 
 
 
Technology
 
$
13,609

 
$
2,166

 
$
156

 
1,781

 
$
13,380

Life sciences
 
1,971

 
409

 

 
3,612

 
5,174

Asset based loans
 
684

 

 

 
679

 
1,363

Venture capital/private equity
 
197

 

 

 
(54
)
 
143

SBA and USDA
 
627

 
128

 

 
115

 
614

Other
 
2

 

 

 
9

 
11

Total commercial loans
 
17,090

 
2,703

 
156

 
6,142

 
20,685

Real estate loans:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
1,163

 
390

 

 
(71
)
 
702

Total real estate loans
 
1,163

 
390

 

 
(71
)
 
702

Construction:
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
10

 

 

 
9

 
19

Total construction loans
 
10

 

 

 
9

 
19

Credit cards
 
116

 

 

 
34

 
150

Total loans
 
$
18,379

 
$
3,093

 
$
156

 
$
6,114

 
$
21,556

 
 
 
 
 
 
 
 
 
 
 

17


The following tables summarize the allowance for loan losses individually and collectively evaluated for impairment at June 30, 2015 and December 31, 2014, broken out by portfolio segment:
(in thousands)
 
June 30, 2015
 
 
Ending Balance:
Individually
Evaluated for
Impairment
 
Ending Balance:
Collectively
Evaluated for
Impairment
Commercial loans
 
 
 
 
Technology
 
$
5,385

 
$
9,074

Life sciences
 
313

 
3,595

Asset based loans
 

 
2,161

Venture capital/private equity
 

 
374

SBA and USDA
 

 
622

Other
 
2,467

 
52

Total commercial loans
 
8,165

 
15,878

Real estate loans:
 
 
 
 
SBA and USDA
 
18

 
681

Total real estate loans
 
18

 
681

Construction:
 
 
 
 
SBA and USDA
 

 
61

Total construction loans
 

 
61

Credit cards
 

 
234

Total loans
 
$
8,183

 
$
16,854

(in thousands)
 
December 31, 2014
 
 
Ending Balance:
Individually
Evaluated for
Impairment
 
Ending Balance:
Collectively
Evaluated for
Impairment
Commercial loans
 
 
 
 
Technology
 
$
4,523

 
$
7,381

Life sciences
 
1,181

 
2,476

Asset based loans
 
280

 
3,084

Venture capital/private equity
 

 
250

SBA and USDA
 
46

 
576

Other
 
1,564

 
12

Total commercial loans
 
7,594

 
13,779

Real estate loans:
 
 
 
 
SBA and USDA
 
510

 
800

Total real estate loans
 
510

 
800

Construction:
 
 
 
 
SBA and USDA
 

 
43

Total construction loans
 

 
43

Credit cards
 

 
180

Total loans
 
$
8,104

 
$
14,802


18


Credit Quality
The following table summarizes the aging of gross loans, broken out by portfolio segment, at June 30, 2015 and December 31, 2014. See Note 2 to the Consolidated Financial Statements in the Company's 2014 Form 10-K for a discussion of credit quality indicators.
(in thousands)
 
June 30, 2015
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90+ Days
Past Due
 
Total Loans
Past Due
 
Current
 
Total Loans
 
Loans 90+
Days
Past Due
Still Accruing
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$
2,381

 
$
2,289

 
$
1,200

 
$
5,870

 
$
733,146

 
$
739,016

 
$

Life sciences
 

 

 

 

 
307,240

 
307,240

 

Asset-based loans
 

 

 

 

 
143,204

 
143,204

 

Venture capital/private equity
 

 

 

 

 
216,268

 
216,268

 

SBA and USDA
 

 

 
539

 
539

 
36,387

 
36,926

 

Other
 

 

 

 

 
14,062

 
14,062

 

Total commercial loans
 
2,381

 
2,289

 
1,739

 
6,409

 
1,450,307

 
1,456,716

 

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 

 
385

 
1,754

 
2,139

 
35,856

 
37,995

 

Total real estate loans
 

 
385

 
1,754

 
2,139

 
35,856

 
37,995

 

Construction loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 

 

 

 

 
6,752

 
6,752

 

Total construction loans
 

 

 

 

 
6,752

 
6,752

 

Credit cards
 

 

 

 

 
23,379

 
23,379

 

Total loans, gross
 
$
2,381

 
$
2,674

 
$
3,493

 
$
8,548

 
$
1,516,294

 
$
1,524,842

 
$

(in thousands)
 
December 31, 2014
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90+ Days
Past Due
 
Total Loans
Past Due
 
Current
 
Total Loans
 
Loans 90+
Days
Past Due
Still Accruing
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$

 
$

 
$

 
$

 
$
631,979

 
$
631,979

 
$

Life sciences
 

 

 

 

 
274,057

 
274,057

 

Asset-based loans
 

 

 

 

 
177,701

 
177,701

 

Venture capital/private equity
 

 

 

 

 
169,143

 
169,143

 

SBA and USDA
 

 

 
175

 
175

 
35,434

 
35,609

 

Other
 
3,245

 

 

 
3,245

 
3,609

 
6,854

 

Total commercial loans
 
3,245

 

 
175

 
3,420

 
1,291,923

 
1,295,343

 

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 

 

 
408

 
408

 
36,570

 
36,978

 

Total real estate loans
 

 

 
408

 
408

 
36,570

 
36,978

 

Construction loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 

 

 

 

 
4,035

 
4,035

 

Total construction loans
 

 

 

 

 
4,035

 
4,035

 

Credit cards
 

 

 

 

 
17,980

 
17,980

 

Total loans, gross
 
$
3,245

 
$

 
$
583

 
$
3,828

 
$
1,350,508

 
$
1,354,336

 
$


19


The following tables summarize impaired loans as they relate to allowance for loan losses, broken out by portfolio segment, at June 30, 2015 and December 31, 2014:
 
(in thousands)
 
June 30, 2015
 
 
 
Allowance for
loan losses
related
to impaired loans
 
Impaired loans with
related allowance
for loan losses
 
Impaired loans with
no related allowance
for loan losses
 
Recorded
investment in
impaired loans
 
Total of unpaid
principal of
impaired loans
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$
5,385

 
$
8,792

 
$
1,200

 
$
9,992

 
$
10,507

 
Life Sciences
 
313

 
1,911

 

 
1,911

 
1,976

 
SBA and USDA
 

 

 
539

 
539

 
611

 
Other
 
2,467

 
3,343

 

 
3,343

 
3,409

 
Total commercial loans
 
8,165

 
14,046

 
1,739

 
15,785

 
16,503

 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
18

 
385

 
1,767

 
2,152

 
2,745

 
Total real estate loans
 
18

 
385

 
1,767

 
2,152

 
2,745

 
Total loans, gross
 
$
8,183

 
$
14,431

 
$
3,506

 
$
17,937

 
$
19,248

 
(in thousands)
 
December 31, 2014
 
 
 
Allowance for
loan losses
related
to impaired loans
 
Impaired loans with
related allowance
for loan losses
 
Impaired loans with
no related allowance
for loan losses
 
Recorded
investment in
impaired loans
 
Total of unpaid
principal of
impaired loans
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$
4,523

 
$
8,757

 
$
730

 
$
9,487

 
$
10,398

 
Life Sciences
 
1,181

 
2,511

 

 
2,511

 
4,140

 
Asset-based loans
 
280

 
570

 

 
570

 
570

 
SBA and USDA
 
46

 
175

 

 
175

 
183

 
Other
 
1,564

 
3,245

 

 
3,245

 
3,261

 
Total commercial loans
 
7,594

 
15,258

 
730

 
15,988

 
18,552

 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
510

 
1,251

 

 
1,251

 
1,261

 
Total real estate loans
 
510

 
1,251

 

 
1,251

 
1,261

 
Total loans, gross
 
$
8,104

 
$
16,509

 
$
730

 
$
17,239

 
$
19,813


20


The following table summarizes average impaired loans, broken out by portfolio segment, during the three and six months ended June 30, 2015 and 2014:
(in thousands)
 
Three Months Ended June 30,
 
 
2015
 
2014
 
 
Average recorded
investment in
impaired loans
 
Interest income
recognized
 
Average recorded
investment in
impaired loans
 
Interest income
recognized
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
13,620

 
$

 
$
8,159

 
$

Life sciences
 
2,311

 

 
2,214

 

Asset-based loans
 
334

 

 

 

SBA and USDA
 
550

 

 
624

 

Other
 
3,337

 

 

 

Total commercial loans
 
20,152

 

 
10,997

 

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
2,872

 

 
1,283

 

Total real estate loans
 
2,872

 

 
1,283

 

Credit cards
 

 

 

 

Total loans, gross
 
$
23,024

 
$

 
$
12,280

 
$

(in thousands)
 
Six Months Ended June 30,
 
 
2015
 
2014
 
 
Average recorded
investment in
impaired loans
 
Interest income
recognized
 
Average recorded
investment in
impaired loans
 
Interest income
recognized
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
9,008

 
$

 
$
7,572

 
$

Life sciences
 
1,746

 

 
1,375

 

Asset-based loans
 
312

 

 

 

SBA and USDA
 
301

 

 
717

 

Other
 
2,882

 

 

 

Total commercial loans
 
14,249

 

 
9,664

 

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
1,465

 

 
1,283

 

Total real estate loans
 
1,465

 

 
1,283

 

Credit cards
 

 

 
10

 

Total loans, gross
 
$
15,714

 
$

 
$
10,957

 
$

 
 
 
 
 
 
 
 
 

21


The following table summarizes the credit quality indicators, broken out by portfolio segment, at June 30, 2015 and December 31, 2014:
(in thousands)
 
June 30, 2015
 
 
Pass
 
Performing
(Criticized)
 
Impaired
 
Total
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
693,726

 
$
35,298

 
$
9,992

 
$
739,016

Life sciences
 
293,746

 
11,583

 
1,911

 
307,240

Asset-based loans
 
128,946

 
14,258

 

 
143,204

Venture capital/private equity
 
216,268

 

 

 
216,268

SBA and USDA
 
32,175

 
4,212

 
539

 
36,926

Other
 
10,719

 

 
3,343

 
14,062

Total commercial loans
 
1,375,580

 
65,351

 
15,785

 
1,456,716

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
35,843

 

 
2,152

 
37,995

Total real estate loans
 
35,843

 

 
2,152

 
37,995

Construction loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
6,752

 

 

 
6,752

Total construction loans
 
6,752

 

 

 
6,752

Credit cards
 
23,379

 

 

 
23,379

Total loans, gross
 
$
1,441,554

 
$
65,351

 
$
17,937

 
$
1,524,842

(in thousands)
 
December 31, 2014
 
 
Pass
 
Performing
(Criticized)
 
Impaired
 
Total
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
575,483

 
$
47,009

 
$
9,487

 
$
631,979

Life sciences
 
257,143

 
14,403

 
2,511

 
274,057

Asset-based loans
 
160,558

 
16,573

 
570

 
177,701

Venture capital/private equity
 
169,143

 

 

 
169,143

SBA and USDA
 
35,040

 
394

 
175

 
35,609

Other
 
3,609

 

 
3,245

 
6,854

Total commercial loans
 
1,200,976

 
78,379

 
15,988

 
1,295,343

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
29,613

 
6,114

 
1,251

 
36,978

Total real estate loans
 
29,613

 
6,114

 
1,251

 
36,978

Construction loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
4,035

 

 

 
4,035

Total construction loans
 
4,035

 

 

 
4,035

Credit cards
 
17,980

 

 

 
17,980

Total loans, gross
 
$
1,252,604

 
$
84,493

 
$
17,239

 
$
1,354,336

Troubled debt restructurings (“TDRs”)
Uncollateralized loans are measured for impairment based on the present value of expected future cash flows, discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral.

22


The following table summarizes the Company's loans classified as TDRs, broken out by portfolio segment, during the three and six months ended June 30, 2015:
(dollars in thousands)
 
Three Months Ended June 30, 2015
 
 
Modifications
 
TDRs That
Subsequently Defaulted
 
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
Number of
Contracts
 
Recorded
Investment
Commercial loans:
 
 
 
 
 
 
 
 
 
 
Technology
 

 
$

 
$

 

 
$

Life Sciences
 

 

 

 
1

 
600

Other
 
1

 
3,343

 
3,343

 

 

Total commercial loans
 
1

 
3,343

 
3,343

 
1

 
600

Total loans, gross
 
1

 
$
3,343

 
$
3,343

 
1

 
$
600

(dollars in thousands)
 
Six Months Ended June 30, 2015
 
 
Modifications
 
TDRs That
Subsequently Defaulted
 
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
Number of
Contracts
 
Recorded
Investment
Commercial loans:
 
 
 
 
 
 
 
 
 
 
Technology
 

 
$

 
$

 
1

 
$
366

Life Sciences
 

 

 

 
1

 
600

Other
 
1

 
3,343

 
3,343

 

 

Total commercial loans
 
1

 
3,343

 
3,343

 
2

 
966

Total loans, gross
 
1

 
3,343

 
3,343

 
2

 
966

The loan identified as a TDR during the three and six months ended June 30, 2015, was restructured to defer interest payments. The loan is considered a nonperforming loan and, as such, was individually considered for allowance for loan losses calculations. There were no modifications of TDRs during the three and six months ended June 30, 2014.
The Bank currently has no commitments to lend to borrowers with loans identified as TDRs.
 
 
 
 
 
 
 
 
 
 
 
5.
INTANGIBLE ASSETS
The Bank recognizes servicing right intangibles related to obligations to service financial assets. See Note 15 for information about the Company's servicing assets. The Bank acquired certain intangible assets, consisting of non-compete agreements and existing customer relationships, as part of its acquisition of Sand Hill Finance LLC on December 31, 2013. The non-compete agreements and existing customer relationships are finite-lived intangible assets subject to amortization. The non-compete agreements intangible asset had a one-year amortization period and the existing customer relationships intangible asset has a three-year amortization period. The acquired intangible assets do not have renewal or extension provisions.

23


The Company's finite-lived intangible assets at June 30, 2015 and December 31, 2014, are as follows:
(in thousands)
 
June 30, 2015
 
December 31, 2014
Non-compete agreements
 
$
210

 
$
210

Existing customer relationships
 
590

 
590

Total gross carrying amounts
 
800

 
800

Accumulated amortization - non-compete agreements
 
(210
)
 
(210
)
Accumulated amortization - existing customer relationships
 
(295
)
 
(197
)
Total accumulated amortization
 
(505
)
 
(407
)
Total intangible assets subject to amortization, net
 
$
295

 
$
393

Amortization expense, net of tax for the three and six months ended June 30, 2015, amounted to $30 thousand and $62 thousand, respectively. Amortization expense, net of tax for the three and six months ended June 30, 2014, amounted to $62 thousand and $125 thousand, respectively. Amortization expense, net of tax is included in other noninterest expense on the accompanying consolidated statements of income.
The following table shows the expected amortization for the next five years for intangible assets at June 30, 2015:
(in thousands)
 
 
2015
 
99

2016
 
196

 
 
$
295


6.
DEPOSITS
Time deposits in denominations of $100,000 or more were approximately $9.2 million and $16.0 million at June 30, 2015 and December 31, 2014, respectively. Interest expense paid on time deposits individually exceeding $100,000 totaled $3 thousand and $8 thousand for the three and six months ended June 30, 2015, respectively. Interest expense paid on time deposits individually exceeding $100,000 totaled $16 thousand and $30 thousand for the three and six months ended June 30, 2014, respectively. At June 30, 2015, time deposits scheduled to mature on or before June 30, 2016, totaled $8.2 million. The remaining $1.0 million is scheduled to mature in 2017. At June 30, 2015 and December 31, 2014, the aggregate amount of overdrawn demand deposits reclassified to loans was $0.1 million and $0.9 million, respectively.

7.
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
Securities purchased under agreements to resell generally mature within one to four days from the transaction date. The Company had no reverse repurchase agreements outstanding at June 30, 2015 or December 31, 2014.
Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. The Company had no repurchase agreements outstanding at June 30, 2015 or December 31, 2014.

8.
BORROWINGS
The Company may purchase federal funds through unsecured federal funds lines of credit totaling $60.0 million. These lines of credit are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate. The Company also has the ability to utilize short-term borrowings from the Federal Reserve Bank with interest based upon the Federal Reserve US Primary Credit Discount Rate. This $83.4 million line is secured by loans and investment securities. There were no outstanding borrowings for these lines at June 30, 2015 and December 31, 2014.

24


In addition, the Company has the ability to borrow longer term from the Federal Home Loan Bank ("FHLB"), with a $250.4 million line of credit available. The rate on these advances varies based on borrowing terms. Advances from this line of credit must be adequately collateralized with securities. There were no outstanding borrowings for this line at June 30, 2015 and December 31, 2014.
In September 2008, the Company issued $7.4 million of convertible trust preferred securities. These securities were placed through Square 1 Financial Capital Trust I (the “Trust”), a Delaware trust that was formed by the Company, as sponsor, in order to facilitate the issuance of convertible trust preferred securities. The Trust held, as its sole asset, the subordinated debentures issued by the Company. The Company did not consolidate the Trust into its consolidated financial statements. The subordinated debentures issued by the Company amounted to $7.6 million. A debt discount of $1.5 million was recorded and was to be amortized over 30 years.
In 2014, the Company notified the holders of all trust preferred securities of its intent to redeem such securities as of June 30, 2014. All outstanding trust preferred securities were converted by the holders into shares of Company common stock prior to that date and the Trust was dissolved. During the three and six months ended June 30, 2014, investors converted $3.7 million and $7.4 million, respectively, of the outstanding convertible trust preferred securities into 366,500 Class A common shares and 741,500 Class A common shares, respectively, at $10.00 per share. For the three and six months ended June 30, 2014, interest expense on the trust preferred securities was $56 thousand and $215 thousand, respectively.

9.
EQUITY
Preferred Stock
In December 2008, the Company issued 5,000 shares of Series A, 5% Fixed Rate Cumulative Convertible Preferred Stock. Dividends were paid quarterly, in arrears. The preferred stock was convertible into shares of the Company’s common stock at the option of the holder and had a conversion price of $10.00 per share. On April 2, 2014, all shares of preferred stock were converted by the holder into 500,070 shares of common stock.
Issuances of Common Stock
During the three months ended June 30, 2015 and 2014, the Company issued 3,139 shares and 2,290 shares, respectively, of common stock related to vesting of restricted stock units issued under the Company's stock-based incentive compensation plan, and issued 93,925 shares and 78,600 shares, respectively, of common stock related to the exercise of stock options issued under the stock-based incentive compensation plan. During the six months ended June 30, 2015 and 2014, the Company issued 49,600 shares and 42,330 shares, respectively, of common stock related to vesting of restricted stock units issued under the Company's stock-based incentive compensation plan, and issued 319,078 shares and 118,730 shares, respectively, of common stock related to the exercise of stock options issued under the stock-based incentive compensation plan.
In 2005, the Company's organizers received warrants to purchase one additional share of common stock for every share of common stock purchased. These warrants expire 10 years after issuance. At June 30, 2015 and December 31, 2014, there were 4,000 warrants and 30,000 warrants outstanding, respectively, with an exercise price of $10.00 per share. During the three and six months ended June 30, 2015, the Company issued 26,000 shares of common stock related to the exercise of a portion of the outstanding warrants. During the three and six months ended June 30, 2014, the Company issued 28,000 shares and 32,000 shares of common stock related to the exercise of a portion of the outstanding warrants.
On March 31, 2014, the Company sold a total of 3,125,000 shares of Class A common stock in its initial public offering at an initial public offering price of $18.00 and received net proceeds of $51.1 million after expenses. On April 1, 2014, the underwriters exercised in full the underwriters’ purchase option granted in connection with the initial public offering, at the initial public offering price of $18.00, resulting in an additional 468,750 shares purchased from the Company for which it received $7.9 million in net proceeds on April 4, 2014.
During the three and six months ended June 30, 2014, the Company issued shares of its Class A common stock in connection with the conversion of the outstanding convertible trust preferred securities into common shares (see Note 8).
In 2010, in connection with a private placement of Company common stock, the Company issued warrants to purchase 750,000 shares of common stock at any time. The exercise price of the warrants was $5.15 per share. In February 2015, all of the warrants were net exercised for 603,436 shares of common stock. These warrants were originally valued at $1.8

25


million using a Black-Scholes-Merton fair value model and are included in additional paid in capital in the accompanying consolidated balance sheet at December 31, 2014.
Earnings Per Share
Basic and diluted earnings per share are computed based on the weighted average number of shares outstanding during each period. Diluted earnings per share reflects the potential dilution that could occur if convertible preferred stock, convertible trust preferred securities, stock options or warrants were exercised, resulting in the issuance of common stock that then shared in the net income of the Company.
Basic and diluted earnings per common share are calculated as follows:
(in thousands except per share data)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
 
 
2015
 
2014
 
2015
 
2014
Basic:
 
 
 
 
 
 
 
 
Net income
 
$
9,919

 
$
8,051

 
$
18,072

 
$
15,899

Less:
 dividends on preferred stock
 

 
1

 

 
63

Net income attributable to common shares
 
9,919

 
8,050

 
18,072

 
15,836

Basic weighted-average common shares outstanding
 
29,825

 
28,333

 
29,549

 
26,042

Earnings per share—basic
 
$
0.33

 
$
0.28

 
$
0.61

 
$
0.61

Diluted:
 
 
 
 
 
 
 
 
Net income attributable to common shares
 
$
9,919

 
$
8,050

 
$
18,072

 
$
15,836

Plus:
dividends on preferred stock
 

 
1

 

 
63

 
convertible trust preferred securities
 

 
39

 

 
148

Net income attributable to common shares after assumed conversions
 
9,919

 
8,090

 
18,072

 
16,047

Basic weighted-average common shares outstanding
 
29,825

 
28,333

 
29,549

 
26,042

Effect of dilutive stock options and warrants
 
670

 
1,331

 
842

 
1,711

Diluted weighted-average common shares outstanding
 
30,495

 
29,664

 
30,391

 
27,753

Earnings per share—diluted
 
$
0.33

 
$
0.27

 
$
0.60

 
$
0.58

Accumulated Other Comprehensive Income (Loss)
The Company’s only components of accumulated other comprehensive income (loss) relate to unrealized gains and losses on available for sale securities and their related tax effects. Reclassification adjustments out of accumulated other comprehensive income for the three and six months ended June 30, 2015 and 2014 are presented in the following table:
(in thousands)
 
 
 
Three Months Ended June 30,
 
Six Months Ended 
 June 30,
 
 
Location
 
2015
 
2014
 
2015
 
2014
Reclassification adjustment for gains included in net income
 
Net gain (loss) on securities
 
$
(1,396
)
 
$
(80
)
 
$
(1,021
)
 
$
(80
)
Related tax expense
 
Income tax expense
 
523

 
30

 
383

 
30

Reclassification adjustment for gains included in net income, net of tax
 
 
 
$
(873
)
 
$
(50
)
 
$
(638
)
 
$
(50
)

10.
INCOME TAXES
The Company and its subsidiaries file a consolidated U.S. federal income tax return. The Company is no longer subject to the assessment of tax with respect to returns that have been filed for years prior to 2009. The Company's effective tax rate is lower than the federal statutory rate primarily as a result of the Company's portion of income from non-taxable investments.

26


Realization of the Company’s net deferred tax assets is dependent upon the Company generating sufficient taxable income in future years to obtain a benefit from the reversal of deductible temporary differences and from tax loss carry-forwards. The Company has concluded that, based on expected future results and the future reversals of existing taxable temporary differences, it is more likely than not that its deferred tax assets will be realized, except for a $0.3 million valuation allowance for North Carolina. The Company’s net operating loss carry-forwards will begin to expire in 2029.
The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. At June 30, 2015 and December 31, 2014, the Company did not record a liability for uncertain tax positions because no material positions existed.
The Company classifies tax related interest and penalties as a component of income taxes. Interest and penalties for all periods presented were immaterial.

11.
REGULATORY MATTERS AND RESTRICTIONS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, as set forth in the table below. Management believes that at June 30, 2015, the Company and the Bank met all capital requirements to which they are subject and are “well-capitalized”.
On January 1, 2015, the Basel III regulatory standard on bank capital adequacy became effective. The rule establishes a new Common Equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets), and requires institutions to hold 8.0% total capital and 4.0% Tier 1 capital to average consolidated assets (“Leverage Ratio”). It also increases the Tier 1 capital to risk-based assets threshold ratio for "well capitalized" from 6.0% to 8.0% or risk-weighted assets.
The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. Regulatory authorities may further limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the bank.
The Company’s actual capital amounts and ratios at June 30, 2015 and December 31, 2014, and the minimum capital requirements, are presented in the following table:
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Minimum Requirements to be:
COMPANY
 
Actual
 
Adequately Capitalized
 
Well Capitalized
 
 
Amount
 
Ratio
 
Amount    
 
Ratio    
 
Amount
 
Ratio
June 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital ratio
 
$
344,658

 
13.12
%
 
$
210,097

 
8.00
%
 
$
262,621

 
10.00
%
Tier 1 risk-based capital ratio
 
317,608

 
12.09

 
157,572

 
6.00

 
210,097

 
8.00

Common equity Tier 1 capital ratio
 
317,608

 
12.09

 
118,179

 
4.50

 
170,703

 
6.50

Tier 1 leverage ratio
 
317,608

 
9.07

 
140,118

 
4.00

 
175,148

 
5.00

December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital ratio
 
$
318,344

 
14.95
%
 
$
170,340

 
8.00
%
 
$
212,925

 
10.00
%
Tier 1 risk-based capital ratio
 
294,441

 
13.83

 
85,170

 
4.00

 
127,755

 
6.00

Tier 1 leverage ratio
 
294,441

 
9.71

 
121,289

 
4.00

 
151,611

 
5.00


27


The Bank’s actual capital amounts and ratios at June 30, 2015 and December 31, 2014, and the minimum capital requirements, are presented in the following table:
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Minimum Requirements to be:
BANK
 
Actual
 
Adequately Capitalized
 
Well Capitalized
 
 
Amount
 
Ratio
 
Amount    
 
Ratio    
 
Amount
 
Ratio
June 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital ratio
 
$
335,229

 
12.82
%
 
$
209,186

 
8.00
%
 
$
261,483

 
10.00
%
Tier 1 risk-based capital ratio
 
308,179

 
11.79

 
156,890

 
6.00

 
209,186

 
8.00

Common equity Tier 1 capital ratio
 
308,179

 
11.79

 
117,667

 
4.50

 
169,964

 
6.50

Tier 1 leverage ratio
 
308,179

 
8.82

 
139,787

 
4.00

 
174,733

 
5.00

December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital ratio
 
$
309,928

 
14.61
%
 
$
169,752

 
8.00
%
 
$
212,190

 
10.00
%
Tier 1 risk-based capital ratio
 
286,025

 
13.48

 
84,876

 
4.00

 
127,314

 
6.00

Tier 1 leverage ratio
 
286,025

 
9.44

 
121,186

 
4.00

 
151,483

 
5.00


12.
RETIREMENT PLAN
The Company approved in January 2006 the establishment of an employee benefit plan (the “Plan”) pursuant to Section 401(k) of the Internal Revenue Code for the benefit of its employees. The Plan includes provisions for discretionary employee contributions, subject to limitation under the Internal Revenue Code. Under the Plan, employees may contribute up to an annual maximum as determined by the Internal Revenue Code. During 2015 and 2014, the Company matched 100% of the first 3% of employee contributions and 50% on contributions between 3-5%. The expense related to the plan for the three and six months ended June 30, 2015 amounted to $0.3 million and $0.7 million, respectively. The expense related to the plan for the three and six months ended June 30, 2014 amounted to $0.2 million and $0.6 million, respectively.

13.
STOCK-BASED COMPENSATION PLAN
The Company maintains a stock-based incentive compensation plan covering certain officers, directors and employees. Grants of options are made by the Compensation Committee of the Board of Directors. Excluding minimal exceptions, all grants must be at no less than fair market value on the date of grant, must be exercised no later than seven years from the date of grant, and may be subject to some vesting provisions. Grants generally vest over five years from the date of grant. The 2009 Stock Incentive Plan, as amended, provides for the issuance of up to 2,820,542 restricted stock units and options to purchase shares of the Company’s stock. At June 30, 2015, 932,818 shares of common stock remained available for future issuance through stock options or restricted stock units.

28


The following table presents a rollforward of the Company’s stock options outstanding during the six months ended June 30, 2015:
 
 
 
 
 
 
Weighted
Average
Remaining
Contractual
Life in
Years
 
 
Shares
 
Weighted Average Exercise Price
 
Outstanding at beginning of period
 
1,175,675

 
$
6.12

 
3.37
Granted
 

 

 

Exercised
 
(325,986
)
 
6.07

 

Forfeited
 
(660
)
 
6.00

 

Outstanding at end of period
 
849,029

 
$
6.14

 
3.97
Options exercisable at period end
 
533,319

 
$
6.07

 
3.94
The following table provides information for restricted stock units issued under the stock-based incentive compensation plan during the six months ended June 30, 2015:
 
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Nonvested at beginning of period
 
376,372

 
$
10.01

Granted
 
101,548

 
26.22

Vested
 
(70,210
)
 
17.01

Forfeited
 
(13,626
)
 
9.83

Nonvested at end of period
 
394,084

 
$
12.94

The Company’s pre-tax compensation cost for stock-based employee compensation was $0.9 million and $2.2 million, respectively, for the three and six months ended June 30, 2015. The Company’s pre-tax compensation cost for stock-based employee compensation was $0.7 million and $1.7 million, respectively, for the three and six months ended June 30, 2014. At June 30, 2015, there was $4.2 million of unrecognized compensation cost related to non-vested stock-based compensation under this plan to be recognized over five years.

14.
DERIVATIVES
The Company receives equity warrants with net settlement terms in connection with extending loan commitments to certain of its customers. These warrants are obtained at the inception of a loan facility or the amendment of a loan facility. These warrants are not obtained in lieu of other fees, interest or payments. These warrants potentially provide an additional return, in addition to the traditional loan yield from interest and fees, in the event of a liquidity event of the borrowing company. The Company holds these equity warrants for future investment gains, rather than to hedge economic risks. In general, the equity warrants entitle the Company to buy a specific number of shares of the customer’s stock at a specific price over a specific time period. The warrants may also include contingent provisions which provide for additional shares to be purchased at a specific price if defined future events occur, such as future rounds of equity financing by the customer, or upon additional borrowings by the customer. All of the Company’s equity warrants contain net share settlement provisions, which permit the customer to deliver to the Company, upon the Company’s exercise of the warrant, the amount of shares with a current fair value equal to the net gain under the warrant agreement.
ASC 815 Derivatives and Hedging requires that all derivative instruments be recorded on the balance sheet at fair value. Equity warrants with net share settlement provisions are considered derivatives. The Company's equity warrants portfolio is primarily comprised of holdings in non-public companies and the Company’s practice generally is to monetize its positions as soon as a liquidity event occurs. Often there is a lock-up period requiring the Company to hold its equity position in a publicly traded security until the expiration of the lock-up period. The Company estimates the initial fair value of non-public company equity warrants using a Black-Scholes option pricing model to approximate fair market value. The model estimates market value for each warrant based on the most recent equity offering at the time of issuance, the warrant specific exercise price, the warrant’s expected life, a risk-free interest rate based on a duration matched U.S. Treasury rate and volatility factors derived from indices of comparable publicly traded companies. On a monthly basis, the Company

29


adjusts the value of equity warrants in non-public companies using a Black-Scholes model to approximate fair market value based on changes to the risk-free interest rate, the volatility rate and the warrant’s expected life.
The Company also holds warrants in public companies. When a private company goes public there is often a lock-up period requiring the Company to hold its equity position in a publicly traded security until the expiration of the lock-up period. The Company adjusts the value of equity warrants in public companies on a monthly basis based on the month-end closing stock price adjusted for the option value of the warrant. The model estimates market value for each warrant based on the share price as of the evaluation date, the warrant specific exercise price, the warrant’s expected life, a risk-free interest rate based on a duration matched U.S. Treasury rate and uses a company specific volatility factor. See Note 15 for further information regarding the fair value of the Company's equity warrants. Any changes from the grant date in the fair value of equity warrant assets will be recognized as increases or decreases to warrant valuation and as unrealized gains or losses in non-interest income. When a portfolio company completes an initial public offering on a publicly reported market or is acquired, the Company may exercise these equity warrant assets for shares or cash. Shares received from the exercise of warrants and subject to lock-up agreements are held as equity securities in the Company's available for sale portfolio.
The grant date fair values of equity warrants received in connection with extending loan commitments are considered to be loan fees and are recognized over the life of the loan commitment as an adjustment to loan yield through loan interest income. At June 30, 2015 and December 31, 2014, unearned income on loans included $2.2 million and $2.0 million, respectively, related to the initial valuation of equity warrant assets. For the three and six months ended June 30, 2015, the Company recognized $0.6 million and $1.0 million, respectively, in income from the amortization of loan fees related to the initial valuation of equity warrant assets. For the three and six months ended June 30, 2014, the Company recognized $0.3 million and $0.6 million, respectively, in income from the amortization of loan fees related to the initial valuation of equity warrant assets.
Warrants held, which amounted to $5.1 million and $4.3 million in 484 and 461 companies at June 30, 2015 and December 31, 2014, respectively, are shown as warrant valuation in the accompanying consolidated balance sheets. At June 30, 2015, included in the $5.1 million in equity warrant assets in 484 companies are $0.6 million of equity warrant assets held in nine publicly traded companies. At December 31, 2014, included in the $4.3 million in equity warrant assets in 461 companies are $0.2 million of equity warrant assets held in six publicly traded companies.
During the three months ended June 30, 2015, the Company did not exercise any warrants for equity securities. During the three months ended June 30, 2015, the Company monetized equity securities for $0.1 million in proceeds following the expiration of their applicable lock-up periods. These equity securities had an initial value of $0.1 million. The Company had obtained these equity securities through the exercise of warrants in two public companies.
During the six months ended June 30, 2015, the Company exercised warrants with a total value of $33 thousand and received equity securities in one publicly traded company. During the six months ended June 30, 2015, the Company monetized equity securities for $0.9 million in proceeds following the expiration of their applicable lock-up periods. These equity securities had an initial value of $1.2 million and the Company recognized a loss of $0.3 million. The Company had obtained these equity securities through the exercise of warrants in four public companies.
During the three and six months ended June 30, 2014, the Company exercised warrants with a total value of $1.4 million and received equity securities in four publicly traded companies of which one was monetized for $0.3 million. During the three and six months ended June 30, 2014, the Company exited $0.8 million in warrants in one publicly traded company and $0.8 million in warrants in warrants in three publicly traded companies, respectively.
At June 30, 2015 and December 31, 2014, the fair value of equity securities included in investments obtained through the exercise of warrants and still held was $0.1 million and $0.9 million, respectively (see Note 3).

30


The following table presents gains and losses on equity warrant exercises and the number of companies on which warrants were exercised, broken out by stage of emerging companies:
(in thousands except number of companies)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Equity warrant assets:
 
 
 
 
 
 
 
 
Gains:
 
 
 
 
 
 
 
 
Early stage
 
$
60

 
$
889

 
$
206

 
$
1,030

Expansion stage
 
90

 
1,144

 
197

 
1,534

Late stage
 
10

 
127

 
496

 
454

Total gains on exercise of equity warrant assets
 
160

 
2,160

 
899

 
3,018

Losses:
 
 
 
 
 
 
 
 
Expansion stage
 

 
(2
)
 

 
(2
)
Late stage
 
(4
)
 

 
(4
)
 

Total losses on exercise of equity warrant assets (1)
 
(4
)
 
(2
)
 
(4
)
 
(2
)
Net gains on exercise of equity warrant assets
 
156

 
2,158

 
895

 
3,016

Non-monetized write off of warrant assets
 
(66
)
 
(97
)
 
(125
)
 
(176
)
Net realized gains on equity warrants
 
90

 
2,061

 
770

 
2,840

Change in fair value of equity warrant assets
 
149

 
(2,040
)
 
(69
)
 
(624
)
Warrant income
 
$
239

 
$
21

 
$
701

 
$
2,216

 
 
 
 
 
 
 
 
 
Number of companies on which warrant gains were realized:
 
 
 
 
 
 
 
 
Early stage
 
4

 
6

 
9

 
11

Expansion stage
 
8

 
12

 
14

 
17

Late stage
 
1

 
2

 
6

 
5

Total number of companies
 
13

 
20

 
29

 
33

(1) Realized warrant losses for the three and six months ended June 30, 2015 related to one late stage company. Realized warrant losses for the three and six months ended June 30, 2014 related to one expansion stage company.

15.
FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES
Fair Value Measurements
The Company's marketable investment securities and derivative instruments are financial instruments recorded at fair value on a recurring basis. The Company makes estimates regarding valuation of assets and liabilities measured at fair value in preparing its consolidated financial statements. ASC 825-10 provides an option to report selected financial assets and liabilities at fair value. The Company has not elected to measure any financial assets or liabilities using the fair value option under ASC 825-10.
ASC 820, Fair Value Measurements and Disclosures defines fair value as the price that would be received to sell an asset or paid to transfer a liability (the “exit price”) in an orderly transaction between market participants at the measurement date. Fair value is a market-based measurement considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measurement.
ASC 820 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect the Company's estimates about market data.

31


The three levels for measuring fair value are based on the reliability of inputs and are as follows:
Level 1
  
Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to instruments utilizing Level 1 inputs. Since valuations are based on quoted prices that are readily available in an active market, valuation of these products does not entail a significant degree of judgment. Assets utilizing Level 1 inputs include exchange-traded equity securities.
Level 2
  
Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, directly or indirectly. Assets and liabilities utilizing Level 2 inputs include: U.S. treasury and agency securities, mortgage-backed securities, collateralized mortgage obligations, commercial mortgage-backed securities, municipal bonds and notes, Over-the-Counter (“OTC”) derivative instruments (foreign exchange forwards and option contracts, interest rate swaps related to the Company's senior notes, subordinated notes and junior subordinated debentures), and equity warrant assets for shares of public company capital stock.
 
 
Level 3
  
Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Assets utilizing Level 3 inputs include: limited partnership interests in private equity funds, direct equity investments in private companies, mortgage-backed securities, and equity warrant assets for shares of private company capital stock.
For inactive markets, there is little information, if any, to evaluate if individual transactions are orderly. Accordingly, the Company is required to estimate, based upon all available facts and circumstances, the degree to which orderly transactions are occurring. Price quotes based upon transactions that are not orderly are not considered to be determinative of fair value and are given little, if any, weight in measuring fair value. Price quotes based upon transactions that are orderly are considered in determining fair value, with the weight given based upon the facts and circumstances. If sufficient information is not available to determine if price quotes are based upon orderly transactions, less weight is given to the price quote relative to other transactions that are known to be orderly.
To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment that the Company uses to determine fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement is determined is based on the lowest level input that is significant to the fair value measurement in its entirety.
Investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.
The types of instruments valued based on quoted market prices in active markets include the Company’s U.S. government and agency securities, mortgage-backed securities and asset-backed securities (“ABS”). Such instruments are generally classified within level 1 or level 2 of the fair value hierarchy. As required by ASC 820, the Company does not adjust the quoted price for such instruments.
Level 3 valuations are for instruments that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Such instruments in this category include some investment securities, all impaired loans, warrants and foreclosed assets.
Transfers between fair value hierarchy levels would represent assets or liabilities that were previously categorized at a higher level for which the inputs to the estimate became less observable or classified at a lower level for which the inputs became more observable during the period. The Company's policy is to recognize transfers between levels at the end of the period.

32


The following is a summary of the valuation methods and significant assumptions used to estimate fair value:
Available for sale securities
Valuations for the available-for-sale securities are provided by third party external pricing service providers. The Company reviews the methodologies used to determine the fair value, including understanding the nature and observability of the inputs used to determine the price. The Company obtains additional corroboration depending on the type of security, the frequency of trades of the security and the level of liquidity or depth of the market.
Following is a summary of the significant inputs used for each class of assets and liabilities:
U.S. pass-through government mortgages are evaluated based on benchmark curves as well as security set-ups, to be announced (TBA) market, and broker feeds. Fixed-rate Ginnie Mae pools backed by fixed rate reverse mortgages are evaluated based on prepayment speeds, cash flows, swap curves, spread adjustments, coupon and average life. New issue data, monthly payment information and collateral performance are also monitored.
U.S. government collateralized mortgage obligations are evaluated based on benchmark curves, security set-up, prepayment speeds, cashflow scenario analysis, supporting collateral identification and collateral performance. Adjustments are made for spread, yield, price and prepayment speeds. Volatility-driven, multi-dimensional spread tables as well as Option Adjusted Spread model applications are applied.
Non-agency mortgage evaluation methodology is based on security set-up, prepayment speeds, cashflow scenario analysis, benchmark comparisons and supporting collateral identification and performance. Depending on the characteristics of a given tranche, Option Adjust Spread model or multi-dimensional single cash flow stream model is applied.
Municipal bonds are evaluated based on stated coupon rates, final maturity dates, callable options and yield analysis including benchmark comparisons, yield to maturity and yield to worst. Adjustments are made for ratings updates and material event notices. Quotes are based on spreads to other municipal benchmark bonds with similar characteristics or relative to market rates on U.S. treasury bonds of similar maturity.
Corporate and trust preferred security methodology is based on security set up, benchmark comparisons, yield to maturity, issuer name, coupon rate, maturity date and any applicable issuer call option feature. An option adjusted spread model is used for issues that have early redemption features. Adjustments are made for corporate actions. The Floating Rate Note model is applied to variable rate note evaluations.
The methodology for fixed and floating rate asset backed securities is based on benchmark curves as well as security set-up, prepayment speeds, benchmark yields, spread adjustments, ratings updates, collateral performance and price history. Tranche level attributes, cash flows and market color (as available) are also monitored.
SBA pool evaluation methodology is determined by benchmark rates and swap curves, cashflow scenario analysis, coupon, maturity, and supporting collateral identification and collateral performance. The unique structures associated with SBA and SBIC programs are taken into account. Additional adjustments can be made based on the original and remaining terms, coupon, seasonality of the pools and default factors.
U.S. treasury securities are evaluated based on security set up, yield to maturity and through reviewing Treasury trading platform feeds (both active market makers and inter-dealer brokers) for consistency and outliers.
Equity warrant assets
Fair value measurements of equity warrant assets of publicly-traded portfolio companies are valued based on a modified Black-Scholes pricing model. The model uses the stock price of publicly-traded companies, stated exercise prices, warrant expiration dates, the risk-free interest rate and market-observable option volatility assumptions for companies with 90 or more days of trading history. For public companies with less than 90 days of trading history, the iShares Russell Microcap index (IWC) is used to estimate volatility. Further, option expiration dates are modified to account for estimates to actual life relative to stated expiration.
Fair value measurements of equity warrant assets of private portfolio companies are priced based on a modified Black-Scholes option pricing model to estimate asset value by using stated exercise prices, option expiration dates, risk-free interest rates and option volatility assumptions. Option volatility assumptions used in the modified Black-Scholes model are based on the iShares Russell Microcap index (IWC). Option expiration dates are modified to account for estimates to actual life relative to stated expiration.

33


Servicing asset
Valuation for the Company's servicing asset is provided by a third party external pricing service provider. The Company reviews the methodology used to determine the fair value, including understanding the nature and observability of the inputs used to determine the fair value. The valuation uses generated future cashflows for each asset based on the asset's unique characteristics, market-based assumptions for prepayment speeds and, in the case of non-guaranteed portions of SBA loans, losses and recoveries. The present value of the future cash flows are then calculated utilizing market-based discount rate assumptions. In all cases, each loan’s expected payment for each monthly period is modeled in order to create the most detailed cash flow stream possible.
Venture capital fund investments
To determine the estimated fair value of the Company's venture capital fund investments, the Company evaluates various factors related to the underlying private company entities. The factors are specific to each underlying private company. The factors evaluated include, but are not limited to, actual and forecasted results, cash position, and market comparable companies.

34


The following tables present quantitative information about Level 3 fair value measurements:
(dollars in thousands)
 
June 30, 2015
 
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Weighted Average Range
Available for sale securities:
 
 
 
 
 
 
 
 
Corporates
 
$
3,011

 
Sensitivity analyses
 
Indicative pricing
 
(1)
Non-agency MBS
 
185,113

 
Volatility-driven, multi-dimensional spread tables, optional adjusted spread model and prepayment model
 
Indicative pricing
 
(1)
 
 
 
 
 
 
Collateral performance
 
(1)
Other ABS
 
106,974

 
Multi-dimensional, collateral specific spread tables
 
Indicative pricing
 
(1)
 
 
 
 
 
 
Collateral performance
 
(1)
Warrants
 
5,125

 
Modified Black-Scholes option pricing model
 
Volatility
 
19.5% - 127.2% (2)
 
 
 
 
 
 
Risk-free interest rate
 
0.6% - 1.2% (2)
 
 
 
 
 
 
Remaining life assumption
 
21.8% - 50.8% (2)
Servicing asset
 
1,450

 
Discounted cash flow
 
Discount rates
 
(1)
 
 
 
 
 
 
Default rates
 
(1)
 
 
 
 
 
 
Prepayment rates
 
(1)
 
 
 
 
 
 
Servicing costs
 
(1)
Venture capital fund investments
 
4,232

 
Private company equity pricing
 
Actual and forecasted results, cash position, market comparable companies
 
(3)
(dollars in thousands)
 
December 31, 2014
 
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Weighted Average Range
Available for sale securities:
 
 
 
 
 
 
 
 
Non-agency MBS
 
$
173,099

 
Volatility-driven, multi-dimensional spread tables, optional adjusted spread model and prepayment model
 
Indicative pricing
 
(1)
 
 
 
 
 
 
Collateral performance
 
(1)
Other ABS
 
47,621

 
Multi-dimensional, collateral specific spread tables
 
Indicative pricing
 
(1)
 
 
 
 
 
 
Collateral performance
 
(1)
Warrants
 
4,304

 
Modified Black-Scholes option pricing model
 
Volatility
 
20.2% - 67.0% (2)
 
 
 
 
 
 
Risk-free interest rate
 
1.2 % - 1.5% (2)
 
 
 
 
 
 
Remaining life assumption
 
54.0% - 89.4% (2)
Servicing asset
 
1,222

 
Discounted cash flow
 
Discount rates
 
(1)
 
 
 
 
 
 
Default rates
 
(1)
 
 
 
 
 
 
Prepayment rates
 
(1)
 
 
 
 
 
 
Servicing costs
 
(1)
Venture capital fund investments
 
3,704

 
Private company equity pricing
 
Actual and forecasted results, cash position, market comparable companies
 
(3)
(1)
The Company uses third-party pricing information without adjustment for this Level 3 fair value measurement.
(2)
Low end of range relates to private equity warrant assets portfolio and high end of range relates to public equity warrant assets portfolio.

35


(3)
The factors are specific to each underlying private company, and as such, a weighted average or range of values for the unobservable inputs is not meaningful.
Following are tables that present information about the Company's investment securities, warrants, servicing asset, and venture capital fund investments, measured at fair value on a recurring basis:
(in thousands)
 
At June 30, 2015
 
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Ending
Balance
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Available for sale securities:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
159,501

 
$

 
$

 
$
159,501

Agency direct obligations
 
30,435

 

 

 
30,435

SBA pools
 

 
164,574

 

 
164,574

Agency MBS
 

 
674,285

 

 
674,285

Municipal bonds
 

 
98,931

 

 
98,931

Corporates
 

 
117,614

 
3,011

 
120,625

Non-agency MBS
 

 

 
185,113

 
185,113

Other ABS
 

 

 
106,974

 
106,974

Equity securities
 
904

 

 

 
904

Total available for sale securities
 
$
190,840

 
$
1,055,404

 
$
295,098

 
$
1,541,342

Warrants
 
$

 
$

 
$
5,125

 
$
5,125

Servicing asset
 
$

 
$

 
$
1,450

 
$
1,450

Venture capital fund investments
 
$

 
$

 
$
4,232

 
$
4,232

(in thousands)
 
At December 31, 2014
 
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Ending
Balance
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Available for sale securities:
 
 
 
 
 
 
 
 
U.S. treasuries
 
$
29,641

 
$

 
$

 
$
29,641

Agency direct obligations
 
30,631

 

 

 
30,631

SBA pools
 

 
179,822

 

 
179,822

Agency MBS
 

 
614,922

 

 
614,922

Municipal bonds
 

 
98,490

 

 
98,490

Corporates
 

 
118,359

 

 
118,359

Non-agency MBS
 

 

 
173,099

 
173,099

Other ABS
 

 

 
47,621

 
47,621

Equity securities
 
1,948

 

 

 
1,948

Total available for sale securities
 
$
62,220

 
$
1,011,593

 
$
220,720

 
$
1,294,533

Warrants
 
$

 
$

 
$
4,304

 
$
4,304

Servicing asset
 
$

 
$

 
$
1,222

 
$
1,222

Venture capital fund investments
 
$

 
$

 
$
3,704

 
$
3,704



36


The following tables present additional information about Level 3 securities, venture capital fund investments, servicing assets and warrants, measured at fair value on a recurring basis:
(dollars in thousands)
 
Three Months Ended June 30, 2015
 
 
Available for sale securities
 
 
 
 
 
 
 
 
 
 
Corporates
 
Non-Agency MBS
 
Other ABS
 
Venture Capital Fund Investments
 
Servicing Asset
 
Warrants
 
Total
Balance at March 31, 2015
 
$

 
$
164,749

 
$
67,043

 
$
3,834

 
$
1,393

 
$
4,649

 
$
241,668

Transfers into Level 3
 
3,011

 

 

 

 

 

 
3,011

Transfers out of Level 3
 

 

 

 

 

 
(29
)
 
(29
)
Total gains (losses):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
included in net income
 

 

 

 
337

 
(14
)
 
239

 
562

included in other comprehensive income
 

 
(12,688
)
 
(4,785
)
 

 

 

 
(17,473
)
Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
 

 
47,787

 
46,009

 
231

 

 

 
94,027

Sales
 

 
(14,735
)
 
(1,293
)
 

 

 
(137
)
 
(16,165
)
Issuances
 

 

 

 

 
147

 
403

 
550

Settlements
 

 

 

 
(170
)
 
(76
)
 

 
(246
)
Balance at June 30, 2015
 
$
3,011

 
$
185,113

 
$
106,974

 
$
4,232

 
$
1,450

 
$
5,125

 
$
305,905

(dollars in thousands)
 
Three Months Ended June 30, 2014
 
 
Available for sale securities
 
 
 
 
 
 
 
 
 
 
Corporates
 
Non-Agency MBS
 
Other ABS
 
Venture Capital Fund Investments
 
Servicing Asset
 
Warrants
 
Total
Balance at March 31, 2014
 
$
29,391

 
$
66,651

 
$
24,605

 
$
3,958

 
$
1,298

 
$
6,596

 
$
132,499

Transfers into Level 3
 

 

 

 

 

 

 

Transfers out of Level 3
 
(23,389
)
 

 

 
(953
)
 

 
(1,369
)
 
(25,711
)
Total gains (losses):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
included in net income
 

 

 

 
1,415

 
6

 
21

 
1,442

included in other comprehensive income
 
83

 
(2,773
)
 
(6,810
)
 

 

 

 
(9,500
)
Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
 

 
23,759

 
16,252

 
170

 

 

 
40,181

Sales
 

 
(2,203
)
 

 

 

 
(994
)
 
(3,197
)
Issuances
 

 

 

 

 
55

 
493

 
548

Settlements
 

 

 

 
(257
)
 
(34
)
 

 
(291
)
Balance at June 30, 2014
 
$
6,085

 
$
85,434

 
$
34,047

 
$
4,333

 
$
1,325

 
$
4,747

 
$
135,971


37


(dollars in thousands)
 
Six Months Ended June 30, 2015
 
 
Available for sale securities
 
 
 
 
 
 
 
 
 
 
Corporates
 
Non-Agency MBS
 
Other ABS
 
Venture Capital Fund Investments
 
Servicing Asset
 
Warrants
 
Total
Balance at December 31, 2014
 
$

 
$
173,099

 
$
47,621

 
$
3,704

 
$
1,222

 
$
4,304

 
$
229,950

Transfers into Level 3
 
3,011

 

 

 

 

 

 
3,011

Transfers out of Level 3
 

 

 

 

 

 
(38
)
 
(38
)
Total gains (losses):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
included in net income
 

 

 

 
337

 
(9
)
 
701

 
1,029

included in other comprehensive income
 

 
(22,929
)
 
(8,252
)
 

 

 

 
(31,181
)
Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
 

 
60,677

 
68,898

 
474

 

 

 
130,049

Sales
 

 
(25,734
)
 
(1,293
)
 

 

 
(942
)
 
(27,969
)
Issuances
 

 

 

 

 
331

 
1,100

 
1,431

Settlements
 
 
 

 

 
(283
)
 
(94
)
 

 
(377
)
Balance at June 30, 2015
 
$
3,011

 
$
185,113

 
$
106,974

 
$
4,232

 
$
1,450

 
$
5,125

 
$
305,905

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
 
Six Months Ended June 30, 2014
 
 
Available for sale securities
 
 
 
 
 
 
 
 
 
 
Corporates
 
Non-Agency MBS
 
Other ABS
 
Venture Capital Fund Investments
 
Servicing Asset
 
Warrants
 
Total
Balance at December 31, 2013
 
$
26,301

 
$
52,170

 
$
22,091

 
$
4,066

 
$
1,265

 
$
5,105

 
$
110,998

Transfers into Level 3
 
2,994

 

 
2,762

 

 

 

 
5,756

Transfers out of Level 3
 
(23,389
)
 

 

 
(953
)
 

 
(1,369
)
 
(25,711
)
Total gains (losses):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
included in net income
 

 

 

 
1,415

 
18

 
2,216

 
3,649

included in other comprehensive income
 
179

 
(4,405
)
 
(7,058
)
 

 

 

 
(11,284
)
Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchases
 

 
39,872

 
16,252

 
170

 

 

 
56,294

Sales
 

 
(2,203
)
 

 

 

 
(1,800
)
 
(4,003
)
Issuances
 

 

 

 

 
110

 
595

 
705

Settlements
 

 

 

 
(365
)
 
(68
)
 

 
(433
)
Balance at June 30, 2014
 
$
6,085

 
$
85,434

 
$
34,047

 
$
4,333

 
$
1,325

 
$
4,747

 
$
135,971

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

For the three and six months ended June 30, 2015, one available for sale securities was transferred from Level 2 due to lack of observable inputs to substantiate a Level 2 valuation. For the three months ended June 30, 2014, no available for sale securities were transferred from Level 2 due to lack of observable inputs to substantiate a Level 2 valuation. For the six months ended June 30, 2014, two available for sale securities were transferred from Level 2 due to lack of observable inputs to substantiate a Level 2 valuation.

38


Investments in Entities that Calculate Net Asset Value Per Share
FASB guidance (ASC 825-10-50-6A) requires disclosures about the fair value measurements of investments in certain entities that calculate net asset value per share or its equivalents. These disclosures include the fair value of funds; significant investment strategies of the investees; for investments that cannot be redeemed, estimates of the time periods over which underlying assets are expected to be liquidated; the amounts of the Company's unfunded commitments; redemption features of the investments; restrictions on the ability to sell the investments; and information about sales in certain circumstances.
The Company has investments in venture capital funds that calculate net asset value per share. The Company's investments in venture capital funds generally cannot be redeemed. Alternatively, the Company expects distributions, if any, to be received primarily through M&A activity and IPOs of the underlying assets of the fund. The Company currently does not have any plans to sell any of these fund investments. If the Company decides to sell these investments in the future, generally the investee fund’s management must approve of the buyer before the sale of the investments can be completed. The fair values of the fund investments have been estimated using the net asset value per share of the investments, adjusted for any differences between the Company's measurement date and the date of the fund investment’s net asset value based on the most recently available financial information from the investee general partner. The most recently available financial information is generally as of the end of the previous quarter. For example, the June 30, 2015 financial statements reflect the March 31, 2015 financial information from the investee general partner, adjusted for any contributions paid, distributions received from the investment, and significant fund transactions or market events during the reporting period.
The following tables summarize the estimated fair values and remaining unfunded commitments for these investments:
(in thousands)
 
June 30, 2015
 
 
Carrying Value
 
Fair Value
 
Unfunded Commitments
Venture capital fund investments
 
$
4,232

 
$
4,232

 
$
1,634

  Total
 
$
4,232

 
$
4,232

 
$
1,634

(in thousands)
 
December 31, 2014
 
 
Carrying Value
 
Fair Value
 
Unfunded Commitments
Venture capital fund investments
 
$
3,704

 
$
3,704

 
$
2,076

  Total
 
$
3,704

 
$
3,704

 
$
2,076

Venture capital fund investments include investments made by Square 1 Financial, Inc. and Square 1 Bank. These investments represent commitments to venture capital funds that invest in or lend money to primarily U.S. and global technology and life sciences companies and invest in U.S. based venture capital funds themselves. It is estimated that the Company will receive distributions from the fund investments over the next 10 to 13 years, depending on the age of the funds and any potential extensions of terms of the funds.
At June 30, 2015, the $4.2 million venture capital fund investments valuation consisted of $1.6 million of Bank investments primarily for CRA purposes, $1.6 million from Square 1 Ventures, and $1.0 million of holding company investments.
Fair Value of Assets Measured on a Non-recurring Basis
Foreclosed Assets — Upon acquisition, foreclosed assets are initially recorded at the fair value of the asset less cost to sell. Any excess of the recorded investment over the fair value of the property received is charged to the allowance for loan losses. Subsequently, foreclosed assets are carried at the lower of carrying value or net realizable value. Reviews will be performed by management and any subsequent write-downs due to the excess of carrying value of a property over its estimated fair value (less estimated costs to sell) are charged against other expenses. Foreclosed assets are included in other assets in the accompanying consolidated balance sheets.

39


The following table presents information about the Company's assets measured at fair value on a non-recurring basis:
(in thousands)
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Ending
Balance
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
June 30, 2015
 
 
 
 
 
 
 
 
Impaired loans
 
$

 
$

 
$
9,754

 
$
9,754

December 31, 2014
 
 
 
 
 
 
 
 
Impaired loans
 
$

 
$

 
$
9,135

 
$
9,135

Financial Instruments Not Carried at Fair Value
FASB issued guidance over financial instruments (ASC 825-10-65) requires that the Company disclose estimated fair values for the Company's financial instruments not carried at fair value. Fair value estimates, methods and assumptions, set forth below for the Company's financial instruments, are made solely to comply with the requirements of ASC 825.
Fair values are based on estimates or calculations at the transaction level using present value techniques in instances where quoted market prices are not available. Because broadly traded markets do not exist for many of the Company's financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. Fair valuations are management’s estimates of the values, and they are calculated based on indicator prices corroborated by observable market quotes or pricing models, the economic and competitive environment, the characteristics of the financial instruments, expected losses, and other such factors.
These calculations are subjective in nature, involve uncertainties and matters of significant judgment, and do not include tax ramifications; therefore, the results cannot be determined with precision or substantiated by comparison to independent markets, and they may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein does not represent, and should not be construed to represent, the underlying value of the Company.
The following describes the methods and assumptions used in estimating the fair values of financial instruments, excluding financial instruments already recorded at fair value as described above.
Cash and due from banks, federal funds sold and short-term investments
The carrying amounts for cash and due from banks, federal funds sold and short-term investments approximate fair value because of the short maturities of those instruments.
Loans
The fair value of the net loan portfolio has been estimated based on management’s assumptions with respect to present value of expected cash flows, discounted at an interest rate giving consideration to estimated prepayment risk and credit loss factors. There is no material difference between carrying value and fair value of loans as outstanding loans are predominately at variable rates.
Investment securities—held to maturity
The fair value of investment securities held to maturity are based on quoted prices in markets that are not active or for which all significant inputs are observable, directly or indirectly.
FHLB stock
The carrying amount of FHLB stock approximates fair value as it is not practicable to determine the fair value due to restrictions placed on its transferability.
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates fair value due to the short-term nature of the balance.

40


Deposits
The fair values of deposits with no stated maturities are predominately at variable rates and, accordingly, the fair values have been estimated to equal the carrying amounts (the amount payable on demand). The fair values of certificates of deposits are estimated by discounting the future cash flows using the current rates offered for similar deposits with the same remaining maturities.
Short-term borrowings
The Company’s short-term borrowings include securities sold under repurchase agreements, federal funds purchased and short-term lines of credit. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the borrowing and its contractual maturity.
Long-term debt
The Company’s long-term debt includes the Company’s convertible subordinated debentures. Fair value of long-term debt is estimated by discounting the future cash flows using current rates offered with the same maturities, price indications from reputable dealers or utilizing observable market prices of the underlying instrument, whichever is deemed more reliable.
Financial instruments with off-balance sheet risk
With regard to financial instruments with off-balance sheet risk discussed in Note 16, carrying amounts are reasonable estimates of the fair values for such financial instruments. Commitments to extend credit generally result in loans with a market interest rate if funded.
The following tables present the estimated fair values of the Company's financial instruments that are not carried at fair value:
(in thousands)
 
June 30, 2015
 
 
Carrying
Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Estimated
Fair Value
Ending Balance
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
387,347

 
$
387,347

 
$

 
$

 
$
387,347

Investment in time deposits
 
1,002

 
1,002

 

 

 
1,002

Investment securities—held to maturity
 
392,872

 

 
386,395

 
6,420

 
392,815

Loans, net of unearned income
 
1,516,032

 

 

 
1,512,363

 
1,512,363

FHLB stock
 
2,787

 

 

 
2,787

 
2,787

Accrued interest receivable
 
13,110

 

 
13,110

 

 
13,110

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Non-maturity deposits(1)
 
3,554,380

 
3,554,380

 

 

 
3,554,380

Time deposits
 
9,384

 

 
9,369

 

 
9,369

Off-balance sheet financial assets:
 
 
 
 
 
 
 
 
 


Future financing commitments
 

 

 

 
1,431,391

 
1,431,391

(1)Includes noninterest demand deposits, interest-bearing demand deposits and money market deposits.

41


(in thousands)
 
December 31, 2014
 
 
Carrying
Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Estimated
Fair Value
Ending Balance
Financial assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
85,942

 
$
85,942

 
$

 
$

 
$
85,942

Investment in time deposits
 
1,251

 
1,251

 

 

 
1,251

Investment securities—held to maturity
 
300,425

 

 
299,986

 
6,420

 
306,406

Loans, net of unearned income
 
1,346,449

 

 

 
1,336,470

 
1,336,470

FHLB stock
 
2,091

 

 

 
2,091

 
2,091

Accrued interest receivable
 
11,878

 

 
11,878

 

 
11,878

Financial liabilities:
 
 
 
 
 
 
 
 
 
 
Non-maturity deposits(1)
 
2,760,232

 
2,760,232

 

 

 
2,760,232

Time deposits
 
16,320

 

 
16,268

 

 
16,268

Off-balance sheet financial assets:
 
 
 
 
 
 
 
 
 


Future financing commitments
 

 

 

 
1,232,078

 
1,232,078

(1)Includes noninterest demand deposits, interest-bearing demand deposits and money market deposits.

16.
OFF-BALANCE SHEET RISK, COMMITMENTS AND CONTINGENCIES
To meet the financial needs of its customers, the Company is party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments are comprised of unfunded lines of credit and financial standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the accompanying consolidated balance sheet.
The Company’s exposure to credit loss in the event of nonperformance by the other party is represented by the contractual amount of these instruments. The Company uses the same credit policies in making these commitments as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies but may include cash in deposit accounts, trade accounts receivable, property, plant, and equipment and intellectual property. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
At June 30, 2015 and December 31, 2014, unfunded lines of credit were $1.4 billion and $1.2 billion, respectively, and outstanding standby letters of credit amounted to $78.5 million and $68.4 million, respectively.
Three putative stockholder class action lawsuits were filed in connection with the previously disclosed proposed merger between us and PacWest (see Note 1). Manganaro v. Burke et al., Case No. 10817-VCL,  was filed in the Court of Chancery of the State of Delaware on March 20, 2015, and was voluntarily dismissed without prejudice on May 5, 2015. Lakowitz v. Bowers et al., Case No. 1:15-CV-371, was filed in the federal district court for the Middle District of North Carolina on May 6, 2015 and was voluntarily dismissed without prejudice on May 7, 2015. 
Li v. Bowers et al., Case No. 1:15-CV-373 (the “Li Action”), was filed in federal district court for the Middle District of North Carolina on May 7, 2015. The Li Action alleged that the members of the Square 1 board of directors breached their fiduciary duties to Square 1 stockholders and failed to take steps to maximize the value to be paid to the Square 1 stockholders. In addition, the Li Action alleged that PacWest aided and abetted these alleged breaches of fiduciary duties. The Li Action also alleged violations of federal securities laws with respect to allegedly misleading statements contained in the registration statement filed with the SEC in connection with the merger. The plaintiffs in the Li Action sought, among other things, declaratory and injunctive relief, attorneys’ fees and costs, and other and further relief. 
On June 1, 2015, the parties to the Li Action entered into a Memorandum of Understanding which sets forth the parties’ agreement in principle to a settlement of that action. In connection with the settlement of the Li Action, Square 1 and PacWest agreed to make certain additional disclosures, which were contained in the definitive proxy statement and prospectus filed with the SEC with respect to the merger. The settlement remains subject to a number of conditions,

42


including, among other things, final documentation and court approval following notice to the settlement class. There can be no assurance that the settlement will ultimately be approved by the court.
 From time to time, the Company is party, either as a defendant or plaintiff, to other lawsuits in the normal course of its business. While any litigation involves an element of uncertainty, management is of the opinion that the liability, if any, resulting from these other pending legal proceedings in the normal course of business will not have a material adverse effect on our financial condition, liquidity or results of operations.


43



ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements within the meaning of section 27A of the Securities Act and 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” or the negative version of those words or other comparable of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.
There are or will be important factors that could cause our actual results to differ materially from those indicated in these forward-looking statements, including, but are not limited to, the following:
market and economic conditions (including interest rate environment, levels of public offerings, mergers and acquisitions (“M&A”) and venture capital financing activities) and the associated impact on us;
our ability to obtain regulatory approvals and meet other closing conditions to the planned merger of the Company with and into PacWest Bancorp (“PacWest”), with PacWest surviving the merger (the “Merger”), including approval by the Company’s shareholders;
delay in closing the Merger;
difficulties and delays in integrating the Company’s businesses with those of PacWest or fully realizing cost savings and other benefits of the Merger;
changes in management personnel;
the sufficiency of our capital, including sources of capital (such as funds generated through retained earnings) and the extent to which capital may be used or required;
our overall investment plans, strategies and activities, including our investment of excess cash/liquidity;
venture capital/private equity funding and investments;
operational, liquidity and credit risks associated with our business;
deterioration of our asset quality;
our overall management of interest rate risk, including managing the sensitivity of our interest-earning assets and interest-bearing liabilities to interest rates, and the impact to earnings from a change in interest rates;
our ability to execute our strategy and to achieve organic loan and deposit growth;
increased competition in the financial services industry, nationally, regionally or locally, which may adversely affect pricing and terms;
the adequacy of reserves (including allowance for loan and lease losses) and the appropriateness of our methodology for calculating such reserves;
the level of client investment fees and associated margins;
changes in federal tax law or policy;
volatility and direction of market interest rates;
changes in the regulatory environment;
changes in trade, monetary and fiscal policies and laws;
governmental legislation and regulation, including changes in accounting regulation or standards, the nature and timing of the adoption and effectiveness of new requirements under the Dodd-Frank Act, Basel guidelines, capital requirements and other applicable laws and regulations;
changes in interpretation of existing law and regulation;
further government intervention in the U.S. financial system; and
other factors that are discussed in the section titled “Risk Factors,” which are set forth in the Company's 2014 Form 10-K, as filed with the SEC on March 20, 2015.

44


The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this filing. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
The objective of this section is to help potential investors understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the unaudited interim consolidated financial statements and notes thereto in this Form 10-Q and in conjunction with Square 1's consolidated balance sheets as of December 31, 2014 and 2013, and the related consolidated statements of income and comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and notes thereto included in the 2014 Form 10-K.
Management’s Discussion and Analysis includes financial information prepared in accordance with GAAP, as well as certain non-GAAP financial measures such as “efficiency ratio,” “tangible common equity to tangible assets,” “net operating income,” "net interest income," and "core banking noninterest income" (see "Non-GAAP Financial Measures").


45


Summary Financial Information
The following summary financial information is derived in part from our consolidated financial statements. The following is only a summary and you should read it in conjunction with the unaudited interim consolidated financial statements and the related notes.
(Dollars in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Financial Condition Data:
 
 
Average total assets
 
$
3,503,389

 
$
2,644,511

 
$
3,347,745

 
$
2,510,087

Average cash and cash equivalents
 
211,733

 
223,988

 
148,754

 
171,998

Average investment securities - available-for-sale
 
1,337,891

 
1,054,438

 
1,323,749

 
1,011,040

Average investment securities - held-to-maturity
 
373,227

 
194,781

 
366,322

 
179,895

Average loans, net of unearned income
 
1,513,504

 
1,119,867

 
1,441,864

 
1,094,482

Average on-balance sheet deposits
 
3,165,466

 
2,359,042

 
2,990,659

 
2,255,351

Average total client investment funds
 
1,592,218

 
749,976

 
1,516,454

 
690,340

Average borrowings
 
440

 
2,236

 
24,641

 
5,189

Average repurchase agreements
 

 

 

 
3,029

Average total shareholders' equity
 
325,094

 
275,014

 
317,643

 
236,804

 
 
 
 
 
 
 
 
 
Operating Data:
 
 
 
 
 
 
 
 
Interest income
 
$
31,593

 
$
25,075

 
$
60,994

 
$
47,875

Interest expense
 
194

 
199

 
450

 
492

Net interest income
 
31,399

 
24,876

 
60,544

 
47,383

Provision for loan losses
 
3,758

 
3,150

 
9,205

 
6,114

Net interest income after provision for loan losses
 
27,641

 
21,726

 
51,339

 
41,269

Noninterest income
 
7,632

 
6,372

 
13,844

 
13,511

Noninterest expense
 
20,307

 
16,600

 
38,644

 
32,183

Income before income tax expense
 
14,966

 
11,498

 
26,539

 
22,597

Income tax expense
 
5,047

 
3,447

 
8,467

 
6,698

Preferred stock dividends and discount accretion
 

 
1

 

 
63

Net income available to common shareholders
 
9,919

 
8,050

 
18,072

 
15,836


46


 
 
At or For the
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Performance Ratios:
 
(Dollars in thousands)
Return on average assets
 
1.14
%
 
1.22
%
 
1.09
%
 
1.27
%
Return on average common equity
 
12.24

 
11.74

 
11.47

 
13.63

Net interest margin(1)
 
3.83

 
4.03

 
3.89

 
4.07

Efficiency ratio(2)
 
49.33

 
51.29

 
49.13

 
50.96

Average equity to average assets
 
9.28

 
10.40

 
9.49

 
9.43

 
 
 
 
 
 
 
 
 
Capital Ratios (consolidated):
 
 
 
 
 
 
 
 
Tier 1 leverage capital
 
9.07

 
10.42

 
9.07

 
10.42

Common equity Tier 1 capital
 
12.09

 
14.70

 
12.09

 
14.70

Tier 1 risk-based capital
 
12.09

 
14.70

 
12.09

 
14.70

Total risk-based capital
 
13.12

 
15.88

 
13.12

 
15.88

Total shareholders’ equity to assets
 
8.35

 
10.35

 
8.35

 
10.35

Tangible common equity to tangible assets(3)
 
8.34

 
10.33

 
8.34

 
10.33

 
 
 
 
 
 
 
 
 
Asset Quality Ratios:
 
 
 
 
 
 
 
 
Allowance for loan losses as a percent of total loans
 
1.65

 
1.87

 
1.65

 
1.87

Allowance for loan losses as a percent of nonperforming loans
 
139.58

 
175.54

 
139.58

 
175.54

Net charge-offs to average outstanding loans (annualized)
 
0.92

 
0.25

 
0.99

 
0.54

Nonperforming loans as a percent of total loans
 
1.18

 
1.07

 
1.18

 
1.07

Nonperforming assets as a percent of total assets
 
0.46

 
0.45

 
0.46

 
0.45

(1)
Represents net interest income as a percent of average interest-earning assets.
(2)
Represents noninterest expense, excluding merger-related expenses divided by the sum of net interest income and other income, excluding gains or losses on the impairment and sale of securities. Efficiency ratio, as calculated, is a non-GAAP financial measure. See “Non-GAAP Financial Measures.”
(3)
Tangible common equity to tangible assets is a non-GAAP financial measure. Tangible common equity is computed as total shareholders’ equity less intangible assets. Tangible assets are calculated as total assets less intangible assets other than loan servicing intangible assets. We believe that the most directly comparable GAAP financial measure is total shareholders’ equity to assets. See “Non-GAAP Financial Measures.”

47


Non-GAAP Financial Measures
The information set forth above contains certain financial information determined by methods other than in accordance with GAAP. Generally, a non-GAAP financial measure is a numerical measure of financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. These non-GAAP financial measures for us are “efficiency ratio,” “tangible common equity to tangible assets,” “net operating income,” "net interest income," "core banking noninterest income," and "earnings per diluted share excluding merger-related expenses." Although we believe these non-GAAP financial measures provide a greater understanding of our business, these measures are not necessarily comparable to similar measures that may be presented by other companies. The non-GAAP financial measures should be viewed as a supplement to, and not a substitute for, financial measures presented in accordance with GAAP.
Efficiency ratio represents noninterest expense, excluding merger-related expenses divided by the sum of net interest income and other income, excluding gains or losses on the impairment and sale of securities. This measure is used by management to evaluate our operational efficiency.
Tangible common equity to tangible assets ratio is used by management to evaluate the adequacy of our capital levels. Tangible common equity is computed as total shareholders’ equity less intangible assets. Tangible assets are calculated as total assets less intangible assets other than loan servicing intangible assets. We believe that the most directly comparable GAAP financial measure is total shareholders’ equity to assets.
Tangible common equity is computed as total shareholders’ equity less intangible assets. Tangible book value per common share is calculated as tangible common equity divided by common shares outstanding. We believe that the most directly comparable GAAP financial measure is book value per common share.
Non-GAAP net operating income represents net operating income before income tax expense on a fully tax equivalent basis excluding the impact of gains and losses on the sale of securities and impairments. We believe that the most directly comparable GAAP financial measure is income before income tax expense.
Our discussions of net interest income and the net interest margin are presented on a fully taxable equivalent basis based on the federal statutory rate of 35% to consistently reflect income from taxable loans and securities and tax-exempt securities. We believe that the most directly comparable GAAP financial measure is net interest income.
Core banking noninterest income represents recurring income from traditional banking services provided to our customers and excludes line items where results are typically subject to market or other conditions beyond our control. We believe that the most directly comparable GAAP financial measure is noninterest income.
Non-GAAP earnings per diluted share excluding merger-related expenses represents earnings per diluted share on a GAAP basis excluding the impact of recorded charges for merger expenses related to the PacWest Bancorp and Square 1 merger. Merger expenses include merger transaction and integration costs. Management does not consider these expenses to be representative of our fundamental earnings as we would not otherwise incur these expenses as part of our operations in the periods presented. We believe that the most directly comparable GAAP financial measure is earnings per share - diluted.


48


The information provided below reconciles each non-GAAP measure to its most comparable GAAP measure:
 
 
At or For the
(Dollars in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Efficiency Ratio
 
 
 
 
 
 
 
 
Noninterest expense (GAAP)
 
$
20,307

 
$
16,600

 
$
38,644

 
$
32,183

Less: merger-related expenses
 
792

 

 
1,004

 

Adjusted noninterest expense
 
$
19,515

 
$
16,600

 
$
37,640

 
$
32,183

Net interest taxable equivalent income
 
32,725

 
25,863

 
63,124

 
49,321

Noninterest taxable equivalent income
 
7,861

 
6,543

 
14,307

 
13,840

Less: gain on sale of securities and impairment
 
1,025

 
38

 
821

 
4

Adjusted operating revenue
 
$
39,561

 
$
32,368

 
$
76,610

 
$
63,157

Efficiency ratio
 
49.33
%
 
51.29
%
 
49.13
%
 
50.96
%
Tangible Common Equity/Tangible Assets
 
 
 
 
 
 
 
 
Total equity
 
$
326,646

 
$
283,696

 
$
326,646

 
$
283,696

Less: Intangible assets(1)
 
295

 
597

 
295

 
597

Tangible common equity
 
$
326,351

 
$
283,099

 
$
326,351

 
$
283,099

Total assets
 
$
3,912,503

 
$
2,741,524

 
$
3,912,503

 
$
2,741,524

Less: intangible assets(1)
 
295

 
597

 
295

 
597

Tangible assets
 
$
3,912,208

 
$
2,740,927

 
$
3,912,208

 
$
2,740,927

Tangible common equity/tangible assets
 
8.34
%
 
10.33
%
 
8.34
%
 
10.33
%
Net Operating Income
 
 
 
 
 
 
 
 
GAAP income before taxes
 
$
14,966

 
$
11,498

 
$
26,539

 
$
22,597

Add: gain on sale of securities and impairment
 
1,025

 
38

 
821

 
4

Add: tax equivalent adjustment
 
1,555

 
1,157

 
3,043

 
2,266

Non-GAAP net operating income before taxes
 
$
15,496

 
$
12,617

 
$
28,761

 
$
24,859

Net Interest Income
 
 
 
 
 
 
 
 
GAAP net interest income
 
$
31,399

 
$
24,876

 
$
60,544

 
$
47,383

Add: tax equivalent adjustment
 
1,326

 
987

 
2,580

 
1,938

Non-GAAP net interest income (fully tax equivalent basis)
 
$
32,725

 
$
25,863

 
$
63,124

 
$
49,321

Core Banking Noninterest Income
 
 
 
 
 
 
 
 
GAAP noninterest income
 
$
7,632

 
$
6,372

 
$
13,844

 
$
13,511

Less: net gain on securities and impairment
 
1,025

 
38

 
821

 
4

Warrant income
 
239

 
21

 
$
701

 
$
2,216

Gain on sale of loans
 
592

 
249

 
1,398

 
502

Bank owned life insurance
 
424

 
317

 
859

 
607

Other
 
565

 
2,035

 
826

 
2,432

Non-GAAP core banking noninterest income
 
$
4,787

 
$
3,712

 
$
9,239

 
$
7,750

Earnings Per Diluted Share Excluding Merger-related Expenses
 
 
 
 
 
 
 
 
GAAP earnings per share - diluted
 
$
0.33

 
$
0.27

 
$
0.60

 
$
0.58

Add: merger related expenses
 
0.02

 

 
0.02

 

Non-GAAP earnings per diluted share excluding merger costs
 
$
0.35

 
$
0.27

 
$
0.62

 
$
0.58

(1) Does not include a loan servicing asset of $1.4 million and $1.3 million at June 30, 2015 and June 30, 2014, respectively.

49


Executive Overview of Recent Financial Performance
Our strategy is to grow organically in the key U.S. innovation markets. As part of this growth strategy, we expect to continue to evolve our mix of loan business to include more expansion and later stage companies and more business with venture capital firms. We believe this loan mix tilt will help us continue to lower credit costs. Certain elements of our business, such as warrant gains, deposit inflows and to some extent credit quality, can create a degree of quarterly variability to our numbers.
Continued strong balance sheet and revenue growth during the three and six months ended June 30, 2015 resulted in increased net operating income. Consolidated net income available to common shareholders was $9.9 million and diluted earnings per share was $0.33 for the three months ended June 30, 2015, compared to net income available to common shareholders of $8.1 million and diluted earnings per share of $0.27 for the three months ended June 30, 2014. Earnings per share excluding the impact of merger-related expenses was $0.35 per diluted share for the three months ended June 30, 2015 compared to $0.27 for the three months ended June 30, 2014. Consolidated net income available to common shareholders was $18.1 million and diluted earnings per share was $0.60 for the six months ended June 30, 2015, compared to net income available to common shareholders of $15.8 million and diluted earnings per share of $0.58 for the six months ended June 30, 2014. Earnings per share excluding the impact of merger-related expenses was $0.62 per diluted share for the three months ended June 30, 2015 compared to $0.58 for the three months ended June 30, 2014. Return on average common equity was 12.24% and return on average assets was 1.14% for the three months ended June 30, 2015. Return on average common equity was 11.47% and return on average assets was 1.09% for the six months ended June 30, 2015.
During the three and six months ended June 30, 2015, net interest income increased $6.5 million, or 26.2%, and $13.2 million, or 27.8%, respectively, as a result of solid growth in both our loan and investment portfolios driven by significant growth in deposits. Average loan balances for the three and six months ended June 30, 2015, grew 35.2% and 31.7%, respectively, compared to the three and six months ended June 30, 2014. Period-end loans increased 12.6% from December 31, 2014. The loan growth is the result of further deepening of our coverage in key markets and expansion into new markets, more loans to later stage clients, and an increase in our overall brand awareness. Increases in the average balances of our investment portfolio of 37.0% and 41.9%, respectively, for the three and six months ended June 30, 2015 compared to the three and six months ended June 30, 2014, also drove the increase in net interest income. Period-end investment securities increased 21.3% from December 31, 2014.
We also continue to experience favorable funding of our interest earning assets with 67.1% and 66.7%, respectively, of our average deposits for the three and six months ended June 30, 2015 coming from noninterest-bearing deposits, compared to 64.4% and 64.5%, respectively, for the three and six months ended June 30, 2014. Net interest margin decreased to 3.83% and 3.89%, respectively, for the three and six months ended June 30, 2015 compared to 4.03% and 4.07%, respectively, for the same periods in the prior year.
Loan growth was funded by our continued success in growing our low cost deposits from new and existing venture firms and entrepreneurial companies. Our average client funds, which consist of on-balance sheet deposits and client investment funds, increased 53.0% for both the three and six months ended June 30, 2015, compared to the three and six months ended June 30, 2014. Our ability to move deposits off balance sheet is key to managing our balance sheet growth and capital ratios. Our period end client investment funds grew 19.2% from December 31, 2014, reflecting our continuing ability to manage deposits off balance sheet in a manner that benefits both our clients and us.
Credit quality exceeded historical experience during 2014 while credit quality during the three and six months ended June 30, 2015 was more reflective of historical experience. At June 30, 2015, our ratio of nonperforming loans to total loans decreased from December 31, 2014, but increased from June 30, 2014. Net loan charge-offs were 0.92% and 0.99%, respectively, of average loans (annualized) for the three and six months ended June 30, 2015, compared to 0.25% and 0.54%, respectively, for the three and six months ended June 30, 2014. The impact of loan growth and higher net charge offs drove increases of $0.6 million and $3.1 million, respectively, in our provision for loan losses for the three and six months ended June 30, 2015, compared to the three and six months ended June 30, 2014.
Core banking noninterest income, which represents income from traditional banking services provided to our customers, increased $1.1 million and $1.5 million, respectively, for the three and six months ended June 30, 2015 compared to the three months ended June 30, 2014, as we continued to focus on enhancing our product offerings and adding new customers. Total noninterest income increased $1.3 million compared to the three months ended June 30, 2014, as increases of $1.1 million in core banking noninterest income and $1.0 million in the net gain on securities were partially offset by a $1.1 million decrease in unrealized gains from our venture capital fund investments. Total noninterest income increased $0.3 million compared to the six months ended June 30, 2014, as increases of $1.5 million in core banking noninterest income, $0.8 million in the net gain

50


on securities and $0.9 million in the gain on sale of loans were largely offset by decreases of $1.1 million in the unrealized gains from our venture capital fund investments and $1.5 million in warrant income.
Noninterest expense increased $3.7 million compared to the three months ended June 30, 2014 primarily due to $1.8 million higher personnel expenses, $0.3 million higher professional fees and merger-related expenses of $0.8 million. Noninterest expense increased $6.5 million compared to the six months ended June 30, 2014 primarily due to increases in personnel expenses, professional fees and the provision for unfunded credit commitments of $3.4 million, $0.5 million and $0.5 million, respectively, and merger-related expenses of $1.0 million. The increase in personnel expense primarily resulted from an increase in our full-time equivalent employees to 280 at June 30, 2015, from 245 at June 30, 2014, and higher incentive compensation expense. Throughout 2015, we anticipate hiring a similar number of full-time equivalent employees as were hired during the year ended December 31, 2014 mixed between bankers and support staff. Overall, we anticipate an increase in our expenses in the mid-teens in 2015 as we continue to hire additional employees and invest in our franchise to support growth.
Proposed Merger with PacWest Bancorp
On March 1, 2015, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with PacWest Bancorp, a Delaware corporation ("PacWest"), pursuant to which we will merge with and into PacWest, with PacWest as the surviving corporation (the "Merger"). The Merger Agreement also provides that immediately following the Merger, Square 1 Bank, our wholly-owned subsidiary, will merge with and into Pacific Western Bank, a California state-chartered bank and wholly-owned subsidiary of PacWest, with Pacific Western Bank as the surviving bank. Under the terms and subject to the conditions of the Merger Agreement, each issued and outstanding share of common stock of Square 1 will be converted into the right to receive 0.5997 of a share of PacWest common stock. The transaction is currently valued at approximately $867 million. Completion of the Merger is subject to certain customary conditions, including approval by our stockholders and the receipt of certain required regulatory approvals. The Merger was approved by our stockholders on July 29, 2015.
Additional information regarding the Merger is included in our Current Report on Form 8-K filed with the SEC on March 5, 2015 and in the registration statement filed by PacWest with the SEC which includes a proxy statement of Square 1 and a prospectus of PacWest.

Critical Accounting Policies and Estimates
Our management's discussion and analysis of financial condition and results of operations is based on our unaudited interim consolidated financial statements, which were prepared in accordance with GAAP. In preparing our unaudited interim consolidated financial statements, we made certain estimates that were critical in nature to our financial condition and results of operations as they require us to make especially difficult, subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported using different conditions and assumptions. We have discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of our Board of Directors.
There have been no material changes to critical accounting policies and estimates discussed under "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" in the 2014 Form 10-K.

Impact of Recent Accounting Pronouncements
The information required by this item is included in Note 2 to the consolidated financial statements included in this Form 10-Q.

RESULTS OF OPERATIONS
Performance Summary
Three Months Ended June 30, 2015 and 2014. For the three months ended June 30, 2015, we reported net income available to common shareholders of $9.9 million, an increase of $1.9 million, or 23.2%, compared to net income available to common shareholders of $8.1 million for the three months ended June 30, 2014. The increase resulted from a $6.5 million, or

51


26.2%, increase in net interest income and a $1.3 million, or 19.8%, increase in noninterest income, partially offset by a $0.6 million, or 19.3%, increase in the provision for loan losses, a $3.7 million, or 22.3%, increase in noninterest expense and a $1.6 million, or 46.4%, increase in income tax expense.
The increase in net interest income compared to the three months ended June 30, 2014 was primarily driven by the higher average balances of our loan and investment securities portfolios, partially offset by lower yields. The increase in noninterest income was primarily due to a $1.1 million increase in core banking noninterest income and a $1.0 million increase in the net gain on securities, partially offset by a $1.1 million decrease in unrealized gains from our venture capital fund investments. The increase in noninterest expense compared to the three months ended June 30, 2014 was primarily due to $1.8 million higher personnel expenses along with merger-related expenses and higher professional fee expense in the three months ended June 30, 2015. Higher personnel expenses were driven by an increase of 35 full-time equivalent employees and higher incentive compensation expense. The increase in income tax expense was driven by higher pre-tax net income and a higher effective tax rate.
Six Months Ended June 30, 2015 and 2014. For the six months ended June 30, 2015, we reported net income available to common shareholders of $18.1 million, an increase of $2.2 million, or 14.1%, compared to net income available to common shareholders of $15.8 million for the six months ended June 30, 2014. The increase resulted from a $13.2 million, or 27.8%, increase in net interest income, partially offset by a $3.1 million, or 50.6%, increase in the provision for loan losses, a $6.5 million, or 20.1%, increase in noninterest expense, and a $1.8 million, or 26.4%, increase in income tax expense.
The increase in net interest income compared to the six months ended June 30, 2014 was primarily the result of our continued success in attracting low cost deposits and growing our loan portfolio, along with higher balances on our investment portfolio, partially offset by lower yields on our loan and investment portfolios. Noninterest income was relatively flat increasing 2.5% as increases of $1.5 million in core banking noninterest income, $0.8 million in the net gain on securities and $0.9 million in the gain on sale of loans were mostly offset by decreases of $1.1 million in the unrealized gains from our venture capital fund investments and $1.5 million in warrant income. The increase in noninterest expense compared to the six months ended June 30, 2014 was primarily due to $3.4 million higher personnel expenses in the six months ended June 30, 2015 driven by the increase in full-time equivalent employees and higher incentive compensation expense. Merger-related expenses and increases in the provision for unfunded credit commitments and professional fee expense also contributed to higher total noninterest expense. The higher income tax expense was driven by the growth in pre-tax net income and a higher effective tax rate.
Net Interest Income and Net Interest Margin (Fully Tax Equivalent Basis)
The information set forth below contains certain financial information determined by methods other than in accordance with GAAP. See "Non-GAAP Financial Measures" section for a reconciliation of this non-GAAP measure to its most comparable GAAP measure.
Net interest income, the primary contributor to our earnings, represents the difference between the income that we earn on our interest-earning assets and the cost to us of our interest-bearing liabilities. Our net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates that we earn or pay on them. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume changes.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as “rate changes.” The yield earned on loans includes loan fees, which are primarily loan origination fees and loan documentation fees related to loan origination. While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding and no interest income is recognized. Net interest income and the net interest margin are presented on a fully taxable equivalent basis based on the federal statutory rate of 35% to consistently reflect income from taxable loans and securities and tax-exempt securities.

52


Net Interest Income (Fully Tax Equivalent Basis)
Three Months Ended June 30, 2015 and 2014. For the three months ended June 30, 2015, net interest income increased $6.9 million, or 26.5%, to $32.7 million compared to the three months ended June 30, 2014. This increase was primarily driven by a $6.9 million, or 26.3%, increase in interest income. Our interest income increase primarily resulted from:
a $4.5 million, or 25.3%, increase to $22.2 million in interest income on loans, resulting from a 35.2% higher average balance, partially offset by a 46 basis point decline in the yield earned. The 46 basis point decline in the yield earned resulted from increased competitive pressure in the current low rate environment;
a $1.4 million, or 26.3%, increase to $6.8 million in interest income on taxable securities due to a 38.5% higher average balance, partially offset by a 18 basis point decrease in the yield earned. The higher taxable securities balance was driven by investments purchased as a result of deposit growth, and the lower yield was primarily a result of purchases of lower yielding securities; and
a $1.0 million, or 34.2%, increase to $3.8 million in interest income on nontaxable securities caused by a 30.3% higher average balance and a 14 basis point increase in the yield earned on nontaxable securities. The higher nontaxable securities balance and yield was primarily a result of our continued purchases of higher yielding municipal securities.
Interest expense of $0.2 million was flat compared to the three months ended June 30, 2014, and as the impact of the conversion to common stock of the trust preferred securities in the first half of 2014 was offset by the higher average balance and higher yields paid on money market accounts.
Six Months Ended June 30, 2015 and 2014. For the six months ended June 30, 2015, net interest income increased $13.8 million, or 28.0%, to $63.1 million compared to the six months ended June 30, 2014. This increase was primarily driven by a $13.8 million, or 27.6%, increase in interest income. Our interest income increase primarily resulted from:
a $8.2 million, or 24.1%, increase to $42.3 million in interest income on loans, resulting from a 31.7% higher average balance, partially offset by a 37 basis point decline in the yield earned. The 37 basis point decline in the yield earned resulted from increased competitive pressure in the current low rate environment;
a $3.8 million, or 37.7%, increase to $13.7 million in interest income on taxable securities due to a 45.2% higher average balance, partially offset by a 11 basis point decrease in the yield earned. The higher taxable securities balance was driven by investments purchased as a result of deposit growth, and the lower yield was primarily a result of purchases of lower yielding securities; and
a $1.8 million, or 32.9%, increase to $7.4 million in interest income on nontaxable securities caused by a 28.1% higher average balance and a 18 basis point increase in the yield earned on nontaxable securities. The higher nontaxable securities balance and yield was primarily a result of our continued purchases of higher yielding municipal securities.
Interest expense of $0.5 million represented an 8.5% decrease from the six months ended June 30, 2014, and was primarily driven by the conversion to common stock of the trust preferred securities in the first half of 2014, partially offset by higher average deposit balances and higher yields paid on money market accounts.
Net Interest Margin (Fully Tax Equivalent Basis)
Three and Six Months Ended June 30, 2015 and 2014. Our net interest margin decreased to 3.83% and 3.89%, respectively, for the three and six months ended June 30, 2015 compared to 4.03% and 4.07%, respectively, compared to the three and six months ended June 30, 2014.
The primary reasons for the decrease were:
lower loan interest yields in the current low rate environment that continues in 2015; and
an increase in the purchasing of lower yielding securities

These decreases were slightly offset by lower funding costs driven by the redemption of our junior subordinated debt in 2014.

53


Average Balances and Yields
The following table presents information regarding average balances for assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the periods presented. Loan fees are included in interest income on loans. Yields are presented on a tax equivalent basis.
 
 
Three Months Ended June 30,
 
 
2015
 
2014
 
 
Average
Balance
 
Interest
and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest
and
Dividends
 
Yield/
Cost
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits in other banks
 
$
204,375

 
$
127

 
0.25
%
 
$
204,385

 
$
134

 
0.27
%
Federal funds sold and other short-term investments
 
1,001

 
1

 
0.35

 
1,648

 
3

 
0.75

Loans, net of unearned income
 
1,513,504

 
22,207

 
5.89

 
1,119,867

 
17,720

 
6.35

Nontaxable securities
 
303,692

 
3,789

 
5.00

 
233,137

 
2,823

 
4.86

Taxable securities
 
1,407,426

 
6,795

 
1.94

 
1,016,082

 
5,382

 
2.12

Total interest-earning assets
 
3,429,998

 
32,919

 
3.85

 
2,575,119

 
26,062

 
4.06

Less: Allowance for loan losses
 
(24,919
)
 
 
 
 
 
(20,086
)
 
 
 
 
Noninterest-earning assets
 
98,310

 
 
 
 
 
89,478

 
 
 
 
Total assets
 
$
3,503,389

 
 
 
 
 
$
2,644,511

 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
$
96,817

 
18

 
0.08

 
$
117,542

 
21

 
0.07

Money market
 
933,385

 
172

 
0.07

 
692,727

 
106

 
0.06

Time deposits
 
11,733

 
3

 
0.09

 
30,133

 
16

 
0.22

Total interest-bearing deposits
 
1,041,935

 
193

 
0.07

 
840,402

 
143

 
0.07

FHLB advances
 
440

 
1

 
0.38

 

 

 

Junior subordinated debt
 

 

 

 
2,236

 
56

 
10.09

Total interest-bearing liabilities
 
1,042,375

 
194

 
0.07

 
842,638

 
199

 
0.09

Noninterest-bearing deposits
 
2,123,531

 
 
 
 
 
1,518,640

 
 
 
 
Other noninterest-bearing liabilities
 
12,389

 
 
 
 
 
8,219

 
 
 
 
Total liabilities
 
3,178,295

 
 
 
 
 
2,369,497

 
 
 
 
Total shareholders’ equity
 
325,094

 
 
 
 
 
275,014

 
 
 
 
Total liabilities and shareholders’ equity
 
$
3,503,389

 
 
 
 
 
$
2,644,511

 
 
 
 
Net interest income
 
 
 
$
32,725

 
 
 
 
 
$
25,863

 
 
Interest rate spread
 
 
 
 
 
3.78
%
 
 
 
 
 
3.97
%
Net interest margin
 
 
 
 
 
3.83
%
 
 
 
 
 
4.03
%
Ratio of average interest-earning assets to average interest-bearing liabilities
 
 
 
 
 
329.06
%
 
 
 
 
 
305.60
%

54


 
 
Six Months Ended June 30,
 
 
2015
 
2014
 
 
Average
Balance
 
Interest
and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest
and
Dividends
 
Yield/
Cost
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits in other banks
 
$
140,056

 
$
166

 
0.24
%
 
$
155,595

 
$
196

 
0.25
%
Federal funds sold and other short-term investments
 
1,124

 
2

 
0.32

 
1,538

 
5

 
0.63

Loans, net of unearned income
 
1,441,864

 
42,341

 
5.92

 
1,094,482

 
34,123

 
6.29

Nontaxable securities
 
295,499

 
7,372

 
5.03

 
230,629

 
5,546

 
4.85

Taxable securities
 
1,394,572

 
13,693

 
1.98

 
960,306

 
9,943

 
2.09

Total interest-earning assets
 
3,273,115

 
63,574

 
3.92

 
2,442,550

 
49,813

 
4.11

Less: Allowance for loan losses
 
(24,224
)
 
 
 
 
 
(19,780
)
 
 
 
 
Noninterest-earning assets
 
98,854

 
 
 
 
 
87,317

 
 
 
 
Total assets
 
$
3,347,745

 
 
 
 
 
$
2,510,087

 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
$
94,620

 
45

 
0.10

 
$
117,097

 
44

 
0.08

Money market
 
887,462

 
352

 
0.08

 
654,990

 
199

 
0.06

Time deposits
 
14,186

 
7

 
0.10

 
28,138

 
30

 
0.22

Total interest-bearing deposits
 
996,268

 
404

 
0.08

 
800,225

 
273

 
0.07

FHLB advances
 
24,641

 
46

 
0.37

 
995

 
2

 
0.41

Repurchase agreements
 

 

 

 
3,029

 
1

 
0.10

Junior subordinated debt
 

 

 

 
4,194

 
216

 
10.36

Other borrowings
 
166

 

 
0.30

 

 

 

Total interest-bearing liabilities
 
1,021,075

 
450

 
0.09

 
808,443

 
492

 
0.12

Noninterest-bearing deposits
 
1,994,391

 
 
 
 
 
1,455,126

 
 
 
 
Other noninterest-bearing liabilities
 
14,636

 
 
 
 
 
9,714

 
 
 
 
Total liabilities
 
3,030,102

 
 
 
 
 
2,273,283

 
 
 
 
Total shareholders’ equity
 
317,643

 
 
 
 
 
236,804

 
 
 
 
Total liabilities and shareholders’ equity
 
$
3,347,745

 
 
 
 
 
$
2,510,087

 
 
 
 
Net interest income
 
 
 
$
63,124

 
 
 
 
 
$
49,321

 
 
Interest rate spread
 
 
 
 
 
3.83
%
 
 
 
 
 
3.99
%
Net interest margin
 
 
 
 
 
3.89
%
 
 
 
 
 
4.07
%
Ratio of average interest-earning assets to average interest-bearing liabilities
 
 
 
 
 
320.56
%
 
 
 
 
 
302.13
%




55


Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by current volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.
 
 
Three Months Ended June 30, 2015
 
 
Compared to
 
 
Three Months Ended June 30, 2014
 
 
Increase (Decrease)
Due to
 
 
 
 
Rate
 
Volume
 
Net
 
 
(Dollars in thousands)
Interest income:
 
 
 
 
 
 
Interest-bearing deposits in other banks
 
$
(7
)
 
$

 
$
(7
)
Federal funds sold and other short-term investments
 
(2
)
 

 
(2
)
Loans, net of unearned income
 
(1,742
)
 
6,229

 
4,487

Nontaxable securities(1)
 
8

 
958

 
966

Taxable securities
 
(775
)
 
2,188

 
1,413

Total interest-earning assets
 
(2,518
)
 
9,375

 
6,857

Interest expense:
 
 
 
 
 
 
Demand deposits
 
1

 
(4
)
 
(3
)
Money market
 
29

 
37

 
66

Time deposits
 
(3
)
 
(10
)
 
(13
)
Borrowings
 
(10
)
 
(45
)
 
(55
)
Total interest-bearing liabilities
 
17

 
(22
)
 
(5
)
Change in net interest income
 
$
(2,535
)
 
$
9,397

 
$
6,862

(1)
Tax equivalent income.

56


 
 
Six Months Ended June 30, 2015
 
 
Compared to
 
 
Six Months Ended June 30, 2014
 
 
Increase (Decrease)
Due to
 
 
 
 
Rate
 
Volume
 
Net
 
 
(Dollars in thousands)
Interest income:
 
 
 
 
 
 
Interest-bearing deposits in other banks
 
$
(10
)
 
$
(23
)
 
$
(33
)
Loans, net of unearned income
 
(2,612
)
 
10,830

 
8,218

Nontaxable securities(1)
 
25

 
1,801

 
1,826

Taxable securities
 
(1,570
)
 
5,320

 
3,750

Total interest-earning assets
 
(4,167
)
 
17,928

 
13,761

Interest expense:
 
 
 
 
 
 
Demand deposits
 
10

 
(9
)
 
1

Money market
 
82

 
71

 
153

Time deposits
 
(8
)
 
(15
)
 
(23
)
Borrowings
 
(12
)
 
(161
)
 
(173
)
Total interest-bearing liabilities
 
72

 
(114
)
 
(42
)
Change in net interest income
 
$
(4,239
)
 
$
18,042

 
$
13,803

(1)
Tax equivalent income.
Provision for Loan Losses
We consider a number of factors in determining the required level of our loan reserves and the provision required to achieve what we believe is the appropriate reserve level, including loan growth, credit risk rating trends, nonperforming loan levels, delinquencies, loan portfolio concentrations and economic and market trends. The provision for loan losses represents our determination of the amount necessary to be charged against the current period’s earnings to maintain the allowance for loan losses at a level that we consider adequate in relation to the estimated losses inherent in the loan portfolio.
Three and Six Months Ended June 30, 2015 and 2014. For the three months ended June 30, 2015, the provision for loan losses was $3.8 million, an increase of $0.6 million, or 19.3%, compared to the three months ended June 30, 2014. For the six months ended June 30, 2015, the provision for loan losses was $9.2 million, an increase of $3.1 million, or 50.6%, compared to the six months ended June 30, 2014.
The higher provision for the three and six months ended June 30, 2015 reflected the 31.6% growth in our loan portfolio from June 30, 2014 and higher net charge offs, which were lower than historical experience in 2014 but more reflective of historical experience during the three and six months ended June 30, 2015. At June 30, 2015, nonperforming loans totaled $17.9 million, or 1.18%, of total loans compared to $17.2 million, or 1.28%, of total loans, at December 31, 2014, and $12.3 million, or 1.07%, at June 30, 2014. Net loan charge-offs were 0.92% and 0.99%, respectively, of average loans (annualized) for the three and six months ended June 30, 2015 compared to 0.25% and 0.54%, respectively, for the three and six months ended June 30, 2014. The allowance for loan losses to nonperforming loans at June 30, 2015 was 139.58%, compared to 132.87% at December 31, 2014 and 175.54% at June 30, 2014. Specific loan loss allowances relating to nonperforming loans increased to $8.2 million and were 45.6% of nonperforming loans at June 30, 2015, compared to $8.1 million, or 47.0% of nonperforming loans at December 31, 2014 and $6.4 million, or 51.9%, of nonperforming loans at June 30, 2014.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management" for further information about credit risk and credit quality.

57


Noninterest Income
Three and Six Months Ended June 30, 2015 and 2014. The following tables show the components of noninterest income and the related dollar and percentage changes:
 
 
Three Months Ended June 30,
 
Change
 
 
2015
 
2014
 
Dollars
 
Percent
 
 
(Dollars in thousands)
Core banking income:
 
 
 
 
 
 
 
 
Service charges and fees
 
$
1,325

 
$
1,126

 
$
199

 
17.7
 %
Foreign exchange fees
 
1,620

 
1,363

 
257

 
18.9

Credit card and merchant income
 
1,100

 
765

 
335

 
43.8

Letter of credit fees
 
455

 
297

 
158

 
53.2

Client investment fees(1)
 
172

 
65

 
107

 
164.6

Loan documentation fees(1)
 
115

 
96

 
19

 
19.8

Total core banking noninterest income
 
4,787

 
3,712

 
1,075

 
29.0

Net gain on securities
 
1,025

 
38

 
987

 
2,597.4

Warrant income
 
239

 
21

 
218

 
1,038.1

Gain on sale of loans
 
592

 
249

 
343

 
137.8

Bank owned life insurance
 
424

 
317

 
107

 
33.8

Other
 
565

 
2,035

 
(1,470
)
 
(72.2
)
Total noninterest income
 
$
7,632

 
$
6,372

 
$
1,260

 
19.8
 %
(1) Included in other noninterest income in the consolidated statements of income.
 
 
Six Months Ended June 30,
 
Change
 
 
2015
 
2014
 
Dollars
 
Percent
 
 
(Dollars in thousands)
Core banking income:
 
 
 
 
 
 
 
 
Service charges and fees
 
$
2,583

 
$
2,194

 
$
389

 
17.7
 %
Foreign exchange fees
 
3,338

 
3,004

 
334

 
11.1

Credit card and merchant income
 
2,121

 
1,401

 
720

 
51.4

Letter of credit fees
 
697

 
812

 
(115
)
 
(14.2
)
Client investment fees(1)
 
305

 
106

 
199

 
187.7

Loan documentation fees(1)
 
195

 
233

 
(38
)
 
(16.3
)
Total core banking noninterest income
 
9,239

 
7,750

 
1,489

 
19.2

Net gain on securities
 
821

 
4

 
817

 
20,425.0

Warrant income
 
701

 
2,216

 
(1,515
)
 
(68.4
)
Gain on sale of loans
 
1,398

 
502

 
896

 
178.5

Bank owned life insurance
 
859

 
607

 
252

 
41.5

Other(1)
 
826

 
2,432

 
(1,606
)
 
(66.0
)
Total noninterest income
 
$
13,844

 
$
13,511

 
$
333

 
2.5
 %
(1) Included in other noninterest income in the consolidated statements of income.
Core banking noninterest income represents recurring income from traditional banking services provided to our customers (see "Non-GAAP Financial Measures"). The increase in core banking noninterest income for the three and six months ended June 30, 2015, was primarily due to an increased customer base combined with increased utilization of our core banking services by our customers. Service charges and fees represent fees earned on our deposit accounts. Foreign exchange fees are primarily transaction-based fees earned from our customers for performing foreign currency-based transactions on their behalf.

58


Credit card and merchant income represents fees earned on credit card accounts and transactions. Letters of credit fees represent fees charged to issue and process letters of credit for customers. Client investment fees represent fees charged to customers for asset management services.
The increases in service charges and fees for the three and six months ended June 30, 2015 compared to the same periods in 2014 reflects the increase in deposits. Higher foreign exchange fees were driven by increases in our customer's foreign currency-based transactions. The increase in credit card and merchant income was driven by growth in credit card accounts. Credit card balances outstanding were $23.4 million, $18.0 million and $15.0 million at June 30, 2015, December 31, 2014 and June 30, 2014, respectively. Letters of credit fees are driven by the volume of letters of credit. The decrease for the six months ended June 30, 2015 compared to the six months ended June 30, 2014 reflects the impact of higher than typical volume of letters of credit in the first quarter of 2014. Client investment fees have increased as a result of the strong growth in client investment assets under management.
Total noninterest income increased $1.3 million compared to the three months ended June 30, 2014, as the increases in core banking noninterest income and the net gain on securities were partially offset by a $1.1 million decrease in unrealized gains from our venture capital fund investments. An increase in the gain on sale of loans and higher warrant income also contributed to higher noninterest income compared to the three months ended June 30, 2014. Total noninterest income increased $0.3 million compared to the six months ended June 30, 2014, as increases in core banking noninterest income, the net gain on securities and the gain on sale of loans were largely offset by decreases of in warrant income and other noninterest income. The decrease in other noninterest income was driven by a $1.1 million decrease in the unrealized gains from our venture capital fund investments and $0.5 million in fees earned in 2014 on the Square 1 Venture 1, L.P. management contract that was sold on April 1, 2014. The increases in the net gain on securities for the three and six months ended June 30, 2015 were primarily due to gains on sales of mortgage-backed securities during the three months ended June 30, 2015. The higher gains on sale of loans for the three and six months ended June 30, 2015 were due to our strategic decision to sell more SBA loans from our loan portfolio.
Warrant income includes income realized upon the exercise of a warrant, as well as unrealized gains and losses from the quarterly mark-to-market of our warrant portfolio. The timing and volume of successful liquidity events, including IPOs, for the clients in which we had taken warrant positions, and changes in the fair value of our equity warrant assets drive variances in warrant income. The variances in warrant income demonstrate the volatility of this income which is created, in part, by the erratic nature of public equity markets and their receptivity to IPOs.
The following tables show the components of warrant income and the period-to-period changes (see further discussion of our equity warrant assets in Note 14 to the interim consolidated financial statements):
 
 
Three Months Ended June 30,
 
Change
 
 
2015
 
2014
 
Dollars
 
Percent
 
 
(Dollars in thousands)
Equity warrant assets:
 
 
 
 
 
 
 
 
Net gains on exercise of equity warrant assets
 
$
156

 
$
2,158

 
$
(2,002
)
 
(92.8
)%
Non-monetized write off of warrant assets
 
(66
)
 
(97
)
 
31

 
32.0

Net realized gains on equity warrants
 
90

 
2,061

 
(1,971
)
 
(95.6
)
Change in fair value
 
149

 
(2,040
)
 
2,189

 
107.3

Warrant income
 
$
239

 
$
21

 
$
218

 
1,038.1
 %

59


 
 
Six Months Ended June 30,
 
Change
 
 
2014
 
2013
 
Dollars
 
Percent
 
 
(Dollars in thousands)
Equity warrant assets:
 
 
 
 
 
 
 
 
Net gains on exercise of equity warrant assets
 
$
895

 
$
3,016

 
$
(2,121
)
 
(70.3
)%
Non-monetized write off of warrant assets
 
(125
)
 
(176
)
 
51

 
29.0

Net realized gains on equity warrants
 
770

 
2,840

 
(2,070
)
 
(72.9
)
Change in fair value
 
(69
)
 
(624
)
 
555

 
88.9

Warrant income
 
$
701

 
$
2,216

 
$
(1,515
)
 
(68.4
)%
During the three and six months ended June 30, 2015, our net realized gains were primarily driven by equity warrants in private companies that experienced liquidity events, such as an acquisition. During the three months ended June 30, 2015, we did not exercise any warrants for equity securities and realized warrant gains in 13 companies. During the six months ended June 30, 2015, we exercised warrants with a total value of $33 thousand and received equity securities in one publicly traded company that conducted an IPO in 2015 and realized gains in 29 companies.
During the three months ended June 30, 2014, we realized warrant gains in 20 companies, including the monetization of warrants and a realized gain of $0.8 million on warrants exercised upon expiration of the respective lock-up periods that we held in one portfolio company client that conducted IPOs. During the six months ended June 30, 2014, we realized warrant gains in 33 companies, including the monetization of warrants and a realized gain of $0.8 million on warrants exercised upon expiration of the respective lock-up periods that we held in three portfolio company client that conducted IPOs. We also exercised warrants with a total value of $1.4 million and received equity securities in four publicly traded companies during the three and six months ended June 30, 2014.
Noninterest Expense
Three and Six Months Ended June 30, 2015 and 2014. The following table shows the components of noninterest expense and the related dollar and percentage changes:
 
 
Three Months Ended June 30,
 
Change
 
 
2015
 
2014
 
Dollars
 
Percent
 
 
(Dollars in thousands)
Personnel
 
$
12,541

 
$
10,725

 
$
1,816

 
16.9
 %
Occupancy
 
880

 
773

 
107

 
13.8

Data processing
 
1,049

 
918

 
131

 
14.3

Furniture and equipment
 
793

 
660

 
133

 
20.2

Advertising and promotions
 
383

 
342

 
41

 
12.0

Professional fees
 
1,089

 
786

 
303

 
38.5

Telecommunications
 
286

 
285

 
1

 
0.4

Travel
 
285

 
292

 
(7
)
 
(2.4
)
FDIC assessment
 
497

 
347

 
150

 
43.2

Merger-related expenses
 
792

 

 
792

 
100.0

Other
 
1,712

 
1,472

 
240

 
16.3

Total noninterest expense
 
$
20,307

 
$
16,600

 
$
3,707

 
22.3
 %

60


 
 
Six Months Ended June 30,
 
Change
 
 
2015
 
2014
 
Dollars
 
Percent
 
 
(Dollars in thousands)
Personnel
 
24,768

 
$
21,359

 
$
3,409

 
16.0
%
Occupancy
 
1,703

 
1,513

 
190

 
12.6

Data processing
 
1,986

 
1,740

 
246

 
14.1

Furniture and equipment
 
1,558

 
1,362

 
196

 
14.4

Advertising and promotions
 
624

 
617

 
7

 
1.1

Professional fees
 
1,901

 
1,387

 
514

 
37.1

Telecommunications
 
577

 
545

 
32

 
5.9

Travel
 
482

 
458

 
24

 
5.2

FDIC assessment
 
916

 
752

 
164

 
21.8

Merger-related expenses
 
1,004

 

 
1,004

 
100.0

Other
 
3,125

 
2,450

 
675

 
27.6

Total noninterest expense
 
$
38,644

 
$
32,183

 
$
6,461

 
20.1
%
The increases in noninterest expense three and six months ended June 30, 2015 compared to the three and six months ended June 30, 2014 were primarily due to higher personnel expenses, higher professional fees and merger-related expenses. Personnel represented 61.8% of our total noninterest expense and increased $1.8 million, or 16.9%, for the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and increased $3.4 million, or 16.0%, for the six months ended June 30, 2015 compared to the six months ended June 30, 2014. The increase in personnel expense primarily resulted from an increase in our full-time equivalent employees to 280 at June 30, 2015, from 258 at December 31, 2014 and 245 at June 30, 2014, to drive and support our balance sheet and income growth and higher incentive compensation expense. Over the past year we have added 9 venture bankers and client managers in key markets, including California, New York, Boston and Chicago. In addition, our occupancy and furniture and equipment expenses have increased in 2015 due to the addition of a new loan production office in Minneapolis which opened in the first quarter of 2015, San Francisco which opened in the second quarter of 2014, and Chicago which opened in the fourth quarter of 2014, as well as an increase in our lease expenses for our New York loan production office. Data processing fees have also increased to support our overall growth in connection with upgrades for our lending and credit operations. These updates have and will continue to result in increased expenses in 2015 as we continue to hire additional bankers and invest in our franchise. Higher other noninterest expense was primarily driven by increases of $0.1 million and $0.5 million, respectively, in the provision for unfunded credit commitments for the three and six months ended June 30, 2015, compared to the respective periods in the prior year. The provision for unfunded credit commitments was $0.6 million and $1.0 million, respectively, for the three and six months ended June 30, 2015.
Income Tax Provision
Three and Six Months Ended June 30, 2015 and 2014. Income tax expense increased $1.6 million, or 46.4%, for the three months ended June 30, 2015 as compared to the same period in the prior year, primarily due to a $3.5 million, or 30.2%, increase in pre-tax income and a higher effective tax rate. Income tax expense increased $1.8 million, or 26.4%, for the six months ended June 30, 2015 as compared to the same period in the prior year, primarily due to a $3.9 million, or 17.4%, increase in pre-tax income and a higher effective tax rate. Our effective tax rate increased to 33.7% for the three months ended June 30, 2015 from 30.0% for the three months ended June 30, 2014 and increased to 31.9% for the six months ended June 30, 2015 from 29.6% for the six months ended June 30, 2014 due to an increase in the proportion of taxable income to nontaxable income.

DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
Our total assets increased $817.6 million, or 26.4%, to $3.9 billion at June 30, 2015, from $3.1 billion at December 31, 2014, primarily due to deposit growth of $787.2 million, which resulted in $301.4 million in additional period end cash and cash equivalents, a $339.3 million increase in our investment securities portfolio, and a $169.6 million increase in our loan portfolio.

61


Our loan and deposit portfolios include entrepreneurial companies at all stages of their life cycles, as well as venture firms. The following table provides a summary of total loans outstanding, total unfunded loan commitments and deposit balances by stage and type at June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
 
 
Loans Outstanding
 
 
Unfunded Loan
Commitments
 
 
Deposit Balances
 
 
 
Amount
 
Percent
 
 
Amount
 
Percent
 
 
Amount
 
Percent
 
 
 
(Dollars in thousands)
 
Stage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Early
 
$
322,153

 
21.13
%
 
$
191,305

 
13.37
%
 
$
1,724,307

 
48.38
%
Expansion
 
706,156

 
46.31
 
 
293,630

 
20.51
 
 
910,224

 
25.54
 
Late
 
175,213

 
11.49
 
 
275,213

 
19.23
 
 
379,729

 
10.66
 
Total portfolio company
 
1,203,522

 
78.93
 
 
760,148

 
53.11
 
 
3,014,260

 
84.58
 
Venture capital/private equity
 
216,268

 
14.18
 
 
642,839

 
44.91
 
 
548,957

 
15.40
 
SBA and USDA
 
81,673

 
5.36
 
 
2,735

 
0.19
 
 
547

 
0.02
 
Credit cards
 
23,379

 
1.53
 
 
25,669

 
1.79
 
 

 
 
Total
 
1,524,842

 
100.00
%
 
$
1,431,391

 
100.00
%
 
$
3,563,764

 
100.00
%
Less unearned income
 
(8,810
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans, net of unearned income
 
$
1,516,032

 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
December 31, 2014
 
 
 
Loans Outstanding
 
 
Unfunded Loan
Commitments
 
 
Deposit Balances
 
 
 
Amount
 
Percent
 
 
Amount
 
Percent
 
 
Amount
 
Percent
 
 
 
(Dollars in thousands)
 
Stage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Early
 
$
235,649

 
17.40
%
 
$
124,973

 
10.14
%
 
$
1,255,847

 
45.23
%
Expansion
 
620,456

 
45.81
 
 
250,327

 
20.32
 
 
590,974

 
21.29
 
Late
 
234,486

 
17.31
 
 
206,492

 
16.76
 
 
347,666

 
12.52
 
Total portfolio company
 
1,090,591

 
80.52
 
 
581,792

 
47.22
 
 
2,194,487

 
79.04
 
Venture capital/private equity
 
169,143

 
12.49
 
 
613,594

 
49.80
 
 
581,491

 
20.94
 
SBA and USDA
 
76,622

 
5.66
 
 
6,953

 
0.57
 
 
574

 
0.02
 
Credit cards
 
17,980

 
1.33
 
 
29,739

 
2.41
 
 

 
 
Total
 
1,354,336

 
100.00
%
 
$
1,232,078

 
100.00
%
 
$
2,776,552

 
100.00
%
Less unearned income
 
(7,887
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans, net of unearned income
 
$
1,346,449

 
 
 
 
 
 
 
 
 
 
 
 
 


62


Loans
The following table presents the loan balances and associated percentage of each category of loans within our loan portfolio at the dates indicated:
 
 
June 30, 2015
 
December 31, 2014
 
 
Amount
 
Percent
 
Amount
 
Percent
 
 
(Dollars in thousands)
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
739,016

 
48.47
%
 
$
631,979

 
46.66
%
Life sciences
 
307,240

 
20.15

 
274,057

 
20.24

Asset-based loans
 
143,204

 
9.39

 
177,701

 
13.12

Venture capital/private equity
 
216,268

 
14.18

 
169,143

 
12.49

SBA and USDA
 
36,926

 
2.42

 
35,609

 
2.63

Other
 
14,062

 
0.93

 
6,854

 
0.50

Total commercial loans
 
1,456,716

 
95.54

 
1,295,343

 
95.64

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
37,995

 
2.49

 
36,978

 
2.73

Total real estate loans
 
37,995

 
2.49

 
36,978

 
2.73

Construction:
 
 
 
 
 
 
 
 
SBA and USDA
 
6,752

 
0.44

 
4,035

 
0.30

Total construction loans
 
6,752

 
0.44

 
4,035

 
0.30

Credit cards
 
23,379

 
1.53

 
17,980

 
1.33

Total loans
 
1,524,842

 
100.00
%
 
1,354,336

 
100.00
%
Less unearned income(1)
 
(8,810
)
 
 
 
(7,887
)
 
 
Total loans, net of unearned income
 
$
1,516,032

 


 
$
1,346,449

 
 
(1)
Unearned income consists of unearned loan fees, the discount on SBA loans and the unearned initial warrant value.
The 12.5% increase in commercial loans from December 31, 2014 to June 30, 2015 was primarily driven by increases in total loans to venture-backed companies consisting of the technology and life sciences client sector and asset-based loans, and the venture firm client industry segment. Total loans to venture-backed companies were up $105.7 million, or 9.8%, as increases in loans in the life sciences and technology segments were partially offset by an increase in payoffs in asset-based loans and loans to venture firms were up $47.1 million, or 27.9%, at June 30, 2015 compared to December 31, 2014. Within our commercial loan portfolio, our loans to venture firm clients fluctuate from period-to-period based on funding needs driven by investment cycles and timing. The amount of loan commitments that are utilized by these clients vary during the year and often increase at the end of the year when these clients may increase the amount drawn on their lines of credit for various business reasons.
Growth in SBA and USDA loans also contributed to the overall growth in commercial loans from December 31, 2014 to June 30, 2015. Total SBA and USDA loans increased $5.1 million, or 6.6%, from December 31, 2014 to June 30, 2015. We also made a strategic decision to sell more SBA loans in our loan portfolio during the first quarter of 2015. At June 30, 2015, SBA and USDA loans represented 5.4% of our loan portfolio compared to 5.7% at December 31, 2014.

Loan Concentration
Loan concentrations may exist when there are borrowers engaged in similar activities or when there is a diverse group of borrowers that could be similarly impacted by economic or other conditions.

63


The breakdown of total loans by industry sector at June 30, 2015 and December 31, 2014, is as follows:
 
 
June 30, 2015
 
December 31, 2014
 
 
Amount
 
Percent
 
Amount
 
Percent
 
 
(Dollars in thousands)
Venture portfolio industry:
 
 
 
 
 
 
 
 
Software
 
$
256,180

 
16.90
 %
 
$
193,622

 
14.38
 %
Business products and services
 
127,602

 
8.42

 
118,451

 
8.80

Hardware
 
95,682

 
6.31

 
103,667

 
7.70

Consumer products and services
 
115,706

 
7.63

 
81,603

 
6.06

Media and telecom
 
102,224

 
6.74

 
86,187

 
6.40

Biotech
 
122,146

 
8.06

 
103,818

 
7.71

Healthcare services
 
80,536

 
5.31

 
76,094

 
5.65

IT services
 
67,865

 
4.48

 
61,805

 
4.59

Medical devices and equipment
 
73,421

 
4.84

 
65,714

 
4.88

Financial services
 
41,832

 
2.76

 
37,919

 
2.82

Other industries
 
120,335

 
7.94

 
151,136

 
11.22

Total venture portfolio industry
 
1,203,529

 
79.39

 
1,080,016

 
80.21

Venture capital/private equity
 
216,268

 
14.26

 
169,143

 
12.56

SBA and USDA
 
81,673

 
5.39

 
76,622

 
5.69

Credit cards
 
23,379

 
1.54

 
17,980

 
1.34

Other (overdrafts and in-process)
 
(7
)
 

 
10,575

 
0.79

Total loans
 
1,524,842

 
100.58

 
1,354,336

 
100.59

Less unearned income
 
(8,810
)
 
(0.58
)
 
(7,887
)
 
(0.59
)
Loans, net of unearned income
 
$
1,516,032

 
100.00
 %
 
$
1,346,449

 
100.00
 %

64


The following tables provide a summary of total loans by size and category. The breakout of the categories is based on total client balances (individually or in the aggregate) at June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
 
Total
 
Less than $5 Million
 
$5 Million - $10 Million
 
Greater than $10 Million
 
 
Amount
 
Number
 
Amount
 
Number
 
Amount  
 
Number  
 
Amount  
 
Number  
 
 
(Dollars in thousands)
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$
739,016

 
273

 
$
381,897

 
231

 
$
231,276

 
33

 
$
125,843

 
9

Life sciences
 
307,240

 
78

 
124,039

 
56

 
106,934

 
17

 
76,267

 
5

Asset-based loans
 
143,204

 
92

 
33,930

 
81

 
42,274

 
6

 
67,000

 
5

Venture capital/private equity
 
216,268

 
78

 
66,159

 
63

 
67,019

 
9

 
83,090

 
6

SBA and USDA
 
36,926

 
60

 
36,926

 
60

 

 

 

 

Other
 
14,062

 
13

 
9,062

 
12

 
5,000

 
1

 

 

Total commercial loans
 
1,456,716

 
594

 
652,013

 
503

 
452,503

 
66

 
352,200

 
25

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
37,995

 
66

 
32,191

 
65

 
5,804

 
1

 

 

Total real estate loans
 
37,995

 
66

 
32,191

 
65

 
5,804

 
1

 

 

Construction loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
6,752

 
5

 
6,752

 
5

 

 

 

 

Total construction loans
 
6,752

 
5

 
6,752

 
5

 

 

 

 

Credit cards
 
23,379

 
597

 
23,379

 
597

 

 

 

 

Total loans
 
1,524,842

 
1,262

 
$
714,335

 
1,170

 
$
458,307

 
67

 
$
352,200

 
25

Less unearned income
 
(8,810
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned income
 
$
1,516,032

 
 
 
 
 
 
 
 
 
 
 
 
 
 


65


 
 
December 31, 2014
 
 
Total
 
Less than $5 Million
 
$5 Million - $10 Million
 
Greater than $10 Million
 
 
Amount
 
Number
 
Amount
 
Number
 
Amount  
 
Number  
 
Amount  
 
Number  
 
 
(Dollars in thousands)
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$
631,979

 
256

 
$
375,727

 
224

 
$
177,063

 
26

 
$
79,189

 
6

Life sciences
 
274,057

 
76

 
113,053

 
57

 
87,404

 
14

 
73,600

 
5

Asset-based loans
 
177,701

 
67

 
32,717

 
54

 
43,481

 
6

 
101,503

 
7

Venture firm
 
169,143

 
72

 
49,099

 
61

 
31,558

 
5

 
88,486

 
6

SBA and USDA
 
35,609

 
50

 
35,609

 
50

 

 

 

 

Other
 
6,854

 
11

 
6,854

 
11

 

 

 

 

Total commercial loans
 
1,295,343

 
532

 
613,059

 
457

 
339,506

 
51

 
342,778

 
24

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
36,978

 
60

 
31,120

 
59

 
5,858

 
1

 

 

Total real estate loans
 
36,978

 
60

 
31,120

 
59

 
5,858

 
1

 

 

Construction loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
4,035

 
4

 
4,035

 
4

 

 

 

 

Total construction loans
 
4,035

 
4

 
4,035

 
4

 

 

 

 

Credit cards
 
17,980

 
519

 
17,980

 
519

 

 

 

 

Total loans
 
1,354,336

 
1,115

 
$
666,194

 
1,039

 
$
345,364

 
52

 
$
342,778

 
24

Less unearned income
 
(7,887
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned income
 
$
1,346,449

 
 
 
 
 
 
 
 
 
 
 
 
 
 


Loan Maturity
At June 30, 2015, 89.7%, or $1.4 billion, of our total outstanding gross loans were variable rate loans that adjust at specified dates based on our prime lending rate or other variable indices, compared to 91.5%, or $1.2 billion, at December 31, 2014. At June 30, 2015, just over 38% of the loans had floors above the floating rate coupon. After an increase in rates of 100 bps, only 6% of these loans will continue to have floors above the floating rate coupon.

66


The following table sets forth the remaining contractual maturity distribution of our gross loan portfolio, by industry sector, at June 30, 2015 and December 31, 2014, for fixed and variable rate loans:
 
 
June 30, 2015
 
 
Remaining Contractual Maturity of Gross Loans
 
 
One Year
or Less
 
After One
Year and
Through
Five Years
 
After
Five Years
 
Total
 
 
(In thousands)
Fixed-rate loans:
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
1,821

 
$
34,868

 
$

 
$
36,689

Life sciences
 
716

 
79,802

 

 
80,518

Asset-based loans
 
26,585

 
137

 

 
26,722

Venture capital/private equity
 

 
261

 

 
261

SBA and USDA
 

 

 
763

 
763

Other
 
2,500

 

 
3,950

 
6,450

Total commercial loans
 
31,622

 
115,068

 
4,713

 
151,403

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 

 

 
6,065

 
6,065

Total real estate loans
 

 

 
6,065

 
6,065

Total construction loans
 

 

 

 

Credit cards
 

 

 

 

Total fixed-rate loans
 
$
31,622

 
$
115,068

 
$
10,778

 
$
157,468

Variable-rate loans:
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
342,787

 
$
359,540

 
$

 
$
702,327

Life sciences
 
75,171

 
151,551

 

 
226,722

Asset-based loans
 
102,228

 
14,254

 

 
116,482

Venture capital/private equity
 
170,387

 
41,729

 
3,891

 
216,007

SBA and USDA
 

 
359

 
35,804

 
36,163

Other
 
2,612

 
5,000

 

 
7,612

Total commercial loans
 
693,185

 
572,433

 
39,695

 
1,305,313

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 

 
33

 
31,897

 
31,930

Total real estate loans
 

 
33

 
31,897

 
31,930

Construction loans:
 


 


 


 


SBA and USDA
 

 

 
6,752

 
6,752

Total construction loans
 

 

 
6,752

 
6,752

Credit cards
 
23,379

 

 

 
23,379

Total variable rate loans
 
$
716,564

 
$
572,466

 
$
78,344

 
1,367,374

Less unearned income
 
 
 
 
 
 
 
(8,810
)
Total loans, net of unearned income
 
 
 
 
 
 
 
$
1,516,032


67


 
 
December 31, 2014
 
 
Remaining Contractual Maturity of Gross Loans
 
 
One Year
or Less
 
After One
Year and
Through
Five Years
 
After
Five Years
 
Total
 
 
(In thousands)
Fixed-rate loans:
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
2,320

 
$
24,967

 
$

 
$
27,287

Life sciences
 
500

 
56,138

 

 
56,638

Asset-based loans
 
24,669

 
622

 

 
25,291

Venture capital/private equity
 

 
337

 

 
337

SBA and USDA
 

 

 
795

 
795

Other
 

 

 
611

 
611

Total commercial loans
 
27,489

 
82,064

 
1,406

 
110,959

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
1,008

 

 
3,363

 
4,371

Total real estate loans
 
1,008

 

 
3,363

 
4,371

Total fixed-rate loans
 
$
28,497

 
$
82,064

 
$
4,769

 
$
115,330

Variable-rate loans:
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
$
286,017

 
$
318,675

 
$

 
$
604,692

Life sciences
 
57,046

 
160,373

 

 
217,419

Asset-based loans
 
100,010

 
52,400

 

 
152,410

Venture capital/private equity
 
133,303

 
32,596

 
2,907

 
168,806

SBA and USDA
 
235

 
180

 
34,399

 
34,814

Other
 
2,998

 

 
3,245

 
6,243

Total commercial loans
 
579,609

 
564,224

 
40,551

 
1,184,384

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 

 
36

 
32,571

 
32,607

Total real estate loans
 

 
36

 
32,571

 
32,607

Construction loans:
 
 
 
 
 
 
 
 
SBA and USDA
 

 

 
4,035

 
4,035

Total construction loans
 

 

 
4,035

 
4,035

Credit cards
 
17,980

 

 

 
17,980

Total variable rate loans
 
$
597,589

 
$
564,260

 
$
77,157

 
1,239,006

Less unearned income
 
 
 
 
 
 
 
(7,887
)
Total loans, net of unearned income
 
 
 
 
 
 
 
$
1,346,449

Upon maturity, loans satisfying our credit quality standards may be renewed. Renewals are subject to the same underwriting and credit administration practices as we utilize for new loans. It is not our practice to grant loans with unconditional extension or renewal terms.

Investment Securities
Investment securities totaled $1.9 billion at June 30, 2015, an increase of $339.3 million, or 21.3%, compared to $1.6 billion at December 31, 2014. See Notes 3 and 15 to the unaudited interim consolidated financial statements.

68


Our investment securities portfolio is comprised of both available-for-sale securities and securities that we intend to hold to maturity. We purchase securities for our investment securities portfolio to manage interest rate risk, ensure a stable source of liquidity, and to provide a steady source of income in excess of our cost of funds.
Our available-for-sale securities portfolio totaled $1.5 billion at June 30, 2015, an increase of $246.8 million, or 19.1%, compared to $1.3 billion at December 31, 2014.
Legacy non-agency mortgage-backed securities are those that were purchased prior to 2008 before the onset of the financial crisis and represent $17.5 million of the $185.1 million of non-agency mortgage-backed securities held at June 30, 2015, compared to $18.7 million of the $173.1 million of non-agency mortgage-backed securities held at December 31, 2014. The $17.5 million of legacy non-agency mortgage-backed securities purchased before 2008 is spread across multiple originators and issuers. There are 16 unique securities that have an average balance of $1.1 million, with the largest single security having a fair value of $2.8 million at June 30, 2015. The $17.5 million of legacy non-agency mortgage-backed securities have been impaired $5.9 million and represent 0.9% of the $1.9 billion in investment securities at June 30, 2015. The underlying loans in the group are comprised of prime (13%), Alt-A (38%) and sub-prime (49%) loans.
The balance of the $185.1 million is in investment grade non-agency mortgage-backed securities that have been purchased since 2013. The loans underlying these securities are comprised of prime (62%), Alt-A (18%) and sub-prime (20%) loans.
Other asset-backed securities totaled $107.0 million at June 30, 2015, compared to $47.6 million at December 31, 2014. Other asset-backed securities are investment grade and are comprised of student loan securities, a trust preferred collateralized debt obligation ("CDO"), venture debt obligations and securities with underlying consumer loans. The loans underlying the venture debt obligations are similar to the loans in our venture banking portfolio and have an estimated average life of one year or less.
We monitor our non-agency mortgage-backed securities and other asset-backed securities on an ongoing basis. Principal repayment, delinquencies, prepayments and default rates are tracked monthly. In addition, we perform a discounted cash flow analysis for our non-agency mortgage-backed securities on a quarterly basis as part of our other-than-temporary impairment ("OTTI") review. The student loan securities and the trust preferred CDO are monitored semi-annually.
Our held to maturity securities portfolio is mainly comprised of municipal bonds. Our held to maturity securities portfolio had an amortized cost of $392.9 million at June 30, 2015, an increase of $92.4 million, or 30.8%, compared to $300.4 million at December 31, 2014. The increase in this portfolio was primarily due to our purchase of new municipal bond securities and agency mortgage backed securities that we intend to hold until they are either called or reach maturity.
At June 30, 2015, the duration of our available-for-sale securities portfolio was approximately 2.3 years and the overall investment securities portfolio duration was 3.0 years.

69


The following table sets forth the stated maturities and weighted average yields of debt securities at June 30, 2015. Weighted average yields on tax-exempt securities are presented on a tax equivalent basis. While not reflected in the table below, 26.0% of the investment portfolio is either floating rate or adjustable rate securities and will reprice either immediately or within the first year based on the repricing of the underlying loans.
 
 
 
 
June 30, 2015
 
 
 
 
Less than One Year
 
After One to Five Years
 
After Five to Ten Years
 
After Ten Years
 
 
Total
Amortized
Cost
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
 
(Dollars in thousands)
Available-for sale-securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
159,264

 
$

 


 
$
159,264

 
1.02
%
 
$

 


 
$

 


Agency direct obligations
 
30,323

 
20,272

 
0.69

 
10,051

 
0.93

 

 


 

 


SBA pools
 
162,014

 

 


 
4,136

 
1.59

 
82,765

 
1.59

 
75,113

 
1.59

Agency mortgage-backed securities
 
666,405

 

 


 
2,398

 
0.51

 
29,622

 
1.64

 
634,385

 
2.49

Municipal bonds
 
97,417

 

 


 

 


 
15,185

 
3.88

 
82,232

 
4.43

Corporates
 
117,397

 
13,928

 
2.50

 
41,843

 
1.31

 
12,954

 
1.37

 
48,672

 
2.54

Non-agency mortgage-backed securities
 
185,662

 

 


 
701

 
3.62

 
7,417

 
3.96

 
177,544

 
3.21

Other asset-backed securities
 
107,495

 
3,516

 
1.89

 
36,755

 
3.20

 
26,387

 
2.81

 
40,837

 
2.40

Total available for sale securities
 
$
1,525,977

 
$
37,716

 
1.47
%
 
$
255,148

 
1.39
%
 
$
174,330

 
2.07
%
 
$
1,058,783

 
2.70
%
Held-to-maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency mortgage-backed securities
 
$
102,368

 
$

 


 
$

 


 
$

 


 
$
102,368

 
3.85
%
Municipal bonds
 
230,582

 

 


 

 


 
18,295

 
3.81

 
212,287

 
5.49

Corporates
 
59,922

 

 


 

 


 

 


 
59,922

 
4.34

Total held-to-maturity
 
$
392,872

 
$

 
%
 
$

 
%
 
$
18,295

 
3.81
%
 
$
374,577

 
4.86
%
Total securities
 
$
1,918,849

 
$
37,716

 
1.47
%
 
$
255,148

 
1.39
%
 
$
192,625

 
2.23
%
 
$
1,433,360

 
3.26
%

Derivatives
Derivative instruments are recorded as a component of other assets and other liabilities on the balance sheet.
Equity Warrant Assets. In most cases, we seek equity warrants in connection with extending loan commitments to our customers. In general, the equity warrants entitle us to purchase a specific number of shares of a client’s stock at a specific price over a specified time period. The warrants may also include contingent provisions which provide for additional shares to be purchased at a specific price if defined future events occur, such as future rounds of equity financing by the client, or additional borrowings by the client. These warrants are obtained at the inception of a loan facility or the amendment of a loan facility. These warrants are not obtained in lieu of other fees, interest or payments. These warrants potentially provide an additional return, in addition to the traditional loan yield from interest and fees, in the event of a liquidity event of the borrowing company. The grant date fair values of equity warrants received in connection with extending loan commitments are considered to be loan fees and are recognized over the life of the loan commitment as an adjustment to the loan yield through loan interest income. Any changes from the grant date in the fair value of equity warrant assets are recognized as increases or decreases to warrant valuation and as net gains or losses in noninterest income during the period in which the change is recognized. These changes in warrant valuation and related gains or losses may occur as a result of a change in the Black Scholes value of the warrant, or when a portfolio company completes an initial public offering on a publicly reported market or is acquired. We may exercise these equity warrant assets for either shares or cash. When a private company goes public there is

70


often a lock-up period requiring us to hold our equity position in a publicly traded security until the expiration of the lock-up period. Shares received from the exercise of warrants and subject to lock-up agreements are held as equity securities in our available for sale portfolio.
Our equity warrants portfolio is primarily comprised of warrants in non-public companies and our practice generally is to monetize our positions as soon as a liquidity event occurs. Often there is a lock-up period requiring us to hold our equity position in a publicly traded security until the expiration of the lock-up period. Warrants held, which amounted to $5.1 million and $4.3 million in 484 and 461 companies at June 30, 2015 and December 31, 2014, respectively, are shown as warrant valuation in the accompanying consolidated balance sheets. At June 30, 2015, the $5.1 million valuation on warrants held included $0.6 million in equity securities of nine publicly traded companies compared to $0.2 million held in equity securities of six publicly traded companies at December 31, 2014.
During the three months ended June 30, 2015, we did not exercise any warrants for equity securities. During the six months ended June 30, 2015, we exercised warrants with a total value of $33 thousand and received equity securities in one publicly traded company. During the three and six months ended June 30, 2014, we exercised warrants with a total value of $1.4 million and received equity securities in four publicly traded companies of which one was monetized for $0.3 million.
At June 30, 2015, the fair value of equity securities included in equity securities within our available-for-sale investments obtained through the exercise of warrants and still held was $0.1 million, compared to $0.9 million at December 31, 2014 (see Note 3). See Notes 14 and 15 and "Results of Operations - Noninterest Income" for further information regarding our equity warrant assets.
Foreign Exchange Forward Contracts. We enter into foreign exchange forward contracts with clients involved in foreign activities, either as the purchaser or seller, depending upon the clients’ needs. For each forward contract entered into with our clients, we enter into an opposite way forward contract with a correspondent bank, which mitigates the risk of fluctuations in currency rates. At June 30, 2015, we had $9.4 million in gross notional customer outstanding forward contracts and an offsetting $9.3 million in gross notional correspondent bank outstanding forward contracts. At December 31, 2014, we had $5.7 million in gross notional customer outstanding forward contracts and an offsetting $5.6 million in gross notional correspondent bank outstanding forward contracts.

Deposits
The following table sets forth the composition of our deposits at June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
December 31, 2014
 
 
Amount
 
Percent
 
Amount
 
Percent
 
 
(Dollars in thousands)
Period-end:
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
 
$
2,372,673

 
66.58
%
 
$
1,851,004

 
66.67
%
Interest-bearing deposits:
 
 
 
 
 
 
 
 
Demand deposits
 
100,496

 
2.82

 
71,598

 
2.58

Money market
 
1,081,211

 
30.34

 
837,630

 
30.16

Time deposits
 
9,384

 
0.26

 
16,320

 
0.59

Total period end deposits
 
$
3,563,764

 
100.00
%
 
$
2,776,552

 
100.00
%


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The following tables set forth the composition of our average deposits for the three and six months ended June 30, 2015 and 2014:
 
 
Three Months Ended June 30,
 
 
2015
 
2014
 
 
Amount
 
Percent
 
Amount
 
Percent
 
 
(Dollars in thousands)
Average:
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
 
$
2,123,531

 
67.08
%
 
$
1,518,640

 
64.38
%
Interest-bearing deposits:
 
 
 
 
 
 
 
 
Demand deposits
 
96,817

 
3.06

 
117,542

 
4.98

Money market
 
933,385

 
29.49

 
692,727

 
29.36

Time deposits
 
11,733

 
0.37

 
30,133

 
1.28

Total average deposits
 
$
3,165,466

 
100.00
%
 
$
2,359,042

 
100.00
%
 
 
Six Months Ended June 30,
 
 
2015
 
2014
 
 
Amount
 
Percent
 
Amount
 
Percent
 
 
(Dollars in thousands)
Average:
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
 
$
1,994,391

 
66.69
%
 
$
1,455,126

 
64.52
%
Interest-bearing deposits:
 
 
 
 
 
 
 
 
Demand deposits
 
94,620

 
3.16

 
117,097

 
5.19

Money market
 
887,462

 
29.68

 
654,990

 
29.04

Time deposits
 
14,186

 
0.47

 
28,138

 
1.25

Total average deposits
 
$
2,990,659

 
100.00
%
 
$
2,255,351

 
100.00
%
Our deposits increased to $3.6 billion at June 30, 2015, from $2.8 billion at December 31, 2014, an increase of $787.2 million, or 28.4%. This increase was primarily due to growth of our client base and a continued strong funding environment for venture-backed firms. Our noninterest-bearing deposits increased $521.7 million, or 28.2%, and our interest-bearing deposits increased $265.5 million, or 28.7%, during the period.
At June 30, 2015, the aggregate balance of time deposit accounts individually equal to or greater than $100,000 totaled $9.2 million, of which $8.2 million is scheduled to mature within one year. The remaining $1.0 million is scheduled to mature in 2017.
 
Client Investment Funds
We utilize alternative cash investment vehicles to manage our on-balance sheet deposit growth, which tends to be volatile as is typical in the market in which we operate. For example, we offer our clients alternative cash investment vehicles such as sweep accounts and investments in the CDARS, the latter of which allows us to place client deposits in one or more insured depository institutions. Square 1 Asset Management, our registered investment advisor, offers customized solutions to our clients that are tailored to meet the unique corporate cash management needs of entrepreneurial companies and venture firms. The growth in our client investment funds reflects our continuing ability to manage deposits off balance sheet in a manner that benefits our clients and the Bank. We expect to continue to manage our on-balance sheet deposit growth through these alternative investment vehicles for our clients and to grow the amount of assets under management by Square 1 Asset Management.

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The following table sets forth the composition of our client investment funds at June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
December 31, 2014
 
%
Change
Period-end:
 
(Dollars in thousands)
Client investment assets under management
 
$
1,222,834

 
$
976,075

 
25.3
 %
Sweep money market funds
 
458,683

 
404,357

 
13.4

CDARS
 
31,507

 
56,201

 
(43.9
)
Total period-end client investment funds
 
$
1,713,024

 
$
1,436,633

 
19.2
 %

The following tables set forth the composition of average client investment funds for the three and six months ended June 30, 2015 and 2014:
 
 
Three Months Ended June 30,
 
 
2015
 
2014
 
%
Change
Average:
 
(Dollars in thousands)
Client investment assets under management
 
$
1,089,403

 
$
210,551

 
417.4
 %
Sweep money market funds
 
466,521

 
301,154

 
54.9

CDARS
 
36,294

 
238,271

 
(84.8
)
Total average client investment funds
 
$
1,592,218

 
$
749,976

 
112.3
 %

 
 
Six Months Ended June 30,
 
 
2015
 
2014
 
%
Change
Average:
 
(Dollars in thousands)
Client investment assets under management
 
$
1,017,224

 
$
177,015

 
474.7

Sweep money market funds
 
457,645

 
305,979

 
49.6

CDARS
 
41,585

 
207,346

 
(79.9
)
Total average client investment funds
 
$
1,516,454

 
$
690,340

 
119.7


Repurchase Agreements and Borrowings
See Note 7 for further information regarding our repurchase agreements and Note 8 for further information regarding our borrowings.

Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with accounting principles generally accepted in the United States of America, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit and letters of credit.
The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults and any existing collateral has no value. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Financial instruments whose contract amounts represent credit risk at June 30, 2015 and December 31, 2014, are as follows:

73


 
 
June 30, 2015
 
December 31, 2014
 
 
(In thousands)
Commitments to extend credit(1):
 
 
 
 
Future loan commitments
 
$
1,431,391

 
$
1,232,078

Standby letters of credit(2)
 
78,518

 
68,372

Total commitments
 
$
1,509,909

 
$
1,300,450

(1)
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments may require payment of a fee and generally have fixed expiration dates or other termination clauses.
(2)
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.
For the three and six months ended June 30, 2015, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

RISK MANAGEMENT
Overview
Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available for sale securities, which are accounted for on a mark-to-market basis. Other risks that we face are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers due to unforeseen circumstances. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.

Credit Risk
Analysis of Nonperforming and Classified Assets. We place loans that are 90 days or more past due as to principal or interest payments on nonaccrual status, or prior to that if we have determined based upon current information available to us that the timely collection of principal or interest is not probable. When a loan is placed on nonaccrual status, any previously recorded interest is reversed and recorded as a reduction of loan interest and fee income. Typically, collections of interest and principal received on a nonaccrual loan are applied to the outstanding principal as determined at the time of collection of the loan.
Troubled debt restructurings occur when debtors are granted concessions we would not otherwise consider, because of economic or legal reasons pertaining to the debtor’s financial difficulties. Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s).

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The following table provides information with respect to our nonperforming assets and troubled debt restructurings at the dates indicated:
 
 
June 30, 2015
 
December 31, 2014
 
 
(Dollars in thousands)
Nonaccrual loans:
 
 
 
 
Commercial loans:
 
 
 
 
Technology
 
$
9,992

 
$
9,487

Life sciences
 
1,911

 
2,511

Asset-based loans
 

 
570

SBA and USDA
 
539

 
175

Other
 
3,343

 
3,245

Total commercial loans
 
15,785

 
15,988

Real estate loans:
 
 
 
 
SBA and USDA
 
2,152

 
1,251

Total real estate loans
 
2,152

 
1,251

Total nonaccrual loans
 
17,937

 
17,239

Total nonperforming loans
 
$
17,937

 
$
17,239

Nonaccrual troubled debt restructurings
 
$
5,713

 
$
5,859

Total troubled debt restructurings
 
6,158

 
5,859

Less nonaccrual troubled debt restructurings included in total nonaccrual loans
 
(5,713
)
 
(5,859
)
Total nonperforming assets and troubled debt restructurings
 
$
18,382

 
$
17,239

Total nonperforming loans to total loans
 
1.18
%
 
1.28
%
Total nonperforming loans to total assets
 
0.46
%
 
0.56
%
Total nonperforming assets and troubled debt restructurings to total assets
 
0.47
%
 
0.56
%


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The following tables present the composition of portfolio company nonperforming loans by stage at June 30, 2015 and December 31, 2014:
 
 
June 30, 2015
 
 
Amount
 
Number
 
Percent
 
 
(Dollars in thousands)
Stage:
 
 
 
 
 
 
Early
 
$
8,499

 
5

 
55.74
%
Expansion
 
4,332

 
3

 
28.41

Late
 
2,416

 
1

 
15.85

Total portfolio company loans
 
$
15,247

 
9

 
100.00
%
 
 
December 31, 2014
 
 
Amount
 
Number
 
Percent
 
 
(Dollars in thousands)
Stage:
 
 
 
 
 
 
Early
 
$
3,764

 
3

 
23.80
%
Expansion
 
6,398

 
5

 
40.46

Late
 
5,652

 
2

 
35.74

Total portfolio company loans
 
$
15,814

 
10

 
100.00
%
At June 30, 2015, our total nonperforming assets and troubled debt restructurings were $18.4 million, a $1.1 million, or 6.6%, increase from December 31, 2014. At June 30, 2015, nonperforming loans represented 1.18% of our total loans and were comprised of 14 credits that had $8.2 million in specific reserves held against them.
At June 30, 2015, our criticized (performing) and impaired loans represented approximately 5.5% of our total gross loans. This compares to 7.5% at December 31, 2014. 54.4% of our criticized and impaired loans at June 30, 2015 are to companies in the technology sector, across all growth stages compared to 55.5% at December 31, 2014. Loans to technology sector companies represented approximately 48.5% of our loan portfolio at June 30, 2015 and 46.7% of our loan portfolio at December 31, 2014. Loans to early and expansion stage portfolio company clients comprised 71.5% of our nonperforming loans at June 30, 2015 compared to 58.9% at December 31, 2014. It is common for an early or expansion stage client’s remaining liquidity to fall temporarily below the threshold necessary for a pass-rated credit during its capital-raising period for a new round of funding. This situation typically lasts only a few weeks and, in our experience, generally resolves itself with a subsequent round of venture funding. As a result, we expect that some of our early-stage and expansion stage clients will be managed through our criticized portfolio during a portion of their life cycle without resulting in net charge-offs.
Management is proactive in its approach to identifying and resolving problem loans and is focused on working with the borrowers and guarantors of these loans to provide loan modifications when warranted. The level of nonperforming assets fluctuates in response to changing economic and market conditions, the relative size and composition of the loan portfolio, as well as management’s degree of success in resolving problem assets.
Interest income that would have been recorded had nonaccruing loans and troubled debt restructurings been current in accordance with their original terms and had been outstanding throughout the period, amounted to $0.3 million and $0.1 million, respectively, for the three months ended June 30, 2015, and 2014 and amounted to $0.5 million and $0.3 million, respectively, for the six months ended June 30, 2015, and 2014.
Allowance for Loan Losses. The allowance for loan losses, a material estimate which could change significantly in the near-term, is established through a provision for loan losses charged to earnings to account for losses that are inherent in the loan portfolio and estimated to occur, and is maintained at a level that management believes is adequate to absorb losses in the loan portfolio. Loan losses are charged against the allowance for loan losses when management believes that the uncollectibility of the principal loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for loan losses when received.

76


Management’s judgment in determining the adequacy of the allowance is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available and as situations change.
The allowance for loan losses is evaluated on a monthly basis by management and takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions and trends that may affect the borrower’s ability to repay.
The allowance for loan losses consists of the following key elements:
Specific allowance for identified impaired loans. For such loans that are identified as impaired, an allowance is established when the discounted cash flows (or collateral value if the loan is collateral dependent) or observable market price of the impaired loan are lower than the carrying value of that loan.
General valuation allowance, which represents a valuation allowance on the remainder of the loan portfolio, after excluding impaired loans. For this portion of the allowance, loans are reviewed based on industry, stage and structure, and are assigned allowance percentages based on historical loan loss experience adjusted for qualitative factors. Qualitative factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date, may include changes in lending policies and procedures; changes in national and local economic and business conditions, including the condition of various market segments; changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and staff; changes in the volume and severity of past due and classified loans and in the volume of nonaccruals, trouble debt restructurings, and other loan modifications; the existence and effect of any concentrations of credit and changes in the level of such concentrations; and the effect of external factors, such as competition and legal and regulatory requirements, on the level of estimated and inherent credit losses in the Bank’s current portfolio.
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated:
 
 
June 30, 2015
 
December 31, 2014
 
 
Amount
 
% of Allowance of
Total
Allowance
 
% of
Loans in
Category
to Total
Loans
 
Amount
 
% of Allowance of
Total
Allowance
 
% of
Loans in
Category
to Total
Loans
 
 
(Dollars in thousands)
Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
 
Technology
 
$
14,459

 
57.75
%
 
48.47
%
 
$
11,904

 
51.97
%
 
46.66
%
Life sciences
 
3,908

 
15.61

 
20.15

 
3,657

 
15.96

 
20.24

Asset-based loans
 
2,161

 
8.63

 
9.39

 
3,364

 
14.69

 
13.12

Venture capital/private equity
 
374

 
1.49

 
14.18

 
250

 
1.09

 
12.49

SBA and USDA
 
622

 
2.49

 
2.42

 
622

 
2.72

 
2.63

Other
 
2,519

 
10.06

 
0.93

 
1,576

 
6.88

 
0.50

Total commercial loans
 
24,043

 
96.03

 
95.54

 
21,373

 
93.31

 
95.64

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
699

 
2.79

 
2.49

 
1,310

 
5.72

 
2.73

Total real estate loans
 
699

 
2.79

 
2.49

 
1,310

 
5.72

 
2.73

Construction:
 
 
 
 
 
 
 
 
 
 
 
 
SBA and USDA
 
61

 
0.24

 
0.44

 
43

 
0.19

 
0.30

Total construction loans
 
61

 
0.24

 
0.44

 
43

 
0.19

 
0.30

Credit cards
 
234

 
0.94

 
1.53

 
180

 
0.78

 
1.33

Total
 
$
25,037

 
100.00
%
 
100.00
%
 
$
22,906

 
100.00
%
 
100.00
%

77


Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Dollars in thousands)
Allowance at beginning of period
 
$
24,739

 
$
19,094

 
$
22,906

 
$
18,379

Provision for loan losses
 
3,758

 
3,150

 
9,205

 
6,114

Charge-offs:
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
1,630

 
332

 
3,691

 
2,166

Life sciences
 
600

 
409

 
1,961

 
409

Asset-based loans
 
938

 

 
938

 

SBA and USDA
 
26

 

 
64

 

Other
 
246

 

 
246

 
128

Total commercial loans
 
3,440

 
741

 
6,900

 
2,703

Real estate loans:
 
 
 
 
 
 
 
 
SBA and USDA
 
27

 

 
567

 
390

Total real estate loans
 
27

 

 
567

 
390

Total charge offs
 
3,467

 
741

 
7,467

 
3,093

Recoveries:
 
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
 
Technology
 
(6
)
 
(53
)
 
(392
)
 
(156
)
SBA and USDA
 
(1
)
 

 
(1
)
 

Total commercial loans
 
(7
)
 
(53
)
 
(393
)
 
(156
)
Total recoveries
 
(7
)
 
(53
)
 
(393
)
 
(156
)
Net charge offs
 
3,460

 
688

 
7,074

 
2,937

Allowance at end of period
 
$
25,037

 
$
21,556

 
$
25,037

 
$
21,556

Allowance for loan losses to total loans at end of period
 
1.65
%
 
1.87
%
 
1.65
%
 
1.87
%
Net charge offs to average loans outstanding during period (annualized)
 
0.92
%
 
0.25
%
 
0.49
%
 
0.54
%


Market Risk
Market risk is defined as the risk of adverse fluctuations in the market value of financial assets and liabilities due to changes in market rates. Interest rate risk is our primary market risk and can result from timing and volume differences in the repricing of our rate-sensitive assets and liabilities, widening or tightening of credit spreads, changes in the general level of market interest rates and changes in the shape and level of market yield curves. Additionally, changes in interest rates can influence the rate of principal prepayments on mortgage securities, which affects the rate of amortization of purchase premiums and discounts, and ultimately the yield, of such securities. Other market risks include foreign currency exchange risk and equity price risk. These risks are not considered significant and no separate quantitative information concerning them is presented herein.
Interest Rate Risk Management. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Management of interest rate risk is carried out primarily through strategies involving our investment securities and available funding sources. In addition, our policies permit the use of on- and off-balance sheet derivative financial instruments to assist in managing interest rate risk, although to date we have not entered into any derivative financial instruments for such purposes.

78


We have a Management Asset/Liability Committee to communicate, coordinate and control all aspects involving interest rate risk management. The Management Asset/Liability Committee, with oversight from the Board Asset/Liability Committee (“BALCO”), establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals. Adherence to relevant policies is monitored on an ongoing basis.
Net Interest Income Simulation and Economic Value of Equity Analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest sensitive.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. We analyze our interest rate sensitivity position to manage the risk associated with interest rate movements through the use of two simulation models: net interest income (“NII”) simulation and economic value of equity ("EVE"). The EVE simulation provides a long term view of interest rate risk because it analyzes all of the Bank's future cash flows. EVE is defined as the present value of the Bank's assets less the present value of its liabilities, adjusted for any off balance sheet items. The results show a theoretical change in the value of our shareholders' equity as interest rates change.
The NII and EVE simulations are completed monthly and presented to the Asset/Liability Committee. The simulations provide an estimate of the impact of changes in interest rates on net interest income and equity under a range of assumptions. The numerous assumptions used in the simulation process are reviewed by the Asset/Liability Committee on a monthly basis. Changes to these assumptions can significantly affect the results of the simulations. The simulations incorporate assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change adversely over time due to competition or other factors.
Simulation analysis is only an estimate of our interest rate risk exposure at a particular point in time. We continually review the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.
The tables below set forth an approximation of our NII sensitivity exposure for the 12-month periods beginning June 30, 2015 and December 31, 2014, and our EVE sensitivity at June 30, 2015 and December 31, 2014. The simulations use projected repricing of assets and liabilities beginning June 30, 2015 and December 31, 2014, on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the large percentage of variable rate loans and mortgage-backed securities we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that in turn affect the rate sensitivity position. Generally, when interest rates rise, prepayments tend to slow. When interest rates fall, mortgage prepayments tend to rise. Our asset sensitivity would be reduced if mortgage prepayments slow and vice versa. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.
Numerous assumptions are used to model deposits since they do not have a contractual maturity and rates are internally set based on market conditions and management goals. Our assumption is that the rate paid on interest-bearing deposits is tied to the fed funds rate. We also use a pricing beta that represents the correlation between the fed funds rate and the actual rate modeled on interest-bearing deposits. We currently model interest-bearing deposits using a pricing beta of approximately 50% such that for an assumed 1.00% move in the fed funds rate there would be a 0.50% change in the modeled rate that we would pay on interest-bearing deposits. The deposit pricing beta was updated beginning with the first quarter of 2015 and was moved from 70% to 50% based on an updated review of our deposit assumptions. The change will have an impact on our reported interest rate sensitivity. In isolation, reducing the deposit pricing sensitivity from 70% to 50% will reduce the sensitivity of our interest bearing deposits to changes in interest rates. In addition, we also make assumptions as to how deposits will shift between interest-bearing products and non-interest bearing products in response to changes in rates. As rates increase we assume that an increasing percentage of deposits will shift from non-interest bearing to interest-bearing resulting in higher rates being paid on larger balances. The opposite would be true when rates are assumed to decrease.
Caution should be used when interpreting the results of the simulation models as presented in the following tables. There are limitations to our ability to fully model important assumptions such as the shape of the yield curve, actual prepayment speeds, the mix of interest bearing to non-interest bearing deposits and the basis risk between different rate indices. Also rates do not normally move instantaneously as our modeling results indicate. The results should not be interpreted as precise measures and do not represent the actual net interest income or market value of our equity for a given change in rates.


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Estimated Increase/Decrease
in Net Interest Income
 
Estimated Percentage
Change in EVE
Basis Point (“bp”) Change in
Interest Rates
 
12 Months Beginning
 
 
June 30, 2015
 
At June 30, 2015
300
 
18.1%
 
(14.4)%
200
 
12.6
 
(8.5)
100
 
6.2
 
(3.0)
(100)
 
(3.9)
 
(0.6)
(200)
 
(6.0)
 
1.6
 
 
Estimated Increase/Decrease
in Net Interest Income
 
Estimated Percentage
Change in EVE
Basis Point (“bp”) Change in
Interest Rates
 
12 Months Beginning
 
 
December 31, 2014
 
At December 31, 2014
300
 
9.7%
 
(12.8)%
200
 
8.6
 
(5.5)
100
 
5.3
 
(2.0)
(100)
 
(3.4)
 
(0.4)
(200)
 
(4.9)
 
2.4

Rates are immediately increased at the beginning of the projection. The results show that we are asset sensitive and that net interest income will increase as rates rise and will decrease as rates decline. Interest rates do not normally move instantaneously, but the analysis is useful to understanding the potential direction and magnitude of net interest income changes due to changing interest rates.
The EVE analysis shows that we would theoretically lose market value in a rising rate environment. This is primarily due to the fixed rate securities in our investment portfolio, which will lose value as rates rise. The analysis also assumes that amortizing assets will experience slower prepayments as rates increase, which will also cause asset values to decline. The opposite will be true for a declining rate environment where the EVE numbers will improve as the fixed rate securities will increase in value.
When compared to the December 31, 2014 results, the NII sensitivity increased in both the rising interest rate and the falling rate scenarios.
The EVE sensitivity showed a modest increase from December 31, 2014 to June 30, 2015 for the rising rate scenarios and one of the two declining interest rate scenarios. The small increase in sensitivity across most scenarios was primarily caused by interest rate sensitivity in the investment portfolio whose balances will tend to decline in value as rates increase.

Liquidity Risk
Liquidity Management. Liquidity management is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and sales, maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, mortgage prepayments and loan and security sales are greatly influenced by general interest rates, economic conditions and competition.
We regularly adjust our investment in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our asset/liability management, funds management and liquidity policies. The objective of the liquidity policy is to reduce the risk to our earnings and capital arising from the inability to meet obligations in a timely manner without incurring unacceptable losses. This entails ensuring sufficient funds are available at a reasonable cost to meet potential demands from both fund providers and borrowers. Liquid assets, defined as cash, due from banks, federal funds sold, repurchase agreements, and available-for-sale securities,

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were 49.4% of total assets at June 30, 2015. Excess liquid assets are generally invested in investment grade available-for-sale securities.
Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At June 30, 2015, cash and cash equivalents totaled $387.3 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $1.5 billion at June 30, 2015. In addition, at June 30, 2015, we had the ability to borrow $250.4 million from the FHLB. There were no outstanding borrowings under this line at June 30, 2015. Additionally, at June 30, 2015, we had the ability to access $83.4 million from the Federal Reserve Bank’s Discount Window on a collateralized basis. There were no outstanding borrowings under this line at June 30, 2015. We also maintain $60.0 million of unsecured lines of credit from four financial institutions to access federal funds. We had not accessed these unsecured lines of credit as of June 30, 2015. We believe that our liquid assets combined with the available credit lines provide adequate liquidity to meet our current financial obligations.
The following table presents our contractual obligations at June 30, 2015:
 
 
Payments Due by Period
 
 
Total
 
Less Than
One Year
 
One to
Three
Years
 
Three to
Five
Years
 
More
Than Five
Years
 
 
(In thousands)
Contractual Obligations
 
 
 
 
 
 
 
 
 
 
Deposits without stated maturity
 
$
3,554,380

 
$
3,554,380

 
$

 
$

 
$

Time deposits
 
9,384

 
8,381

 
1,003

 

 

Operating lease obligations
 
16,041

 
1,487

 
4,580

 
4,607

 
5,367

Total
 
$
3,579,805

 
$
3,564,248

 
$
5,583

 
$
4,607

 
$
5,367

Capital Management. Our management seeks to maintain adequate capital to support anticipated asset growth, operating needs and unexpected risks, and to ensure that Square 1 Financial and Square 1 Bank are in compliance with all current and anticipated regulatory capital guidelines. Our primary sources of new capital include retained earnings and proceeds from the sale and issuance of capital stock or other securities. Our management engages, in consultation with the BALCO, in an annual capital planning process in an effort to optimize the use of the capital available to us and to appropriately plan for our future capital needs. The capital plan, approved annually by the Board of Directors, considers capital needs for the foreseeable future and allocates capital to both existing and future business activities. Expected future use or activities for which capital may be set aside include balance sheet growth and associated relative increases in market or credit exposure, investment activity, potential product and business expansions, acquisitions and strategic or infrastructure investments.
Regulatory capital ratios for Square 1 Financial and the Bank exceeded minimum federal regulatory guidelines for a well-capitalized depository institution as of June 30, 2015 and December 31, 2014. See Note 11 to the interim consolidated financial statements for further information.
On January 1, 2015, the Basel III regulatory standard on bank capital adequacy became effective. The rule establishes a new Common Equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets), and requires institutions to hold 8.0% total capital and 4.0% Tier 1 capital to average consolidated assets (“Leverage Ratio”). It also increases the Tier 1 capital to risk-based assets threshold ratio for "well capitalized" from 6.0% to 8.0% or risk-weighted assets.
The rule also includes changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. Under the new capital rule, Tier 1 capital consists of Common Equity Tier 1 capital and “Additional Tier 1 capital” instruments meeting certain revised requirements. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period. Finally, Tier 1 capital generally will include accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a two-year transition period, unless an opt-out election is made.
The new capital requirements also include changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one

81


year or less that is not unconditionally cancellable; a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital; and increased risk-weights (from 0% to up to 600%) for equity exposures. See “Supervision and Regulation-State Bank Regulation-New Capital Rule” under Item 1. Business of our 2014 Form 10-K for further information. Our and the Bank's Risk-Based Capital ratios decreased as a result of the changes to both qualifying regulatory capital and risk-weighted assets under the new rules.
Capital ratios for Square 1 Financial and Square 1 Bank, compared to the minimum regulatory ratios to be considered “well capitalized” and “adequately capitalized,” are set forth below.
 
 
 
June 30,
2015
 
December 31, 2014
 
Minimum
Ratio to be
“Well
Capitalized”
 
Minimum
Ratio to be
“Adequately
Capitalized”
 
 
Square 1 Financial:
 
 
 
 
 
 
 
 
 
Total risk-based capital ratio
 
13.12
%
 
14.95
%
 
10.00
%
 
8.00
%
 
Tier 1 risk-based capital ratio
 
12.09

 
13.83

 
8.00

 
6.00

 
Common equity Tier 1 capital ratio
 
12.09

 
11.73

 
6.50

 
4.50

 
Tier 1 leverage ratio
 
9.07

 
9.71

 
5.00

 
4.00

 
Tangible equity to risk-weighted assets ratio
 
12.43

 
14.20

 
N/A

 
N/A

 
 
 
 
 
 
 
 
 
 
 
Square 1 Bank:
 
 
 
 
 
 
 
 
 
Total risk-based capital ratio
 
12.82
%
 
12.21
%
 
10.00
%
 
8.00
%
 
Tier 1 risk-based capital ratio
 
11.79

 
11.13

 
8.00

 
6.00

 
Common equity Tier 1 capital ratio
 
11.79

 
11.13

 
6.50

 
4.50

 
Tier 1 leverage ratio
 
8.82

 
8.16

 
5.00

 
4.00



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management" for discussion of quantitative and qualitative disclosures about market risk.

ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective, in all material respects, as of the end of the period covered by this report, in ensuring that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to management, including the Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Three putative stockholder class action lawsuits were filed in connection with the previously disclosed proposed merger between us and PacWest (see Note 1). Manganaro v. Burke et al., Case No. 10817-VCL,  was filed in the Court of Chancery of the State of Delaware on March 20, 2015, and was voluntarily dismissed without prejudice on May 5, 2015. Lakowitz v. Bowers et al., Case No. 1:15-CV-371, was filed in the federal district court for the Middle District of North Carolina on May 6, 2015 and was voluntarily dismissed without prejudice on May 7, 2015. Li v. Bowers et al., Case No. 1:15-CV-373 (the “Li Action”), was filed in federal district court for the Middle District of North Carolina on May 7, 2015. On June 1, 2015, the parties to the Li Action entered into a Memorandum of Understanding which sets forth the parties’ agreement in principle to a settlement of that action, which remains subject to a number of conditions, including, among other things, final documentation and court approval following notice to the settlement class. There can be no assurance that the settlement will ultimately be approved by the court. See Note 1 "Organization and Basis of Presentation" and Note 16 "Off-balance Sheet Risk, Commitments and Contingencies" of the "Notes to Interim Consolidated Financial Statements (Unaudited)" under Part I, Item 1 of this Form 10-Q for discussions of the merger agreement and related legal proceedings.
We are also party to other legal actions that are routine and incidental to our business. In management’s opinion, the outcome of these matters, individually or in the aggregate, will not have a material effect on our results of operations or financial position. See Note 16 "Off-balance Sheet Risk, Commitments and Contingencies" of the "Notes to Interim Consolidated Financial Statements (Unaudited)" under Part I, Item 1 of this Form 10-Q.

ITEM 1A. RISK FACTORS
There have been no material changes in our assessment of our risk factors from those set forth in the 2014 Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
From April 1, 2015 through June 30, 2015, the Company issued an aggregate of 26,000 shares of its Class A common stock in connection with the exercise by investors of certain founder warrants to purchase the Company’s Class A common stock, at an exercise price of $10.00 per share. The shares of Class A common stock issued upon exercise of the warrants were issued pursuant to the exemption from registration contained in Section 4(a)(2) of the Securities Act, and the regulations promulgated thereunder, as a transaction by an issuer not involving any public offering.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.

ITEM 5. OTHER INFORMATION
None.


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ITEM 6. EXHIBITS
List of Exhibits
 
 
 
 
 
Exhibit
 
Description
 
Method of Filing
 
 
 
 
 
2.1

 
Agreement and Plan of Merger, dated March 1, 2015, by and between Square 1 Financial, Inc. and PacWest Bancorp
 
(incorporated by reference to Exhibit 2.1 in the Registrant’s Current Report on Form 8-K, filed with the SEC on March 5, 2015, File No. 001-36372)
 
 
 
 
 
3.1

 
Second Amended and Restated Certificate of Incorporation of Square 1 Financial, Inc.
 
(incorporated by reference to the Exhibit 3.1 in the Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2014, File No. 001-36372)
 
 
 
 
 
3.2

 
Bylaws of Square 1 Financial, Inc.
 
(incorporated by reference to the Exhibit 3.2 in the Registrant’s Registration Statement on Form S-1, File No. 333-193197)
 
 
 
 
 
4.1

 
Specimen Stock Certificate for Class A Common Stock of Square 1 Financial, Inc.
 
(incorporated by reference to the Exhibit 4.1 in the Registrant’s Registration Statement on Form S-1, File No. 333-193197)
 
 
 
 
 
10.1

 
Square 1 Financial, Inc. 2009 Stock Incentive Plan, as amended
 
(incorporated by reference to the Exhibit 99.1 in the Registrant’s Registration Statement on Form S-8, File No. 333-195221)
 
 
 
 
 
10.2

 
Letter Agreement, dated March 1, 2015, by and between Square 1 Financial, Inc., Square 1 Bank and Patrick Oakes*+
 
(incorporated by reference from Exhibit 10.8 in the Registrant’s Annual Report on Form 10-K for the period ended December 31, 2014, filed with the SEC on March 20, 2015, File No. 001-36372)
 
 
 
 
 
10.3

 
Letter Agreement, dated March 1, 2015, by and between Square 1 Financial, Inc., Square 1 Bank and Gregory Thompson*+
 
(incorporated by reference from Exhibit 10.10 in the Registrant’s Annual Report on Form 10-K for the period ended December 31, 2014, filed with the SEC on March 20, 2015, File No. 001-36372)
 
 
 
 
 
10.4

 
Employment Agreement, dated March 1, 2015, by and between Square 1 Financial, Inc., Square 1 Bank and Jason Kranack*+
 
(incorporated by reference from Exhibit 10.11 in the Registrant’s Annual Report on Form 10-K for the period ended December 31, 2014, filed with the SEC on March 20, 2015, File No. 001-36372)
 
 
 
 
 
10.5

 
Employment Agreement, dated March 1, 2015, by and between Square 1 Financial, Inc., Square 1 Bank and Frank Tower*+
 
(incorporated by reference from Exhibit 10.12 in the Registrant’s Annual Report on Form 10-K for the period ended December 31, 2014, filed with the SEC on March 20, 2015, File No. 001-36372)
 
 
 
 
 
31.1

 
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Filed herewith
 
 
 
 
 
31.2

 
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Filed herewith
 
 
 
 
 
32.1

 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Filed herewith
 
 
 
 
 

85


32.2

 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Filed herewith
 
 
 
 
 
101.INS

 
XBRL Instance Document
 
Filed herewith
 
 
 
 
 
101.SCH

 
XBRL Taxonomy Extension Schema Document
 
Filed herewith
 
 
 
 
 
101.CAL

 
XBRL Taxonomy Calculation Linkbase Document
 
Filed herewith
 
 
 
 
 
101.DEF

 
XBRL Taxonomy Definition Linkbase Document
 
Filed herewith
 
 
 
 
 
101.LAB

 
XBRL Taxonomy Label Linkbase Document
 
Filed herewith
 
 
 
 
 
101.PRE

 
XBRL Taxonomy Presentation Linkbase Document
 
Filed herewith
 
 
 
 
 

86


SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Durham, State of North Carolina on August 12, 2015.
 
 
 
 
 
Square 1 Financial, Inc.
 
 
 
 
By:
/s/ Douglas H. Bowers
 
 
Douglas H. Bowers
President and Chief Executive Officer
 
 
 
 
 
/s/ Patrick Oakes
 
 
Patrick Oakes
Executive Vice President and Chief Financial Officer (principal financial and accounting officer)
 
 
 

 


87