Attached files

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EX-3.2 - EX-3.2 - CU Bancorpd215093dex32.htm
EX-23.1 - EX-23.1 - CU Bancorpd215093dex231.htm
EX-10.9 - EX-10.9 - CU Bancorpd215093dex109.htm
EX-10.3 - EX-10.3 - CU Bancorpd215093dex103.htm
EX-31.1 - EX-31.1 - CU Bancorpd215093dex311.htm
EX-32.1 - EX-32.1 - CU Bancorpd215093dex321.htm
EX-14.2 - EX-14.2 - CU Bancorpd215093dex142.htm
EX-14.1 - EX-14.1 - CU Bancorpd215093dex141.htm
EX-12.1 - EX-12.1 - CU Bancorpd215093dex121.htm
EX-10.4 - EX-10.4 - CU Bancorpd215093dex104.htm
EX-31.2 - EX-31.2 - CU Bancorpd215093dex312.htm
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20015

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            

CU BANCORP

(Exact name of registrant as specified in its charter)

Commission File Number 001-35683

 

California   90-0779788
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

818 W. 7th Street, Suite 220

Los Angeles, California

  90017
(Address of principal executive offices)   (Zip Code)

(213) 430-7000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(g) of the Act:

None

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, no par value, The NASDAQ Stock Market, LLC

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant is not required to file reports pursuant Section 13 or 15(d) of the Exchange act.    Yes  ¨    No  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, if definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated Filer   x
Non Accelerated Filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 30, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $342 million based upon the closing price of shares of the registrant’s Common Stock, no par value, as reported by The NASDAQ Stock Market, LLC.

The number of shares outstanding of the registrant’s common stock (no par value) at the close of business on March 8, 2016 was 17,372,998.

DOCUMENTS INCORPORATED BY REFERENCE

The information required to be disclosed pursuant to Part III of this report either shall be (i) deemed to be incorporated by reference from selected portions of CU Bancorp’s definitive proxy statement for the 2016 Annual Meeting of Shareholders, if such proxy statement is filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Company’s most recently completed fiscal year, or (ii) included in an amendment to this report filed with the SEC on Form 10-K/A not later than the end of such 120 day period.


Table of Contents

TABLE OF CONTENTS

 

PART I

  

ITEM 1

     Business      5   

ITEM 1A

     Risk Factors      28   

ITEM 1B

     Unresolved Staff Comments   

ITEM 2

     Properties      47   

ITEM 3

     Legal Proceedings      47   

ITEM 4

     Mine Safety Disclosures      47   

PART II

  

ITEM 5

     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      48   

ITEM 6

     Selected Financial Data      51   

ITEM 7

     Management’s Discussion and Analysis of Financial Condition and Results of Operations      53   

ITEM 7A

     Quantitative and Qualitative Disclosures About Market Risk      87   

ITEM 8

     Financial Statements and Supplementary Data      94   

ITEM 9

     Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      94   

ITEM 9A

     Controls and Procedures      94   

ITEM 9B

     Other Information      95   

PART III

  

ITEM 10

     Directors, Executive Officers and Corporate Governance      95   

ITEM 11

     Executive Compensation      95   

ITEM 12

     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      95   

ITEM 13

     Certain Relationships and Related Transactions, and Director Independence      95   

ITEM 14

     Principal Accountant Fees and Services      95   
PART IV   

ITEM 15

     Exhibits and Financial Statement Schedules      96   

Signatures

     170   

 

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Forward Looking Statements

In addition to the historical information, this Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “1934 Act”). Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results.

The Company’s forward-looking statements include descriptions of plans or objectives of management for future operations, products or services, and forecasts of its revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words “believe,” “expect,” “intend,” “estimate,” “anticipates,” “project,” “assume,” “plan,” “predict,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”

We make forward-looking statements as set forth above and regarding projected sources of funds, availability of acquisition and growth opportunities, dividends, adequacy of our allowance for loan losses and provision for loan losses, our loan portfolio and subsequent charge-offs. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the SEC, Item 1A of this Annual Report on Form 10-K, and the following:

 

   

Current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur.

 

   

The effects of trade, monetary and fiscal policies and laws.

 

   

Possible losses of businesses and population in Los Angeles, Orange, Ventura, San Bernardino or Riverside Counties.

 

   

Loss of customer checking and money-market account deposits as customers pursue other higher-yield investments, particularly in a rising rate environment.

 

   

Possible changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits.

 

   

Competitive market pricing factors.

 

   

Deterioration in economic conditions that could result in increased loan losses.

 

   

Risks associated with concentrations in real estate related loans.

 

   

Risks associated with concentrations in deposits.

 

   

Loss of significant customers.

 

   

Market interest rate volatility.

 

   

Possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans.

 

   

Changes in the speed of loan prepayments, loan origination and sale volumes, loan loss provisions, charge-offs or actual loan losses.

 

   

Compression of our net interest margin.

 

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Stability of funding sources and continued availability of borrowings to the extent necessary.

 

   

Changes in legal or regulatory requirements or the results of regulatory examinations that could restrict growth.

 

   

The inability of our internal disclosure controls and procedures to prevent or detect all errors or fraudulent acts.

 

   

Inability of our framework to manage risks associated with our business, including operational risk and credit risk, to mitigate all risk or loss to us.

 

   

Our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft.

 

   

The effects of man-made and natural disasters, including earthquakes, floods, droughts, brush fires, tornadoes and hurricanes.

 

   

The effect of labor and port slowdowns on small businesses.

 

   

Risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs.

 

   

Lack of take-out financing or problems with sales or lease-up with respect to our construction loans.

 

   

Our ability to recruit and retain key management and staff.

 

   

Availability of, and competition for, acquisition opportunities.

 

   

Risks associated with merger and acquisition integration.

 

   

Significant decline in the market value of the Company that could result in an impairment of goodwill.

 

   

Regulatory limits on the Bank’s ability to pay dividends to the Company.

 

   

The uncertainty of obtaining regulatory approval for various merger and acquisition opportunities.

 

   

New accounting pronouncements.

 

   

The impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and related rules and regulations on the Company’s business operations and competitiveness.

 

   

Our ability to comply with applicable capital and liquidity requirements (including the finalized Basel III capital standards), including our ability to generate capital internally or raise capital on favorable terms.

 

   

Increased regulation of the securities markets, including the securities of the Company, whether pursuant to the Sarbanes-Oxley Act of 2002, or otherwise.

 

   

The effects of any damage to our reputation resulting from developments related to any of the items identified above.

For a more detailed discussion of some of the risk factors, see the section entitled “Risk Factors” below.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

 

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PART I

ITEM 1 — BUSINESS

General

CU Bancorp, headquartered in Downtown Los Angeles, California, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is also a bank holding company within the meaning of Section 1280 of the California Financial Code. Our principal business is to serve as the holding company for our bank subsidiary, California United Bank, which we refer to as “CUB” or the “Bank”. When we say “we,” “our” or the “Company,” we mean the Company on a consolidated basis with the Bank. When we refer to CU Bancorp or the “holding company,” we are referring to the parent company on a stand-alone basis. The shares of CU Bancorp are listed on the NASDAQ Capital Market under the trading symbol “CUNB”.

CU Bancorp was incorporated as a California corporation on November 16, 2011, and became the holding company for California United Bank on July 31, 2012 by acquiring all the voting stock of California United Bank. The creation of the bank holding company for the Bank was approved by the shareholders of the Bank on July 23, 2012.

California United Bank was incorporated on September 30, 2004, under the laws of the State of California and commenced operations on May 23, 2005. The Bank is authorized to engage in the general commercial banking business and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the applicable limits of the law. CUB is a California state-chartered banking corporation and is not a member of the Federal Reserve System.

At year-end 2015, the Company had consolidated total assets of $2.6 billion, total loan balances of $1.8 billion, and total deposits of $2.3 billion. Additional information regarding our business, as well as regarding our acquisitions, is included in the information set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) and Note 2, Business Combinations, of the Notes to Consolidated Financial Statements, and is incorporated herein by reference.

The internet address of the Company’s website is www.cubancorp.com. The Company makes available free of charge through the Company’s website, the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports. The Company makes these reports available on its website on the same day they appear on the Securities and Exchange Commission (“SEC”) website.

Banking Business

CU Bancorp’s principal business is to serve as the holding company for the Bank and for any other banking or banking related subsidiaries which the Company may establish in the future. We have not engaged in any other material activities to date.

The Bank is a full-service commercial bank offering a broad range of banking products and services designed for small and medium-sized businesses, non-profit organizations, business owners and entrepreneurs, and the professional community, including attorneys, certified public accountants, financial advisors and healthcare providers and investors. Our deposit products include demand, money market, and certificates of deposit. Our loan products include commercial, real estate construction, commercial real estate, SBA and personal loans. We also provide cash management services, online banking, commercial credit cards and other primarily business-oriented products.

The principal executive offices of the Bank and the Company are located at 818 W. 7th Street, Suite 220, Los Angeles, CA, 90017. In addition to the Los Angeles headquarters office of the Bank, the Bank has eight additional full-service branches in the Ventura/Los Angeles/Orange County/San Bernardino metropolitan area;

 

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those branches are located in Encino, West Los Angeles, Valencia, Thousand Oaks, Gardena, Anaheim, Irvine/Newport Beach and Ontario. The Los Angeles Headquarters and Ontario full-service branches were acquired as part of the Company’s acquisition of 1st Enterprise Bank in November 2014 (as discussed below). The Anaheim and Irvine/Newport Beach branches were acquired in connection with our acquisition of Premier Commercial Bancorp and Premier Commercial Bank, N.A. in 2012 (as discussed below). The Irvine/Newport Beach branch was relocated in 2013 to ground floor space in a modern office complex into which the former 1st Enterprise Irvine branch was combined in February 2015.

Recent Developments

On November 30, 2014, the Company acquired 1st Enterprise Bank through a merger of 1st Enterprise Bank (“1st Enterprise”) with and into California United Bank. 1st Enterprise common stock was converted, at a ratio of 1.345 shares of CU Bancorp Stock for each share of 1st Enterprise common stock, into approximately 5.2 million shares of CU Bancorp common stock. In addition, CU Bancorp issued 16,400 shares of CU Bancorp Non-Cumulative Perpetual Preferred Stock, Series A (“CU Bancorp Preferred Stock”), to the U.S. Department of the Treasury (“Treasury”) as part of the Small Business Lending Fund program in exchange for 16,400 outstanding shares of 1st Enterprise Non-Cumulative Perpetual Preferred Stock, Series D. The 1st Enterprise merger added $833 million in assets to the Company.

K. Brian Horton (former President and Director of 1st Enterprise) became President and Director of the California United Bank and CU Bancorp following the merger; with David I. Rainer retaining his positions as Chairman of the Board and Chief Executive Officer of the Bank and the Company. Four former 1st Enterprise directors, David C. Holman, K. Brian Horton, Charles R. Beauregard and Jeffrey J. Leitzinger, Ph.D joined the Board of Directors of the Bank and the Company following the merger. Immediately following the transaction, the Company relocated its headquarters to the former Downtown Los Angeles, California headquarters of 1st Enterprise. Three 1st Enterprise branches located in Los Angeles, Ontario, and Irvine began operations as California United Bank effective December 1, 2014. In February 2015, the Irvine branch office was closed and converted to a loan production office, as recognition of the location of CUB’s Irvine/Newport Branch within 1.5 miles and on the same street.

Also in February 2015, the 1st Enterprise data processing system was combined with the Company’s data processing system to provide seamless service and information, as well as access to products and capabilities to all of the Company’s customers.

In December 2015, the Bank’s Simi Valley branch office was closed, although the facility is currently in use as an administrative facility. All accounts were transferred to the Bank’s Conejo Valley Regional Office in Thousand Oaks, California. The Simi Valley branch office was originally acquired in connection with the Bank’s acquisition of California Oaks State Bank on December 31, 2010 and was located adjacent to a retail center which includes other, larger banks.

Strategy

Our strategic objective is to be the premier community-based commercial bank in Southern California, with emphasis on the Greater Los Angeles/Orange/Ventura/San Bernardino and Riverside metropolitan and suburban business areas. The Bank’s value proposition is to provide a premier business banking experience through relationship banking, depth of expertise, resources and products. Our objective is to serve most segments of the business community and industries within our market area. We compete actively for deposits, and emphasize solicitation of core deposits, particularly noninterest-bearing deposits. In managing the top line of our business, we focus on making quality loans and gathering low-cost deposits to maximize our net interest margin and to support growth of a strong and stable loan portfolio.

 

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We maintain a strong community bank philosophy of focusing on and understanding the individualized banking needs of the businesses, professionals, entrepreneurs and other of our core constituents. We believe this focus allows us to be more responsive to our customers’ needs and provide a high level of personal service, which differentiates us from larger competitors. As a locally managed institution with strong ties to the community, our core customers are primarily comprised of businesses and individuals who prefer to build a banking relationship with a community bank that offers and combines financial strength with high quality, competitively priced banking products and personalized services. Our ability to provide relationship business banking and our community roots have been further strengthened in 2015 as we continued to consolidate the benefits of the merger with 1st Enterprise, which operated with a similar philosophy. Because of our identity and origin as a locally-owned and operated bank and our deep connection to the communities we serve, we believe that our level of personal service provides a competitive advantage over the larger in and out-of-state banks, which tend to consolidate decision-making authority outside local communities. We combine this with experienced, in-market relationship banking officers who provide the full suite of available products to customers. Most of our relationship managers live in their market areas and are active in their communities. These individuals and the Company’s marketing outreach are supplemented by the various Advisory Director Boards which are established in strategic regions of our market and which provide us with knowledge of the business environment in individual communities and access to local business leaders. We have established a Director Emeritus Board to retain the expertise and marked acumen of former members of our Board of Directors and the Boards of Premier Commercial Bank and 1st Enterprise. We are also active in charities and non-profit organizations in our market, with a philosophy which emphasizes outstanding corporate citizenship.

We generate our revenue primarily from the interest received on the various loan products and investment securities and fees from providing deposit services and making loans. In sales of the guaranteed portion of SBA loans, we typically receive gains on sale which is also non-interest income. The Bank relies on a foundation of locally generated and relationship-based deposits to fund loans. Our Bank has a relatively low cost of funds compared to its peers due to a high percentage of noninterest-bearing and low cost deposits to total deposits. Other than as discussed herein with regard to reciprocal CDARS® and the ICS™ deposits, we do not currently utilize brokered deposits. Our operations, similar to other financial institutions with operations predominately focused in Southern California, are significantly influenced by economic conditions in Southern California, including the strength of the commercial real estate market, the fiscal and regulatory policies of the federal and state governments and the regulatory authorities that govern financial institutions. See “Supervision and Regulation” below.

We expect to continue to opportunistically expand and grow our business by building on our business strategy and increasing market share in our key Southern California markets. We believe the demographics and growth characteristics within the communities we serve provide us with significant long-term opportunities for internal or organic growth as well as significant franchise enhancement opportunities to leverage our core competencies. We continue to believe that appropriate managed and chosen acquisitive growth and hiring will enable us to take advantage of the infrastructure and scalable platform that we have assembled. The Southern California market is dominated by large regional and national financial institutions. Consolidation continues to reduce the number of community based and locally managed banks in operation. We believe this consolidation has presented opportunities for both organic growth and acquisitions and that there is a significant lack of service provided to our target market by larger banks, as well as a lack of ability to service this segment by smaller banks. Through our personal service, and experienced community-based relationship managers and, along with a broad product line, we believe we can continue to achieve internal growth and attract customers from other larger financial institutions, as well as increase business from existing customers.

Products Offered

The Bank offers a full array of competitively priced commercial and personal loan and deposit products, as well as other services delivered directly or through strategic alliances with other service providers. The products offered are aimed at both business and individual customers in our target market.

 

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Loan Products

We offer a diversified mix of business loans encompassing the following loan products: (i) commercial and industrial loans; (ii) commercial real estate loans; (iii) construction loans; and (iv) SBA loans. We also offer home equity lines of credit “HELOCS”, to accommodate the needs of business owners and individual clients, as well as personal loans (both secured and unsecured) for that customer segment. In the event creditworthy loan customers’ borrowing needs exceed our legal lending limit, or house limit (an amount less than our legal limit which by policy is the highest amount we lend to one borrower, subject to certain exceptions which must be approved by the Chief Credit Officer and the Chief Executive Officer or the President and in limited circumstances (absence of approving officers) by the Chairman of the Board of Directors Loan Committee and the Chief Credit Officer or by the Chairman of the Board of Directors Loan Committee and the Chief Executive Officer or the President), we have the ability to sell participations in those loans to other banks. We encourage relationship banking, obtaining a substantial portion of each borrower’s banking business, including deposit accounts. Other than as set forth below, the Bank does not currently engage in consumer mortgage lending.

Commercial and Industrial Loans. These loans comprise a significant portion of our loan portfolio and are made to businesses located in the Southern California region and surrounding communities whose borrowing needs are generally $5.0 million or less. These loans are directly underwritten by us. These loans are made to finance operations, to provide working capital, or for specific purposes such as to finance the purchase of assets, equipment or inventory. Our commercial and industrial loans may be secured (other than by real estate) or unsecured. They may take the form of single payment, installment, equipment financing loans (secured by the underlying equipment) or lines of credit. These are generally based on the financial strength and integrity of the borrower and guarantor(s) and generally (with some exceptions) are collateralized by short term assets such as accounts receivable, inventory, equipment, real estate or a borrower’s other business assets. Commercial term loans are typically made to finance the acquisition of fixed assets, refinance short-term debt originally used to purchase fixed assets, or, in rare cases, to finance the purchase of businesses.

Construction, Miniperm Loans, Land Development and Other Land Loans. We originate and underwrite interim land and construction loans as well as miniperm loans, collateralized by first or junior deeds of trust on specific commercial properties which are principally in our primary market areas. Land loans are primarily for entitlements and infrastructure. We originate construction, renovation and conversion loans to businesses on commercial, residential and income producing properties, which generally have terms of less than two years. Miniperm loans finance the purchase and/or ownership of commercial properties, including owner-occupied and income producing properties. Miniperm loans are generally made with an amortization schedule ranging from 15 to 25 years with a lump sum balloon payment due in five to ten years. We do not engage in any large tract construction lending. Our construction loans are generally limited to experienced developers who are known to our management. We impose a limit on the loan to value ratio on all real estate lending. The project financed must be supported by current independent third party appraisals (which are reviewed by our appraisal department), environmental reviews where appropriate and other relevant information. We review each loan request and renewal individually.

Commercial and Residential Real Estate Loans. We originate and underwrite commercial property and multi-family loans principally within our service area. Typically, these loans are held in our loan portfolio and collateralized by the underlying property. The property financed must be supported by current independent third party appraisals at the date of origination (which are reviewed by our appraisal department) and other relevant information.

SBA Loans. SBA loans are made through programs designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loans. The Bank has been designated as an SBA Preferred Lender. Our SBA loans fall into three categories, loans originated under the SBA’s 7a Program (“7a Loans”), loans originated under the SBA’s 504 Program (“504 Loans”) and SBA “Express” Loans. SBA 7a Loans are commercial business loans generally made for the purpose of purchasing real estate to be occupied by the business

 

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owner, providing working capital, and/or purchasing equipment or inventory. SBA 504 Loans are collateralized by commercial real estate and are generally made to business owners for the purpose of purchasing or improving real estate for their use and for equipment used in their business.

SBA lending is subject to federal legislation that can affect the availability and funding of the program. From time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued funding of such programs, which could potentially have an adverse financial impact on our business.

Home Equity Lines of Credit “HELOCS”. We offer home equity lines of credit “HELOCS”, which are revolving lines of credit collateralized by senior or junior deeds of trust on residential real properties, the applicants for which are generally our individual clientele and the principals and executives of our business customers. They generally bear a rate of interest that floats with the Bank’s base rate or the prime rate and have maturities of five to ten years.

Personal Loans. We offer personal loans. Generally, these are unsecured, but they may be secured by collateral, including deposit accounts or marketable securities. The Bank does not currently originate first trust deed home mortgage loans or home improvement loans.

Deposit Products

As a full-service commercial bank, we focus deposit generation on relationship accounts, encompassing non-interest bearing demand, interest bearing demand, and money market. In order to facilitate generation of non-interest bearing demand deposits, we require, depending on the circumstances and the type of relationship, our borrowers to maintain deposit balances with us as a typical condition of granting loans. We also offer certificates of deposit and savings accounts. We service our attorney clients by offering Interest on Lawyers’ Trust Accounts, “IOLTA” in accordance with the requirements of the California State Bar. We market deposits by offering the convenience of third party “couriers” or, in appropriate cases armored vehicles, which contract with our customers, as well as a “remote deposit capture” product that allows deposits to be made via computer at the customer’s business location. We also offer customers “e-statements” that allows customers to receive statements electronically, which is more convenient and secure than receiving paper statements, in addition to reducing paper and being environmentally-friendly.

For customers requiring full FDIC insurance on certificates of deposit in excess of $250,000, we offer the CDARS® program, which allows the Bank to place the certificates of deposit with other participating banks to maximize the customers’ FDIC insurance. We receive a like amount of deposits from other participating financial institutions. In addition, we offer on a limited basis the ICS™ program, an insured deposit “sweep” program for demand deposits which is a product offered by Promontory Interfinancial Network, LLC, which is also the provider of the CDARS® program. Similarly to the CD’s discussed above, the Bank receives a like amount of deposits from other financial institutions and all customer deposits are insured by the FDIC. These “reciprocal” CDARS® and ICS deposits are classified as “brokered” deposits in regulatory reports and are currently the only brokered deposits utilized by the Bank; the Bank considers these deposits to be “core” in nature.

Investment Products

We compete with other larger and multi-state institutions for deposits. We have traditionally offered customers requiring either higher yields or more security investment sweeps into multiple types of money market funds provided by Dreyfus Corporation, a wholly owned subsidiary of Bank of New York Mellon Corporation, although this service has been temporarily discontinued. All of the funds invest in short-term securities and seek high current income, the preservation of capital and the maintenance of liquidity and each fund favors stability over growth. As a condition to access these products, we require the customer to maintain a certain level of demand deposits. Furthermore, we have also entered into “repurchase agreements” with sophisticated business

 

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customers, many of whom act as fiduciaries and require additional security above FDIC deposit insurance. These are essentially borrowings by the Bank, secured by U.S. Government and Agency securities from its investment portfolio. These are disclosed on the Bank’s financial statements as “Securities Sold under Agreements to Repurchase.” We also offer a “repo sweep” product whereby the deposits of qualifying customers are “swept” into repurchase agreements on a daily basis.

Through a third party arrangement with a registered representative of National Planning Corporation, member FINRA/SIPC we offer customers, upon request, the ability to purchase mutual funds, securities, annuities and limited types of insurance. The Bank considers this an ancillary product to its commercial banking activities.

Electronic Banking

While personalized, service-oriented banking is the cornerstone of our business plan, we use technology and the Internet as a secondary means for servicing customers, to compete with larger banks and to provide a convenient platform for customers to review and transact business. We offer sophisticated electronic or “internet banking” opportunities that permit commercial customers to conduct much of their banking business remotely from their home or business. However, our customers will always have the opportunity to personally discuss specific banking needs with knowledgeable bank officers and staff who are directly accessible in the branches and offices as well as by telephone and email.

The Bank offers multiple electronic banking options to its customers. It does not allow the origination of deposit accounts through online banking, nor does it accept loan applications through its online services. All of the Bank’s electronic banking services allow customers to review transactions and statements, review images of paid items, transfer funds between accounts at the Bank, place stop orders, pay bills and export to various business and personal software applications. CUB Online Commercial Banking also allows customers to initiate domestic wire transfers and ACH transactions, with the added security and functionality of assigning discrete access and levels of security to different employees of the client and division of functions to allow separation of duties, such as input and release.

Additionally, we offer Positive Pay, an antifraud service that allows businesses to review all issued checks daily and provides them with the ability to pay or reject any item. ACH Positive Pay is also offered to allow customers to review ACH transactions on a daily basis.

We also offer our internet banking customers an additional third party product designed to assist in mitigating fraud risk to both the customer and the Bank in internet banking and other internet activities conducted by the customer, at no cost to the customer.

The Bank has its own “home page” address on the World Wide Web as an additional means of expanding our market and providing banking services through the Internet. Members of the public can also communicate with us through the website. Our website address is: www.californiaunitedbank.com or www.cunb.com.

Other Services

In addition to providing a full complement of lending and deposit products and related services, we provide our customers with many additional services, either directly or through other providers, including, but not limited to, commercial and stand-by letters of credit, domestic and international wire transfers, on site Automated Teller Machines (“ATM’s”) and Visa® Debit Cards and ATM cards. We also provide bank-by-mail services, courier services, armored transport, lock box, cash vault, cash management services, telephone banking, night depositories, credit cards and international services (some of these through arrangements with third parties). Our customers may utilize ATM’s other than California United Bank’s ATM’s; we reimburse our customers for charges for utilization of other banks’ ATM’s up to a maximum of $20 per month.

 

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Competition

The banking business in California, and in our market area, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major financial institutions with many offices operating over a wide geographic area, including institutions based outside of California. The increasingly competitive environment faced by banks is a result primarily of changes in laws and regulations, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. We also compete for loans and deposits with other commercial banks, as well as with finance companies, credit unions, securities and brokerage companies, money market funds and other non-financial institutions. Larger financial institutions offer certain services (such as trust services or wealth management) that we do not offer directly (but some of which we offer indirectly through correspondent institutions or other relationships). These institutions also have the ability to finance extensive advertising campaigns, and have the ability to allocate investment assets to regions of highest yield and demand. By virtue of their greater total capitalization, such institutions also have substantially higher lending limits1 than we have. Customers may also move deposits into the equity and bond markets which also compete with us as an investment alternative.

Our ability to compete is based primarily on the basis of relationship, customer service and responsiveness to customer needs. Our “preferred lender” status with the Small Business Administration allows us to approve SBA loans faster than many of our competitors. We distinguish ourselves with the availability and accessibility of our senior management to customers and prospects. In addition, our knowledge of our markets and industries assists us in locating, recruiting and retaining customers. Our ability to compete also depends on our ability to continue to attract and retain our senior management and experienced relationship managers.

In order to compete with the major financial institutions in our primary service area, we use, to the fullest extent possible, the familiarity of our directors, relationship managers, officers and advisors within our market, its residents, businesses and the flexibility that our independent status will permit. This includes an emphasis on specialized services, local promotional activity, and personal contacts. We also work with the local Chambers of Commerce and professionals such as CPA’s and attorneys to invite local businesses to meet our relationship managers, management and directors. In addition, our directors and shareholders refer customers, as well as bring their own business to the Bank. We also have an active calling program whereby we contact targeted business prospects and solicit both deposit and loan business.

Employees

As of December 31, 2015, we had 265 full-time employees. Our employees are not represented by any union or other collective bargaining agreement.

Financial and Statistical Disclosure

Certain of our statistical information are presented within “Item 6. Selected Financial Data,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 7A. Quantitative and Qualitative Disclosure About Market Risk.” This information should be read in conjunction with the consolidated financial statements contained in “Item 8. Financial Statements and Supplementary Data.”

 

1  Legal lending limits to each customer are limited to a percentage of a bank’s shareholders’ equity, allowance for loan losses, and capital notes and debentures; the exact percentage depends upon the nature of the loan transaction.

 

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Executive Officers of the Registrant

The names, ages as of December 31, 2015, recent business experience and positions or offices held by each of the executive officers of the Company are as follows:

 

Name and Position Held

   Age     

Recent Business Experience

David I. Rainer, Chief Executive Officer and Chairman of the Board      58       Chief Executive Officer and Director of California United Bank since inception in 2005 and of CU Bancorp from inception in 2012. He became Chairman of the Board in June 2009. Mr. Rainer is a member of the Board of Directors of the Federal Reserve Bank of San Francisco, Los Angeles Branch.
K. Brian Horton, President and Director      55       President and Director of CU Bancorp and California United Bank since December 1, 2014. Prior to joining the Company, Mr. Horton was a Director and President of 1st Enterprise Bank (which was acquired by the Company on November 30, 2014). He was a co-founder of 1st Enterprise.
Anne A. Williams, Executive Vice President, Chief Operating Officer, Chief Credit Officer and Director of California United Bank      58       Executive Vice President and Chief Credit Officer of California United Bank since 2005 and of CU Bancorp since 2012. Chief Operating Officer of California United Bank since 2008. Director of California United Bank since January 2009.
Karen A. Schoenbaum, Executive Vice President and Chief Financial Officer      53       Executive Vice President and Chief Financial Officer of California United Bank since October 2009. Executive Vice President and Chief Financial Officer of CU Bancorp since 2012.
Anita Y. Wolman, Executive Vice President, Chief Administrative Officer, General Counsel and Corporate Secretary      64       Executive Vice President & General Counsel of California United Bank since January 2009 and of CU Bancorp since 2012. She has served as General Counsel of the Bank since its inception.

Supervision and Regulation

General

CU Bancorp and the Bank are subject to significant regulation and restrictions by federal and state laws and regulatory agencies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund, and secondarily for the stability of the U.S. banking system. It is not intended for the benefit of shareholders of financial institutions. The following discussion of statutes and regulations is a summary and does not purport to be complete nor does it address all applicable statutes and regulations. This discussion is also qualified in its entirety by reference to the full text and to the implementation and enforcement of the statutes and regulations referred to in this discussion.

Our profitability, like most financial institutions, is primarily dependent on interest rate differentials (“spreads”). In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on interest-earning assets, such as loans extended to customers and securities held in the investment portfolio, will comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on us cannot be predicted.

 

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Our business is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Federal Reserve implements national monetary policies through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The monetary policies of the Federal Reserve in these areas influence the growth of loans, investments, and deposits and also affect interest earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact of any future changes in monetary and fiscal policies on us cannot be predicted.

Initiatives may be proposed or introduced before Congress, the California Legislature, and other government bodies in the future that may further alter the structure, regulation, and competitive relationship among financial institutions and may subject us to increased supervision and disclosure, compliance costs and reporting requirements. In addition, the various bank regulatory agencies often adopt new rules and regulations and policies to implement and enforce existing legislation.

It cannot be predicted whether, or in what form, any such legislation or regulatory changes in policy may be enacted or the extent to which the business of the Bank would be affected thereby. In addition, the outcome of examinations, any litigation, or any investigations initiated by state or federal authorities may result in necessary changes in our operations and increased compliance costs.

Legislation and Regulatory Developments

Dodd Frank Wall Street Reform and Consumer Protection Act

The federal banking agencies continue to implement the remaining requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) as well as promulgating other regulations and guidelines intended to assure the financial strength and safety and soundness of banks and the stability of the U.S. banking system. Following on the implementation in 2014 and effectiveness in 2015 of new capital rules (“the New Capital Rules”) and the so called Volcker Rule restrictions on certain proprietary trading and investment activities, developments in 2015 included:

 

  (i) the extension of the Volcker Rule conformance period until July 21, 2016 and a possible additional extension until 2017 for banking institutions to conform existing investments, including certain collateralized loan obligations, and relationships, with certain exceptions, with “covered funds”, including hedge funds, private equity funds and certain other private funds. The Company and the Bank held no investment positions at December 31, 2015 which were subject to the final rule. — See “Volcker Rule” and has controls in place to ensure compliance with the Volcker Rule going forward.

 

  (ii) the shift in the stress testing cycle and reporting dates required by the banking agencies for institutions with total consolidated assets of $10 billion to $50 billion to assess the potential impact of different scenarios on earnings, losses, liquidity and capital. The Bank is not currently subject to these requirements.

 

  (iii) the implementation of an additional “capital conservation buffer” of 0.625% in 2016 for minimum risk-weighted asset ratios under the New Capital Rules. — See “Capital Adequacy” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources”.

 

  (iv) the effectiveness in October, 2015 of the final TILA-RESPA Integrated Disclosure (“TRID”) rules promulgated by the Consumer Financial Protection Bureau (“CFPB”), as required by the Dodd-Frank Act, which require new mortgage disclosures and training of staff for most mortgage loan applications The Bank typically does not make mortgage loans subject to the TRID requirements. — See “CFPB”.

 

  (v) the release by the Interagency Federal Financial Institutions Examinations Council (“FFIEC”) of a cybersecurity assessment tool for voluntary use by banks which provides guidelines to measure a bank’s individual risk profile” and “Cybersecurity maturity”.

 

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  (vi) the adoption of the Fixing America’s Surface Transportation Act (the “FAST Act”), highway legislation which contains financial services provisions, including (a) expanding the extended 18 months examination cycle for banks with up to $1 billion in assets; (b) deleting the annual privacy notice for banks which have not changed their policy or practices of sharing of information with third parties and (c) limiting the percentage payment of dividends on reserve bank stock held by banks with more than $10 billion in assets. The Bank, as a nonmember state bank, holds no reserve bank stock.

Not all of the rules required or expected to be implemented under the Dodd-Frank Act have been proposed or adopted, and certain of the rules that have been proposed or adopted under the Dodd-Frank Act are subject to phase-in or transitional periods. The Company believes that compliance with new regulations and other initiatives will likely negatively impact revenue and increase the cost of doing business.

In the exercise of their supervisory and examination authority, the regulatory agencies have emphasized corporate governance, capital planning and stress testing, enterprise risk management and other board responsibilities; anti-money laundering compliance; information technology adequacy; cyber security preparedness; vendor management and fair lending and other consumer compliance obligations.

Capital Adequacy Requirements

Bank holding companies and banks are subject to similar regulatory capital requirements administered by state and federal banking agencies. The basic capital rule changes in the New Capital Rules adopted by the federal bank regulatory agencies were fully effective on January 1, 2015, but many elements are being phased in over multiple future years. The risk-based capital guidelines for bank holding companies and, additionally for banks, prompt corrective action regulations (See “Prompt Corrective Action Provisions”), require capital ratios that vary based on the perceived degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, such as loans, and those recorded as off-balance sheet items, such as commitments, letters of credit and recourse agreements. The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risks and dividing its qualifying capital by its total risk-adjusted assets and off-balance sheet items. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting, and other factors. Bank holding companies and banks engaged in significant trading activity may also be subject to the market risk capital guidelines and be required to incorporate additional market and interest rate risk components into their risk-based capital standards. To the extent that the new rules are not fully phased in, the prior capital rules continue to apply.

The New Capital Rules revised the previous risk-based and leverage capital requirements for banking organizations to meet requirements of the Dodd-Frank Act and to implement the international Basel Committee on Banking Supervision Basel III agreements. Many of the requirements in the New Capital Rules and other regulations and rules are applicable only to larger or internationally active institutions and not to all banking organizations, including institutions currently with less than $10 billion or assets, which includes the Company and the Bank. Some of these rules and regulations include required annual stress tests for institutions with $10 billion or more assets and Enhanced Prudential Standards, Comprehensive Capital Analysis and Review requirements, capital plan and Resolution Plan or living will submissions, an additional countercyclical capital buffer, a supplementary leverage ratio and the Liquidity Coverage Ratio rule requiring sufficient high-quality liquid assets which may apply to institutions with $50 billion or more or $250 billion or more assets or which may be identified as Global Systematically Important Banking Institutions (G-SIBs).

Under the risk-based capital guidelines in place prior to the effectiveness of the New Capital Rules, which trace back to the 1988 Basel I accord, there were three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio. To be deemed “well capitalized” a bank must have a total risk-based capital ratio, a Tier 1 risk-based capital ratio, a leverage ratio and a common equity Tier 1 capital ratio of at least ten percent, eight percent, five percent and six and a half percent, respectively.

 

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The following table sets forth the regulatory capital guidelines and the actual capitalization levels for the Company and the Bank as of December 31, 2015:

 

     Adequately
Capitalized
    Well-
Capitalized
    CU Bancorp     California United Bank  
     (greater than or equal to)              

Total Risk-Based Capital Ratio

     8.0     10.0     11.54     11.17

Tier 1 Risk-Based Capital Ratio

     6.0     8.0     10.85     10.47

Leverage Ratio

     4.0     5.0     9.67     9.34

Common Equity Tier 1 Capital Ratio

     4.5     6.5     9.61     10.47

Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the volume and severity of problem loans. Federal regulators may, however, set higher capital requirements when a bank’s particular circumstances warrant and have required many banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well capitalized, in which case institutions may no longer be deemed well capitalized and may therefore be subject to restrictions on taking brokered deposits. As of December 31, 2015, both the Bank’s and the Company’s leverage capital ratios exceeded regulatory minimums.

The following are the New Capital Rules which became applicable to the Company and the Bank beginning January 1, 2015:

 

   

an increase in the minimum Tier 1 capital ratio from 4.00% to 6.00% of risk-weighted assets;

 

   

a new category and a required 4.50% of risk-weighted assets ratio is established for “common equity Tier 1” as a subset of Tier 1 capital limited to common equity;

 

   

a minimum non-risk-based leverage ratio is set at 4.00%;

 

   

changes in the permitted composition of Tier 1 capital to exclude trust preferred securities subject to certain grandfathering exceptions for organizations like the Company which were under $15 billion in assets as of December 31, 2009, mortgage servicing rights and certain deferred tax assets and include unrealized gains and losses on available for sale debt and equity securities unless the organization opts out of including such unrealized gains and losses, which election the Company made in 2015;

 

   

the risk-weights of certain assets for purposes of calculating the risk-based capital ratios are changed for high volatility commercial real estate acquisition, development and construction loans, certain past due non-residential mortgage loans and certain mortgage-backed and other securities exposures; and

 

   

an additional capital conservation buffer of 2.5% of risk weighted assets above the regulatory minimum capital ratios, which will be phased in until 2019 beginning at 0.625% of risk-weighted assets for 2016 and must be met to avoid limitations on the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses.

Including the capital conservation buffer of 2.5%, the New Capital Rules would result in the following minimum ratios to be considered well capitalized: (i) a Tier 1 risk-based capital ratio of 8.5%, (ii) a common equity Tier 1 capital ratio of 7.0%, (iii) a total risk-based capital ratio of 10.5%, and (iv) a leverage ratio of 5.0%. At December 31, 2015, the respective capital ratios of the Company and the Bank exceeded the minimum percentage requirements to be deemed “well-capitalized” for regulatory purposes — See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.”

While the New Capital Rules sets higher regulatory capital standards for the Company and the Bank, bank regulators may also continue their past policies of expecting banks to maintain additional capital beyond the new minimum requirements. The need to maintain more and higher quality capital, and greater liquidity going forward than historically has been required, and generally increased regulatory scrutiny with respect to capital

 

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levels, could limit the Company’s business activities, including lending, and its ability to expand, either organically or through acquisitions. It could also result in the Company being required to take steps to increase its regulatory capital that may be dilutive to shareholders or limit its ability to pay dividends or otherwise return capital to shareholders, or sell or refrain from acquiring assets, the capital requirements for which are not justified by the assets’ underlying risks. Moreover, U.S. federal banking agencies have been taking into account expectations regarding the ability of banks to meet these new requirements, including under stressed conditions, in approving actions that represent uses of capital, such as dividend increases, share repurchases and acquisitions.

See “Management’s Discussion and Analysis — Capital Resources.”

Management believes that as of December 31, 2015, the Company and the Bank would meet all requirements under the New Capital Rules applicable to them on a fully phased-in basis if such requirements were currently in effect.

Under Dodd Frank, trust preferred securities and cumulative perpetual preferred stock are excluded from Tier 1 capital, unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. CU Bancorp assumed approximately $12.4 million of junior subordinated debt securities issued to various business trust subsidiaries of Premier Commercial Bancorp and funded through the issuance of approximately $12.0 million of floating rate capital trust preferred securities. These junior subordinated debt securities were issued prior to May 19, 2010. Because CU Bancorp has less than $15 billion in assets, the trust preferred securities that CU Bancorp assumed from Premier Commercial Bancorp will continue to be included in Tier 1 capital, subject to a limit of 25% of Tier 1 capital elements.

The 16,400 shares of 1st Enterprise Non-Cumulative Perpetual Preferred Stock, Series D that were converted into the right to receive 16,400 shares of the Company’s Non-Cumulative Perpetual Preferred Stock, Series A in the merger of 1st Enterprise Bank with and into the Bank will continue to constitute Tier 1 capital, because non-cumulative perpetual preferred stock remained classified as Tier 1 capital following the enactment of Dodd Frank.

Securities Registration and Listing

CU Bancorp’s common stock is registered with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, CU Bancorp is subject to the information, proxy solicitation, insider trading, corporate governance, and other disclosure requirements and restrictions of the Exchange Act, as well as the Securities Act of 1933 (the “Securities Act”), both administered by the SEC. We are required to file annual, quarterly and other current reports with the SEC. The SEC maintains an internet site, http://www.sec.gov, at which all forms accessed electronically may be accessed. Our SEC filings are also available on our website at www.cubancorp.com.

Our securities are listed on the NASDAQ Capital Market and trade under the symbol “CUNB”. As a company listed on the NASDAQ Capital Market, CU Bancorp is subject to NASDAQ standards for listed companies. CU Bancorp is also subject to the Sarbanes-Oxley Act of 2002, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), provisions of the Dodd-Frank Act, and other federal and state laws and regulations which address, among other issues, requirements for executive certification of financial presentations, corporate governance requirements for board, audit and compensation committees and their members, as well as disclosure of controls and procedures and internal control over financial reporting, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. NASDAQ has also adopted corporate governance rules, which are intended to allow shareholders and investors to more easily and efficiently monitor the performance of companies and their directors.

 

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Corporate Governance and the JOBS Act

Pursuant to the Sarbanes-Oxley Act, publicly-held companies such as the Company have significant requirements, particularly in the area of external audits, financial reporting and disclosure, conflicts of interest, and corporate governance. The Dodd-Frank Act has added new corporate governance and executive compensation requirements, including mandated resolutions for public company proxy statements such as an advisory vote on executive compensation (more frequently referred to as “say-on-pay” votes) or executive compensation payable in connection with a merger (more frequently referred to as “say-on-golden parachute” votes) and new stock exchange listing standards.

However, CU Bancorp is an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012 ( the “JOBS Act”) and as a result, CU Bancorp is not yet subject to all of these regulations. CU Bancorp also will not be subject to certain requirements of Section 404 of the Sarbanes-Oxley Act, including the additional level of review of its internal control over financial reporting as may occur when outside auditors attest as to its internal control over financial reporting. The Bank is subject to an additional level of review of its internal controls over financial reporting under FDICIA.

Further, an emerging growth company may elect to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies, but must make such election when the company is first required to file a registration statement. Such an election is irrevocable during the period a company is an emerging growth company. At inception, CU Bancorp elected to take advantage of the benefits of this extended transition period to comply with new or amended accounting pronouncements in the same manner as a private company, although prior to 2013 there were no such accounting pronouncements. During 2013, however, the Company “opted-in” to compliance with new or amended accounting pronouncements in the same fashion as other public companies. As a result, for the year ended December 31, 2015, the Company’s financial statements are comparable to companies which complied with such new or revised accounting standards when originally effective.

CU Bancorp may remain an emerging growth company until the earlier of: (i) the last day of the fiscal year in which it has total annual gross revenues of $1.0 billion or more; (ii) the last day of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities pursuant to an effective registration statement under the Securities Act of 1933, which is fiscal year 2017; (iii) the date on which CU Bancorp has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or (iv) the date on which CU Bancorp is deemed to be a “large accelerated filer” under Securities and Exchange Commission regulations (generally, at least $700 million of voting and non-voting equity held by non-affiliates).

Dividends

It is the Federal Reserve’s policy that bank holding companies should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also the Federal Reserve’s policy that bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking subsidiaries. The Federal Reserve has also discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.

The terms of our Subordinated Debentures also limit our ability to pay dividends on our common stock. If we are not current in our payment of dividends in our payment of interest on our Subordinated Debentures, we may not pay dividends on our common stock.

Quarterly dividends are paid to the U.S. Department of the Treasury pursuant to the terms of the CU Bancorp Preferred Stock. The payment of preferred dividends does not require approval from the Federal Reserve and other regulatory agencies.

 

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California law additionally limits the Company’s ability to pay dividends. A corporation may make a distribution/dividend from retained earnings to the extent that the retained earnings exceed (a) the amount of the distribution plus (b) the amount, if any, of dividends in arrears on shares with preferential dividend rights. Alternatively, a corporation may make a distribution/dividend, if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution/dividend.

The Bank is a legal entity that is separate and distinct from its holding company. The Company is dependent on the performance of the Bank for funds which may be received as dividends from the Bank for use in the operation of the Company and the ability of the Company to pay dividends to shareholders. Subject to the regulatory restrictions which currently further restrict the ability of the Bank to declare and pay dividends, future cash dividends by the Bank will depend upon management’s assessment of future capital requirements, contractual restrictions, and other factors. When effective, the new minimum capital rule may restrict dividends by the Bank, if the additional capital conservation buffer is not achieved.

The powers of the board of directors of the Bank to declare a cash dividend to the Company is subject to California law, which restricts the amount available for cash dividends to the lesser of a bank’s retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still be paid, with the prior approval of the California Department of Business Oversight (“DBO”) in an amount not exceeding the greatest of (1) retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the net income of the bank for its current fiscal year.

Bank Holding Company Regulation

As a bank holding company, CU Bancorp is registered with and subject to regulation and periodic examination by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, or the BHCA. We are also required to file with the Federal Reserve periodic reports of our operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require. CU Bancorp is also a bank holding company within the meaning of Section 1280 of the California Financial Code and is subject to examination by, and may be required to file reports with, the DBO.

Federal Reserve policy historically has required bank holding companies to act as a source of financial strength to their bank subsidiaries and to commit capital and financial resources to support those subsidiaries in circumstances where it might not otherwise do so. Dodd-Frank codified this policy as a statutory requirement. Under this requirement, CU Bancorp is expected to commit resources to support the Bank, including at times when we may not be in a financial position to do so. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to such a commonly controlled institution.

Pursuant to the BHCA, we are required to obtain the prior approval of the Federal Reserve before we acquire all or substantially all of the assets of any bank or ownership or control of voting shares of any bank if, after giving effect to such acquisition, we would own or control, directly or indirectly, more than 5 percent of such bank. In connection with such transactions, the Federal Reserve is required to consider certain competitive, management, financial, anti-money laundering compliance and other impacts.

Under the BHCA, we may not engage in any business other than managing or controlling banks or furnishing services to our subsidiaries that the Federal Reserve deems to be so closely related to banking as “to be a proper incident thereto.” We are also prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5 percent of the voting shares of any company unless the company is engaged in banking activities or the Federal Reserve determines that the activity is so closely related to banking as to be a

 

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proper incident to banking. The Federal Reserve’s approval must be obtained before the shares of any such company can be acquired and, in certain cases, before any approved company can open new offices.

The BHCA and regulations of the Federal Reserve also impose certain constraints on the redemption or purchase by a bank holding company of its own shares of stock.

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance activities and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Pursuant to the Gramm-Leach-Bliley Act (“GLB Act”) and Dodd-Frank, in order to elect and retain financial holding company status, a bank holding company and all depository institution subsidiaries of a bank holding company must be well capitalized and well managed, and, except in limited circumstances, depository subsidiaries must be in satisfactory compliance with the Community Redevelopment Act (“CRA”), which requires banks to help meet the credit needs of the communities in which they operate. Failure to sustain compliance with these requirements or correct any non-compliance within a fixed time period could lead to divestiture of subsidiary banks or require all activities to conform to those permissible for a bank holding company. CU Bancorp has not elected financial holding company status and has not engaged in any activities determined by the Federal Reserve to be financial in nature or incidental or complementary to activities that are financial in nature.

Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by federal and state law in dealing with their holding companies and other affiliates, specifically under Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W (and similar state statutes). Subject to certain exceptions set forth in the Federal Reserve Act, a bank can make a loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate, accept securities of an affiliate as collateral for a loan or extension of credit to any person or company, issue a guarantee or accept letters of credit on behalf of an affiliate only if the aggregate amount of the above transactions of such subsidiary does not exceed 10 percent of such subsidiary’s capital stock and surplus on an individual basis or 20 percent of such subsidiary’s capital stock and surplus on an aggregate basis. Such transactions must be on terms and conditions that are consistent with safe and sound banking practices and on terms no less favorable than those available from unaffiliated persons. A bank holding company banking subsidiary may not purchase a “low-quality asset,” as that term is defined in the Federal Reserve Act, from an affiliate. Such restrictions also prevent a holding company and its other affiliates from borrowing from a banking subsidiary of the holding company unless the loans are secured by collateral. Dodd-Frank significantly expands the coverage and scope of the limitations on affiliate transactions within a banking organization.

The Federal Reserve has cease and desist powers over parent bank holding companies and non-banking subsidiaries where the action of a parent bank holding company or its non-financial institutions represent an unsafe or unsound practice or violation of law. The Federal Reserve has the authority to regulate debt obligations, other than commercial paper, issued by bank holding companies by imposing interest ceilings and reserve requirements on such debt obligations.

In addition to these explicit limitations, the federal regulatory agencies have general authority to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

 

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Subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring “control” of a bank or bank holding company. As a bank holding company, we are required to obtain prior approval from the Federal Reserve before (i) acquiring all or substantially all of the assets of a bank or bank holding company, (ii) acquiring direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless we own a majority of such bank’s voting shares), or (iii) merging or consolidating with any other bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s record of addressing the credit needs of the communities it serves, including the needs of low and moderate income neighborhoods, consistent with the safe and sound operation of the bank, under the CRA. In its most recent examination of its CRA activities the Bank received an “Outstanding” rating.

Stock Redemptions and Repurchases

It is an essential principle of safety and soundness that a banking organization’s redemption and repurchases of regulatory capital instruments, including common stock, from investors be consistent with the organization’s current and prospective capital needs. In assessing such needs, the board of directors and management of a bank holding company should consider the Dividend Factors discussed previously under “Dividends”. The risk-based capital rules directs bank holding companies to consult with the Federal Reserve before redeeming any equity or other capital instrument included in Tier 1 or Tier 2 capital prior to stated maturity, if such redemption could have a material effect on the level or composition of the organization’s capital base. Bank holding companies experiencing financial weaknesses, or that are at significant risk of developing financial weaknesses, must consult with the appropriate Federal Reserve supervisory staff before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration. Similarly, any bank holding company considering expansion, either through acquisitions or through new activities, also generally must consult with the appropriate Federal Reserve supervisory staff before redeeming or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration. In evaluating the appropriateness of a bank holding company’s proposed redemption or repurchase of capital instruments, the Federal Reserve will consider the potential losses that the holding company may suffer from the prospective need to increase reserves and write down assets from continued asset deterioration and the holding company’s ability to raise additional common stock and other Tier 1 capital to replace capital instruments that are redeemed or repurchased. A bank holding company must inform the Federal Reserve of a redemption or repurchase of common stock or perpetual preferred stock for cash or other value resulting in a net reduction of the bank holding company’s outstanding amount of common stock or perpetual preferred stock below the amount of such capital instrument outstanding at the beginning of the quarter in which the redemption or repurchase occurs. In addition, a bank holding company must advise the Federal Reserve sufficiently in advance of such redemptions and repurchases to provide reasonable opportunity for supervisory review and possible objection should the Federal Reserve determine a transaction raises safety and soundness concerns.

Regulation Y requires that a bank holding company that is not well capitalized or well managed, or that is subject to any unresolved supervisory issues, provide prior notice to the Federal Reserve for any repurchase or redemption of its equity securities for cash or other value that would reduce by 10% or more the holding company’s consolidated net worth aggregated over the preceding 12-month period.

Annual Reporting; Examinations

The holding company is required to file an annual report with the Federal Reserve, and such additional information as the Federal Reserve may require. The Federal Reserve may examine a bank holding company and any of its subsidiaries, and charge the company for the cost of such an examination.

 

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Imposition of Liability for Undercapitalized Subsidiaries

FDICIA requires bank regulators to take “prompt corrective action” to resolve problems associated with insured depository institutions. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company “having control of” the undercapitalized institution “guarantees” the subsidiary’s compliance with the capital restoration plan until it becomes “adequately capitalized.” For purposes of this statute, the holding company has control of the Bank. Under FDICIA, the aggregate liability of all companies controlling a particular institution is limited to the lesser of five percent of the depository institution’s total assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with applicable capital standards. FDICIA grants greater powers to bank regulators in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed distributions, or might be required to consent to a merger or to divest the troubled institution or other affiliates.

State Law Restrictions

As a California corporation, the holding company is subject to certain limitations and restrictions under applicable California corporate law. For example, state law restrictions in California include limitations and restrictions relating to indemnification of directors, distributions and dividends to shareholders (discussed above), transactions involving directors, officers or interested shareholders, maintenance of books, records, and minutes, and observance of certain corporate formalities.

Bank Regulation

The Bank, as a California state-chartered bank, is subject to primary supervision and examination by the DBO, as well as the FDIC. Under the Federal Deposit Insurance Act (“FDI Act”) and the California Financial Code, California state chartered commercial banks may generally engage in any activity permissible for national banks. Therefore, the Bank may form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking” activities commonly conducted by national banks in operating subsidiaries or subsidiaries of bank holding companies. Further, pursuant to amendments enacted by the GLB Act, California banks may conduct certain “financial” activities in a subsidiary to the same extent as may a national bank, provided the bank is and remains “well-capitalized,” “well-managed” and in satisfactory compliance with the CRA, which requires banks to help meet the credit needs of the communities in which they operate. The Bank currently has no financial subsidiaries.

Specific federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds, the nature and amount of and collateral for certain loans, borrowings, capital requirements, certain check-clearing activities, branching, and mergers and acquisitions.

California banks are also subject to various federal statutes and regulations including Federal Reserve Regulation O, Federal Reserve Act Sections 23A and 23B and Regulation W and similar state statutes, which restrict or limit loans or extensions of credit to “insiders,” including officers, directors and principal shareholders, and loans or extension of credit by banks to affiliates or purchases of assets from affiliates, including parent bank holding companies, except pursuant to certain exceptions and terms and conditions at least as favorable to those prevailing for comparable transactions with unaffiliated parties.

The Bank is a member of the Federal Home Loan Bank (“FHLB”) of San Francisco. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region and makes available loans or advances to its members. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. As an FHLB member, the Bank is required to own a certain amount of capital stock in the

 

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FHLB. At December 31, 2015, the Bank was in compliance with the FHLB’s stock ownership requirement and our investment in FHLB capital stock totaled $8 million.

In addition to the foregoing, the following summary identifies some of the more significant laws, regulations, and policies that affect our operations; it is not intended to be a complete listing or description of all laws and regulations that apply to us and is qualified in its entirety by reference to the applicable laws and regulations.

Supervision and Enforcement Authority

The federal and California regulatory structure gives the bank regulatory agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The regulatory agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before an institution’s capital becomes impaired. The guidelines establish operational and managerial standards generally relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees and benefits. Further, the regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. If, as a result of an examination, the DBO or the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, the DBO and the FDIC, and separately the FDIC, as insurer of the Bank’s deposits, have residual authority to:

 

   

Require affirmative action to correct any conditions resulting from any violation or practice;

 

   

Direct an increase in capital and the maintenance of higher specific minimum capital ratios, which may preclude the Bank from being deemed well-capitalized and restrict its ability to accept certain brokered deposits;

 

   

Restrict the Bank’s growth geographically, by products and services, or by mergers and acquisitions;

 

   

Enter into informal or formal enforcement orders, including memoranda of understanding, written agreements and consent or cease and desist orders or prompt corrective action orders to take corrective action and cease unsafe and unsound practices;

 

   

Require prior approval of senior executive officer or director changes; remove officers and directors and assess civil monetary penalties; and

 

   

Terminate FDIC insurance, revoke the charter and/or take possession of and close and liquidate the Bank or appoint the FDIC as receiver.

Prompt Corrective Action Authority

The Federal Deposit Insurance Act requires the federal bank regulatory agencies to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards, including requiring the prompt submission of an acceptable capital restoration plan. Depending on the bank’s capital ratios, the agencies’ regulations define five categories in which an insured depository institution will be placed: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At each successive lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends or executive bonuses. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal

 

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banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.

The prompt corrective action standards were also changed as the New Capital Rules ratios became effective. Under the new standards, in order to be considered well-capitalized, the bank will be required to meet the new common equity Tier 1 ratio of 6.5%, an increased Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged).

The federal banking agencies also may require banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well-capitalized, in which case institutions may no longer be deemed to be well-capitalized and may therefore be subject to certain restrictions such as taking brokered deposits.

The prompt corrective action standards were changed when the new capital rule ratios become effective as discussed under “Legislation and Regulatory Developments.”

Brokered Deposit Restrictions

Well-capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are generally not permitted to accept, renew, or roll over brokered deposits. CUB is eligible to accept brokered deposits but, except with regard to reciprocal deposits related to CDARS and ICS products, does not utilize brokered deposits at this time and has no current intention of doing so in the near term.

Loans to One Borrower

With certain limited exceptions, the maximum amount that a California bank may lend to any borrower at any one time (including the obligations to the bank of certain related entities of the borrower) may not exceed 25 percent (and unsecured loans may not exceed 15 percent) of the bank’s shareholders’ equity, allowance for loan loss, and any capital notes and debentures of the bank. The Bank by policy has lower “house limits” that it generally will not exceed without the approval of the Chief Credit Officer and the Chief Executive Officer or the President and in limited circumstances (absence of approving officers) by the Chairman of the Board of Directors Loan Committee and the Chief Credit Officer or by the Chairman of the Board of Directors Loan Committee and the CEO or the President.

Extensions of Credit to Insiders and Transactions with Affiliates

The Federal Reserve Act and Federal Reserve Regulation O place limitations and conditions on loans or extensions of credit to a bank or bank holding company’s executive officers, directors and principal shareholders (i.e., in most cases, those persons who own, control or have power to vote more than 10 percent of any class of voting securities); any company controlled by any such executive officer, director or shareholder; or any political or campaign committee controlled by such executive officer, director or principal shareholder.

Such loans and leases must comply with loan-to-one-borrower limits; require prior full board approval when aggregate extensions of credit to the person exceed specified amounts; must be made on substantially the same terms (including interest rates and collateral) and follow credit-underwriting procedures no less stringent than those prevailing at the time for comparable transactions with non-insiders; must not involve more than the normal risk of repayment or present other unfavorable features; and in the aggregate must not exceed the bank’s unimpaired capital and unimpaired surplus. The California Financial Code and DBO regulations adopt and apply Regulation O to the Bank and provide additional limitations on loans to affiliates.

 

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Affiliate Transactions

The Bank also is subject to certain restrictions imposed by Federal Reserve Act Sections 23A and 23B, as amended by Dodd-Frank, and Federal Reserve Regulation W on any extensions of credit by the Bank to, or the issuance of a guarantee or letter of credit on behalf of, any affiliates or insiders, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates or insiders. Affiliates include parent holding companies, sister banks, sponsored and advised companies, financial subsidiaries (but not operating subsidiaries or other permissible bank subsidiaries) and investment companies where the Bank’s affiliate serves as investment advisor. Sections 23A and 23B and Regulation W generally:

 

   

prevent any affiliates or insiders from borrowing from the bank unless the loans are secured by marketable obligations of designated amounts;

 

   

limit such loans and investments to or in any affiliate individually to 10 percent of the bank’s capital and surplus;

 

   

limit such loans and investments to all affiliates in the aggregate to 20 percent of the bank’s capital and surplus; and

 

   

require such loans and investments to or in any affiliate or insider to be on terms and under conditions substantially the same or at least as favorable to the bank as those prevailing for comparable transactions with non-affiliated parties.

Additional restrictions on transactions with affiliates may be imposed on the Bank under the FDI Act’s prompt corrective action regulations and the supervisory authority of the federal and state banking agencies.

Deposit Insurance

The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the Deposit Insurance Fund (the “DIF”) up to prescribed limits for each depositor. Pursuant to Dodd-Frank, the maximum deposit insurance amount has been permanently increased to $250,000 per depositor. As required by Dodd-Frank, the FDIC adopted a DIF restoration plan which became effective on January 1, 2011. Among other things, the plan: (1) raises the minimum designated reserve ratio, which the FDIC is required to set each year, to 1.35 percent and removes the upper limit on the designated reserve ratio and consequently on the size of the fund; (2) requires that the fund reserve ratio reach 1.35 percent by 2020; (3) eliminates the requirement that the FDIC provide dividends from the fund when the reserve ratio is between 1.35 percent and 1.5 percent; and (4) continues the FDIC’s authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.5 percent. The FDIC has set a long-term goal of getting its reserve ratio up to 2% of insured deposits by 2027.

In 2015 our FDIC insurance assessment was $1.5 million.

The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also result in the revocation of the bank’s charter by the DBO.

Depositor Preference

The Federal Deposit Insurance Act provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institutions, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails,

 

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insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured non-deposit creditors, with respect to any extensions of credit they have made to such insured depository institution.

Audit Requirements

The Bank is required to have an annual independent audit, alone or as a part of its bank holding company’s audit, and to prepare all financial statements in accordance with U.S. generally accepted accounting principles. The holding company has an annual independent audit; the Bank does not have a separate independent audit. CU Bancorp’s Audit and Risk Committee serves as the Audit Committee for the Bank and is composed entirely of independent directors. As required by NASDAQ, CU Bancorp has certified that its audit committee has adopted a formal written charter and meets the requisite number of directors, independence, and qualification standards. The combined Audit and Risk Committee meets NASDAQ and bank regulatory agency requirements.

Under the Sarbanes-Oxley Act, Management is required to assess the effectiveness of CU Bancorp’s internal control over financial reporting as of December 31, 2015. These assessments are included in Part II — Item 9A — “Controls and Procedures.”

Anti-Money Laundering and OFAC Regulation

A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The Bank Secrecy Act of 1970 (“BSA”) and subsequent laws and regulations require the Bank to take steps to prevent the use of the Bank or its systems from facilitating the flow of illegal or illicit money and to file suspicious activity reports.

An institution such as the Bank must provide anti-money laundering (“AML”) training to employees, designate an AML compliance officer and annually audit the AML program to assess its effectiveness. The federal regulatory agencies continue to issue regulations and new guidance with respect to the application and requirements of BSA and AML. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. Based on their administration by Treasury’s Office of Foreign Assets Control (“OFAC”), these are typically known as the “OFAC” rules.

Failure of a financial institution to maintain and implement adequate BSA, AML and OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

Community Reinvestment Act

Under the CRA, the Bank has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with CRA. CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities and to take that record into account in its evaluation of certain applications by such institution, such as applications for charters, branches and other deposit facilities, relocations, mergers, consolidations and acquisitions or engage in certain activities pursuant to the GLB Act. The Bank currently falls under the “large bank” category for CRA purposes. An unsatisfactory rating may be the basis for denying the application. Based on its most recent examination report in 2013, the Bank received an overall CRA rating of “Outstanding,” the highest rating possible.

 

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Consumer Compliance and Fair Lending Laws

The Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the USA PATRIOT Act of 2001, the Bank Secrecy Act, the Foreign Account Tax Compliance Act (effective 2013), the CRA, the Fair Debt Collection Practices Act, as amended by the Fair and Accurate Credit Transactions Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act, various state law counterparts, and the Consumer Financial Protection Act of 2010, which constitutes part of Dodd-Frank and is discussed in further detail below. The enforcement of Fair Lending laws has been an increasing area of focus for regulators. Fair Lending laws related to extensions of credit are included in The Equal Credit Opportunity Act and the Fair Housing Act, which prohibit discrimination in residential real estate and credit transactions based on race, color, national origin, sex, marital status, familial status, religion, age, physical ability, the fact that all or part of the applicant’s income derives from a public assistance program or the fact that the applicant has exercised any right under the Consumer Credit Protection Act. Under the Fair Lending laws, lenders can also be liable for policies which have a disparate impact on, or result in disparate treatment of, a protected class of applicants or borrowers. Lenders are required to have a Fair Lending program that is of sufficient scope to monitor the inherent Fair Lending risk of the institution and that appropriately remediates any issues which are identified. Generally, regulatory agencies are required to refer fair lending violations to the Department of Justice for investigation.

In addition, federal law and certain state laws (including California) currently contain client privacy protection provisions. These provisions limit the ability of banks and other financial institutions to disclose non-public information about consumers to affiliated companies and non-affiliated third parties. These rules require disclosure of privacy policies to clients and, in some circumstance, allow consumers to prevent disclosure of certain personal information to affiliates or non-affiliated third parties by means of “opt out” or “opt in” authorizations. Pursuant to the GLB Act and certain state laws (including California) companies are required to notify clients of security breaches resulting in unauthorized access to their personal information.

Dodd-Frank provided for the creation of the CFPB as an independent entity within the Federal Reserve with broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The bureau’s functions include investigating consumer complaints, conducting market research, rulemaking, supervising and examining bank consumer transactions, and enforcing rules related to consumer financial products and services. CFPB regulations and guidance apply to all financial institutions and banks with $10 billion or more in assets are subject to examination by the CFPB. Banks with less than $10 billion in assets, including the Bank, will continue to be examined for compliance by their primary federal banking agency.

In 2014, the CFPB adopted revisions to Regulation Z, which implement the Truth in Lending Act, pursuant to the Dodd-Frank Act, and apply to all consumer mortgages (except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans). The revisions mandate specific underwriting criteria for home loans in order for creditors to make a reasonable, good faith determination of a consumer’s ability to repay and establish certain protections from liability under this requirement for “qualified mortgages” meeting certain standards. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount; in particular, the revisions will prevent banks from making “no doc” and “low doc” home loans, as the rules require that banks determine a consumer’s ability to pay based in part on verified and documented information. Because we do not originate “no doc” or “low doc” loans, we do not believe this regulation will have a significant impact on our operations. As the Bank does not currently originate residential mortgages, it is not expected that the new CFPB rules with regard to residential mortgage lending will have a substantial impact on the Bank or its operations.

 

 

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Customer Information Security

The Federal Reserve and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. These guidelines require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We have adopted a customer information security program designed to comply with such requirements.

Privacy

The Gramm-Leach-Bliley Act of 1999 and the California Financial Information Privacy Act require financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the statutes require explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information and, except as otherwise required by law, prohibit disclosing such information except as provided in the Bank’s policies and procedures. CUB has implemented privacy policies addressing these restrictions which are distributed regularly to all existing and new customers of the Bank.

Available Information

We maintain an Internet website for CU Bancorp at www.cubancorp.com and a website for CUB at www.californiaunitedbank.com. At www.cubancorp.com and via the “Investor Relations” link at the Bank’s website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room, located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. You may obtain copies of the Company’s filings on the SEC site. These documents may also be obtained in print upon request by our shareholders to our Investor Relations Department.

We have adopted a written code of ethics that applies to all directors, officers and employees of the Company, including our principal executive officer and senior financial officers, in accordance with Section 406 of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and Exchange Commission promulgated thereunder. The code of ethics, which we call our Principles of Business Conduct and Ethics, is available on our corporate website, www.cubancorp.com in the section entitled “Corporate Governance.” In the event that we make changes in, or provide waivers from, the provisions of this code of ethics that the SEC requires us to disclose, we intend to disclose these events on our corporate website in such section. In the Corporate Governance section of our corporate website, we have also posted the charters for our Audit and Risk Committee and our Compensation, Nominating and Corporate Governance Committee. In addition, information concerning purchases and sales of our equity securities by our executive officers and directors is posted on our website.

Our Investor Relations Department can be contacted at CU Bancorp, 818 W. 7th Street, Suite 220, Los Angeles, CA, 90017, Attention: Investor Relations, telephone (818) 257-7700, or via e-mail to Kschoenbaum@cunb.com.

All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.

 

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ITEM 1A — RISK FACTORS

In addition to the other information on the risks we face and our management of risk contained in this Annual Report on Form 10-K or in our other SEC filings, the following are significant risks which may affect us. Events or circumstances arising from one or more of these risks could adversely affect our business, financial condition, operating results and prospects and the value and price of our common stock could decline. The risks identified below are not intended to be a comprehensive list of all risks we face and additional risks that we may currently view as not material may also impair our business operations and results.

Readers and prospective investors in our securities should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this report. This report is qualified in its entirety by these risk factors.

RISKS RELATED TO THE BANKING INDUSTRY

Difficult Economic and Market Conditions Have Adversely Affected Our Industry

Our financial performance generally, and the ability of borrowers to pay interest on and repay the principal of outstanding loans and the value of the collateral securing those loans, is highly dependent upon the business and economic conditions in the markets in which we operate and in the United States as a whole. Although the U.S. and local economy continues to show modest signs of improvement, certain sectors, remain soft, and unemployment and under-employment remain a concern. Local governments and many businesses are still experiencing serious difficulties. In addition, concerns about the performance of international economies, including the potential impact of European debt and economic conditions in Asia, can impact the economy here in the United States. These economic pressures on consumers and businesses may adversely affect our business, financial condition, results of operations and stock price. In particular, we may face the following risks in connection with these events:

 

   

Current deadlock in Congress and failure to address systemic issues.

 

   

Our banking operations are concentrated primarily in southern California. The State of California has experienced significant fiscal challenges the long-term effects of which on the State’s economy cannot be predicted. Further deterioration of the economic conditions in Southern California could impair borrowers’ ability to service their loans, decrease the level and duration of deposits by customers, and erode the value of loan collateral. These conditions could increase the amount of our non-performing assets and have an adverse effect on our efforts to collect our non-performing loans or otherwise liquidate our non-performing assets (including other real estate owned) on terms favorable to us, if at all, and could also cause a decline in demand for our products and services, or a lack of growth or a decrease in deposits, any of which may cause us to incur losses, adversely affect our capital, and hurt our business.

U.S. Financial Markets and Economic Conditions Could Adversely Affect Our Liquidity, Results of Operations and Financial Condition

In the past, the impact of adverse economic events has been particularly acute in the financial sector. Although the Company is well-capitalized and has not suffered any liquidity issues as a result of these events, the cost and availability of funds may be adversely impacted and the demand for our products and services may decline if the recovery from the recession does not continue. In view of the concentration of our operations and the collateral securing our loan portfolio in Southern California, we may be particularly susceptible to adverse economic conditions in the State of California.

Disruptions in the Real Estate Market Could Materially and Adversely Affect Our Business

In conjunction with the 2008 financial crisis, the real estate market experienced a slow-down due to negative economic trends and credit market disruption. While recovery in Southern California real estate appears to be

 

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continuing, the long-term impact cannot be quantified. At December 31, 2015, 51% and 7% of our total gross loans were comprised of commercial real estate and real estate construction loans, respectively. Of the commercial real estate loans, 43% was owner-occupied. Any downturn in the real estate market could materially and adversely affect our business because a significant portion of our loans are secured by real estate. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would be more likely to suffer losses on loans. Substantially all of our real property collateral is located in Southern California. If there is a decline in real estate values, especially in Southern California, the collateral for our loans would provide less security. Real estate values could be affected by, among other things, a decline in economic conditions, an increase in foreclosures, a decline in real property sale volumes, a significant increase in interest rates, increased levels of unemployment, drought, earthquakes, brush fires and other natural disasters particular to California.

Additional Requirements Imposed by the Dodd-Frank Act and Related Regulation Could Adversely Affect Us

The Dodd-Frank Act imposed additional regulatory requirements including the following:

 

   

the establishment of strengthened capital and liquidity requirements for banks and bank holding companies, including minimum leverage and risk-based capital requirements no less than the strictest requirements in effect for depository institutions as of the date of enactment;

 

   

the requirement by statute that bank holding companies serve as a source of financial strength for their depository institution subsidiaries;

 

   

enhanced regulation of financial markets, including the derivative and securitization markets, and the elimination of certain proprietary trading activities by banks;

 

   

additional corporate governance and executive compensation requirements; enhanced financial institution safety and soundness regulations,

 

   

revisions in FDIC insurance assessments; and

 

   

the creation of new regulatory bodies, such as the Bureau of Consumer Financial Protection and the Financial Services Oversight Counsel.

Some of the provisions remain subject to final rulemaking and/or implementation. Accordingly, we cannot fully assess its impact on our operations and costs.

Current and future legal and regulatory requirements, restrictions, and regulations, including those imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations. We may also be required to invest significant management attention and resources to evaluate and make changes required by the legislation and related regulations and may make it more difficult for us to attract and retain qualified executive officers and employees.

Significant Changes in Banking Laws or Regulations and Federal Monetary Policy Could Materially Affect Our Business

The banking industry is subject to extensive federal and state regulation, and significant new laws or changes in, or repeals of, existing laws may cause results to differ materially. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which existing regulations are applied. For further discussion of the regulation of financial services, see “Supervision and Regulation.”

 

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We cannot predict the substance or impact of any change in regulation, whether by regulators or as a result of legislation, or in the way such statutory or regulatory requirements are interpreted or enforced. Compliance with such current and potential regulation and scrutiny may significantly increase our costs, impede the efficiency of our internal business practices, require us to increase our regulatory capital and limit our ability to pursue business opportunities in an efficient manner.

We are subject to extensive laws, regulations and supervision, and may become subject to future laws, regulations and supervision, if any, that may be enacted, which could limit or restrict our activities, may hamper our ability to increase our assets and earnings, and could adversely affect our profitability.

Bank Clients Could Move Their Money to Alternative Investments Causing Us to Lose a Lower Cost Source of Funding

Demand deposits can decrease when clients perceive alternative investments, as providing a better risk/return tradeoff. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit accounts offered by other out-of-area financial institutions or non-bank service providers. Additionally, if the economy continues to trend upward, customers may withdraw deposits to utilize them to fund business expansion or equity investment. Moreover, should interest rates rise this may impact the Bank’s ability to maintain its current percentage of non-interest bearing deposits. When clients move money out of bank demand deposits, particularly non-interest bearing deposits, we lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income.

Several rating agencies publish unsolicited ratings of the financial performance and relative financial health of many banks, including CUB, based on publicly available data. As these ratings are publicly available, a decline in the Bank’s ratings may result in deposit outflows or the inability of the Bank to raise deposits in the secondary market as broker-dealers and depositors may use such ratings in deciding where to deposit their funds.

Our Business Is Subject To Interest Rate Risk and Fluctuations in Interest Rates Could Reduce Our Net Interest Income and Adversely Affect Our Business.

A substantial portion of our income is derived from the differential, or “spread,” between the interest earned on loans, investment securities and other interest-earning assets, and the interest paid on deposits, borrowings and other interest-bearing liabilities. The interest rate risk inherent in our lending, investing, and deposit taking activities is a significant market risk to us and our business. Income associated with interest earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by fluctuations in interest rates. The magnitude and duration of changes in interest rates, events over which we have no control, may have an adverse effect on net interest income. Prepayment and early withdrawal levels, which are also impacted by changes in interest rates, can significantly affect our assets and liabilities. Increases in interest rates may adversely affect the ability of our floating rate borrowers to meet their higher payment obligations, which could in turn lead to an increase in non-performing assets and net charge-offs.

Generally, the interest rates on our interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent, or on the same basis. Even assets and liabilities with similar maturities or periods of re-pricing may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in general market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. Certain assets, such as adjustable rate loans, may have features such as floors that limit changes in interest rates on a short-term basis.

After a seven year stimulus campaign known as quantitative easing, in December 2015 the Federal Reserve decided to raise short-term interest rates for the first time since the 2008 financial crisis. The Federal Reserve said in its December announcement that it “is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.”

 

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The Federal Reserve noted that some economic benchmarks were doing well, like continued job growth, more spending by businesses and consumers and the revival of the housing market; however, if the job market improves more quickly than expected or inflation rises, rate hikes could come sooner, or the Federal Reserve could wait longer if the job market or inflation slows. A persistent low interest rate environment likely will adversely affect the interest income we earn on loans and investments.

We seek to minimize the adverse effects of changes in interest rates by structuring our asset-liability composition to obtain the maximum spread. We use interest rate sensitivity analysis and a simulation model to assist us in managing asset-liability composition. However, such management tools have inherent limitations that impair their effectiveness.

The Fiscal and Monetary Policies Of the Federal Government and Its Agencies Could Have a Material Adverse Effect On Our Earnings.

The Federal Reserve regulates the supply of money and credit in the U.S. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. They can also materially decrease the value of financial assets we hold. Federal Reserve policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans, or could adversely create asset bubbles which result from prolonged periods of accommodative policy, and which in turn result in volatile markets and rapidly declining collateral values. Changes in Federal Reserve policies are beyond our control and difficult to predict.

Inflation and Deflation May Adversely Affect Our Financial Performance

The Consolidated Financial Statements and related financial data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation or deflation. The primary impact of inflation on our operations is reflected in increased operating costs. Conversely, deflation will tend to erode collateral values and diminish loan quality. Virtually all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the general levels of inflation or deflation

The Company Has Liquidity Risk

Liquidity risk is the risk that the Company will have insufficient cash or access to cash to satisfy current and future financial obligations, including demands for loans and deposit withdrawals, funding operating costs, and for other corporate purposes. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. The Company mitigates liquidity risk by establishing and accessing lines of credit with various financial institutions and having back-up access to the brokered Certificate of Deposits “CD’s” markets (which it has not utilized other than on a testing basis). Results of operations could be affected if the Company were unable to satisfy current or future financial obligations. See Part II, Item 7, “Liquidity” for more information.

 

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Severe Weather, Natural Disasters, Acts of War or Terrorism and Other External Events Could Significantly Impact the Company’s Business

Severe weather, drought, fire, natural disasters such as earthquakes, or tsunamis, acts of war or terrorism and other adverse external events could have a significant impact on the Company’s ability to conduct business. Such events could affect the stability of the Bank’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event in the future could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

The Financial Condition of Other Financial Institutions Could Adversely Affect Us

Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, and other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.

We Currently Hold a Significant Amount of Bank-Owned Life Insurance.

At December 31, 2015, we held $50 million of bank-owned life insurance (BOLI) on current and former senior employees and executives, with a cash surrender value of $50 million, as compared with $39 million of BOLI, with a cash surrender value of $39 million, at December 31, 2014. The eventual repayment of the cash surrender value is subject to the ability of the various insurance companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually monitor the financial strength of the various companies with whom we carry these policies. However, any one of these companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase in cash surrender value and penalties for early termination, both of which would adversely impact earnings.

RISKS RELATED TO CREDIT

We May Suffer Losses in Our Loan Portfolio Despite Our Underwriting Practices

We mitigate the risks inherent in our loan portfolio by adhering to sound and proven underwriting practices, managed by experienced and knowledgeable credit professionals. These practices include analysis of a borrower’s prior credit history, financial statements, tax returns, and cash flow projections, valuations of collateral based on reports of independent appraisers and verifications of liquid assets. Although we believe that our underwriting criteria is appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan loss.

The Repayment of Our Income Property Loans, Consisting of Commercial and Multi-family Real Estate Loans, May Be Dependent On Factors Outside Our Control or the Control of Our Borrowers.

We originate commercial and multi-family real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. Repayment of these loans is often dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover

 

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operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions.

For example, if the cash flow from the borrower’s project is reduced as a result of the financial impairment of a lessee who cannot pay the rent, or as a result of leases not being obtained or renewed in a timely manner or at all, the borrower’s ability to repay the loan may be impaired. Commercial and multi-family real estate loans also expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multi-family real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment.

If we foreclose on a commercial or multi-family real estate loan, our holding period for the collateral may be longer than for residential mortgage loans because there are fewer potential purchasers of the collateral. Additionally, commercial and multi-family real estate loans generally have relatively large balances to single borrowers or groups of related borrowers. Accordingly, if we make any errors in judgment in the collectability of our commercial and multi-family real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. As of December 31, 2015, our commercial and multi-family real estate loans totaled $1.0 billion, or 55 percent of our total loans and leases held-for-investment.

Repayment Of Our Commercial And Industrial Loans Is Often Dependent On The Cash Flows Of The Borrower, Which May Be Unpredictable, and The Collateral Securing These Loans May Not Be Sufficient To Repay the Loan In The Event Of Default

We make our commercial and industrial loans primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Collateral securing commercial and industrial loans are generally the working assets of a business that fluctuate in value, may depreciate over time, and could be difficult to appraise. For example, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect the amounts due from its customers, and for loans secured by inventory, the sale or liquidation of the inventory may be dependent not only on the quality of the inventory but also on finding a willing buyer. As of December 31, 2015, our commercial and industrial loans totaled $537 million, or 29 percent of our total loans and leases held-for-investment.

Supervisory Guidance on Commercial Real Estate Concentrations Could Restrict Our Activities and Impose Financial Requirements or Limits on the Conduct of Our Business

The Federal Regulatory Agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending intended to help ensure that institutions pursuing a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. Recently there have been concerns about commercial real estate lending and underwriting expressed by the agencies along with historical concerns that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. Existing guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending by providing supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks’ commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Our lending and risk management practices will be taken into account in supervisory evaluation of capital adequacy. Our commercial real estate portfolio (which includes owner-occupied nonresidential properties, construction, land development and other land, and

 

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multifamily residential properties) has increased from 58% at December 31, 2014 to 62% at December 31, 2015. If our risk management practices with regard to this portion of our portfolio are found to be deficient, it could result in increased reserves and capital costs or a need to reduce this type of lending which could negatively impact earnings.

Our Allowance for Loan Loss May Not be Adequate to Cover Actual Losses

We maintain an allowance for loan loss on organic loans, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of risk of losses within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for possible loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; limited loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio as well as levels utilized by peers. The determination of the appropriate level of the allowance for loan loss inherently involves a high degree of subjectivity and requires the Bank to make significant estimates of current credit risks and future trends, all of which may undergo material changes.

Deterioration in economic conditions affecting borrowers and collateral, new information regarding existing loans, identification of problem loans and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan loss. In addition, bank regulatory agencies periodically review the Bank’s allowance for loan loss and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan loss; the Bank will need additional provisions to increase the allowance for loan loss. Any increases in the allowance for loan loss will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Allowance for Loan Loss” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for loan loss.

On December 20, 2012, the FASB issued for public comment a Proposed ASU, Financial Instruments-Credit Losses (Subtopic 825-15) (the Credit Loss Proposal or “CECL), that would substantially change the accounting for credit losses under U.S. GAAP. Under U.S. GAAP’s current standards, credit losses are not reflected in the financial statements until it is probable that the credit loss has been incurred. Under the Credit Loss Proposal, an entity would reflect in its financial statements its current estimate of credit losses on financial assets over the expected life of each financial asset. On March 12, 2014, the FASB modified its plan, deciding that the model would apply only to instruments measured at amortized cost, as opposed to all financial products; distinguishing between debt securities and loans. The Credit Loss Proposal, if adopted as proposed, may have a negative impact on our reported earnings, capital, regulatory capital ratios, as well as on regulatory limits which are based on capital (e.g., loans to one borrower) since it would accelerate the recognition of estimated credit losses.

Liabilities from Environmental Regulations Could Materially and Adversely Affect Our Business and Financial Condition

In the course of the Bank’s business, the Bank may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. The Bank may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clear up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of any contaminated site, the Bank may be subject to common law claims by third parties based on damages, and costs resulting from environmental contamination emanating from the property. If the Bank ever becomes subject to significant

 

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environmental liabilities, the Company’s business, financial condition, liquidity, and results of operations could be materially and adversely affected.

California’s Current Drought may Impact the Economy

At December 31, 2015, California continued to experience a severe drought in all areas of the State. This extended drought has produced chronic and significant shortages to municipal and industrial, environmental, agricultural, and wildlife refuge water supplies and led to historically low groundwater levels. This recent dry hydrology has set many new Statewide records, including the driest four-year period of statewide precipitation (2012-2015). The exceptionally dry conditions in 2014 and 2015 resulted in low reservoir storages which created a challenge to deliver critical water supplies and provide adequate cold water for instream fisheries resources. January 2015 was the driest January on record for precipitation Statewide. 2015 also produced by far the lowest snowpack in the Sierra Nevada since records have been kept, and by some estimates based on tree-ring analysis, was the lowest over the past five centuries.

The cumulative effect of these sustained dry conditions is demonstrated in reduced natural runoff for streamflow, limited surface water storage in reservoirs, increased groundwater pumping, and significant effects to fish and wildlife populations.

While 2016 is forecasted to be a strong El Nino year, typically characterized by wet conditions, the ability to predict at this time whether 2016 will be wet or dry is limited. While we do not have a portfolio of agricultural loans which would be most impacted by the drought, the effects of increased costs for water and municipal restrictions on the level of use could have an adverse effect on the operations of some of our client base, the extent of which is yet unknown, and it is possible that the overall economy of California may be negatively affected by the impact of this drought and lack of water or the increased cost of the resource, which could have a negative impact on the Company’s results, loan quality and collateral.

RISK RELATED TO LEGISLATION AND REGULATION

Significant Changes in Banking Laws or Regulations and Federal Monetary Policy Could Materially Affect Our Business

The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws which may cause results to differ materially. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Parts of our business are also subject to federal and state securities laws and regulations. Significant changes in these laws and regulations would also affect our business. For further discussion of the regulation of financial services, including a description of significant recently-enacted legislation and other regulatory initiatives taken in response to the recent financial crisis, see “Supervision and Regulation”.

New Capital and Liquidity Standards Adopted By The U.S. Banking Regulators Have Resulted In Banks and Bank Holding Companies Needing To Maintain More And Higher Quality Capital And Greater Liquidity Than Has Historically Been The Case.

New capital standards, both as a result of the Dodd-Frank Act and the new U.S. Basel III-based capital rules have had a significant effect on banks and bank holding companies. The New Capital Rules require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. For additional information, see “Capital Requirements” under Part I, Item 1 “Business.”

The need to maintain more and higher quality capital, as well as greater liquidity, going forward than historically has been required, and generally increased regulatory scrutiny with respect to capital levels, could limit the Company’s business activities, including lending, and its ability to expand, either organically or through

 

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acquisitions. It could also result in being required to take steps to increase its regulatory capital that may be dilutive to shareholders or limit its ability to pay dividends or otherwise return capital to shareholders, or sell or refrain from acquiring assets, the capital requirements for which are not justified by the assets’ underlying risks.

We Face a Risk Of Noncompliance and Enforcement Action With the Bank Secrecy Act and Other Anti-Money Laundering Statutes and Regulations

The Bank Secrecy Act of 1970, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, a bureau of the U.S. Department of the Treasury, is authorized to impose significant civil money penalties for violations of those requirements and engages in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and U.S. Internal Revenue Service (“IRS”). We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures and systems are deemed deficient, we could be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including any acquisition plans which could be identified. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition, results of operations and prospects.

Limits on Our Ability to Lend

The Bank’s legal lending limit as of December 31, 2015 was approximately $65 million for secured loans and $39 million for unsecured loans. While we believe we can accommodate the needs of substantially all of our target market, we compete with many financial institutions with larger lending limits.

Increases in Deposit Insurance Premiums and Special FDIC Assessments Will Negatively Impact Our Earnings.

We may pay higher FDIC premiums in the future. The Dodd-Frank Act increased the minimum FDIC deposit insurance reserve ratio from 1.15 percent to 1.35 percent. The FDIC has adopted a plan under which it will meet this ratio by the statutory deadline of December 31, 2020. The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the minimum reserve ratio on institutions with assets less than $10.0 billion. The FDIC has not published a final rule implementing this offset. In addition to the minimum reserve ratio, the FDIC must set a designated reserve ratio. The FDIC has set a designated reserve ratio of 2.0, which exceeds the minimum reserve ratio.

As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution’s total assets minus its Tier 1 capital, instead of its deposits. Although our FDIC insurance premiums were initially reduced by these regulations, it is possible that our future insurance premiums will increase.

BUSINESS STRATEGY RISK

We Compete Against Larger Banks and Other Institutions

We face substantial competition for deposits and loans in our market place. Competition for deposits primarily comes from other commercial banks, savings institutions, thrift and loan associations, money market and mutual funds and other investment alternatives. Competition for loans comes from other commercial banks, savings institutions, mortgage banking firms, thrift and loan associations and other financial intermediaries. Our

 

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larger competitors, by virtue of their larger capital resources, have substantially greater lending limits than we have. They also provide certain services for their customers, including trust, wealth management and international banking, which we only are able to offer indirectly through our correspondent relationships. In addition, they have greater resources and are able to offer longer maturities and on occasion, lower rates on fixed rate loans as well as more aggressive underwriting.

There is Risk Related to Acquisitions

We have engaged in expansion through acquisitions and may consider acquisitions in the future. In November 2014, we completed the merger of 1st Enterprise with and into the Bank and in July 2012, we completed a merger with Premier Commercial Bancorp and its subsidiary Premier Commercial Bank, N.A. In December 2010, we acquired California Oaks State Bank. We cannot predict the frequency, size or timing of any future acquisitions, and we typically do not comment publicly on a possible acquisition until we have signed a definitive agreement. There can be no assurance that our future acquisitions, if any, will have the anticipated positive results.

There are risks associated with any such expansion. These risks include, among others, incorrectly assessing the asset quality of a bank acquired in a particular transaction, encountering greater than anticipated costs in integrating acquired businesses, facing resistance from customers or employees, being unable to profitably deploy assets acquired in the transaction or litigation resulting from circumstances occurring at the acquired entity prior to the date of acquisition or resulting from the acquisition. Our earnings, financial condition, and prospects after a merger or acquisition depend in part on our ability to successfully integrate the operations of the acquired company. We may be unable to integrate operations successfully or to achieve expected cost savings. Any cost savings which are realized may be offset by losses in revenues or other charges to earnings. To the extent we issue capital stock in connection with additional transactions, if any, these transactions and related stock issuances may have a dilutive effect on earnings per share and share ownership.

While our management is experienced in acquisition strategy and implementation, acquisitions involve inherent uncertainty and we cannot determine all potential events, facts and circumstances that could result in loss or give assurances that our investigation or mitigation efforts will be sufficient to protect against any such loss.

Although we have historically shown the ability to grow organically as well as through acquisition, our ability to grow may be limited if we cannot make acquisitions. We compete with other financial institutions with respect to proposed acquisitions.

Issuing Additional Shares Of Our Common Stock To Acquire Other Banks and Bank Holding Companies May Result In Dilution For Existing Shareholders and May Adversely Affect the Market Price Of Our Stock.

In connection with our growth strategy, we have issued, and may issue in the future, shares of our common stock to acquire additional banks or bank holding companies that may complement our organizational structure. Resales of substantial amounts of common stock in the public market and the potential of such sales could adversely affect the prevailing market price of our common stock and impair our ability to raise additional capital through the sale of equity securities. We usually must pay an acquisition premium above the fair market value of acquired assets for the acquisition of banks or bank holding companies. Paying this acquisition premium, in addition to the dilutive effect of issuing additional shares, may also adversely affect the prevailing market price of our common stock.

Impairment of Goodwill or Amortizable Intangible Assets Associated With Acquisitions Would Result In a Charge to Earnings

Goodwill is initially recorded at fair value and is not amortized, but is reviewed at least annually or more frequently if events or changes in circumstances indicate that the carrying value may not be fully recoverable. If

 

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our estimates of goodwill fair value change, we may determine that impairment charges are necessary. Estimates of fair value are determined based on a complex model using cash flows and company comparisons. If management’s estimates of future cash flows are inaccurate, the fair value determined could be inaccurate and impairment may not be recognized in a timely manner.

Our Decisions Regarding the Fair Value of Assets Acquired Could Be Different Than Initially Estimated Which Could Materially and Adversely Affect Our Business, Financial Condition, Results of Operations, and Future Prospects

We acquired portfolios of loans in the 1st Enterprise, Premier Commercial Bancorp and California Oaks State Bank acquisitions. Although these loans were marked down to their estimated fair value pursuant to ASC 805 Business Combinations, there is no assurance that the acquired loans will not suffer further deterioration in value resulting in additional charge-offs. The fluctuations in national, regional and local economic conditions may increase the level of charge-offs in the loan portfolios that we acquired from 1st Enterprise, Premier Commercial Bancorp and California Oaks State Bank and correspondingly reduce our net income. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition, even if other favorable events occur.

We May Need to Raise Capital to Support Growth or Acquisition

While the Company’s and the Bank’s capital levels are currently in excess of that required to be considered “well-capitalized” by regulatory agencies, organic growth or a strategic opportunity may require the Company to raise additional capital and/or to maintain capital levels in excess of “well-capitalized”.

We Are Dependent on Key Personnel and the Loss of One or More of Those Key Personnel May Materially and Adversely Affect Our Prospects

Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the California community banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing, compliance and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives and certain other employees.

The Company Plans to Continue to Grow and there are Risks Associated with Growth

The Company intends to increase deposits and loans and to continue to review strategic opportunities which could, if implemented, expand its businesses and operations. Continued growth may present operating and other problems that could adversely affect its individual or combined business, financial condition and results of operations. Its growth may place a strain on its administrative and operational, personnel and financial resources and increase demands on its systems and controls. Our ability to manage growth successfully will depend on its ability to attract qualified personnel and maintain cost controls and asset quality while attracting additional loans and deposits on favorable terms, as well as on factors beyond the our control, such as economic conditions and interest rate trends. If we grow too quickly and are not able to attract qualified personnel, control costs and maintain asset quality, this continued rapid growth could materially adversely affect our financial performance.

Our Deposit Portfolio Includes Significant Concentrations

As a business bank, we provide services to a number of customers whose deposit levels vary considerably and have a significant amount of seasonality. At December 31, 2015, 84 customers maintained balances (aggregating all related accounts, including multiple business entities and personal funds of business owners) in

 

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excess of $4 million. This amounted to $859 million or approximately 44 percent of the Bank’s total customer deposit base. These deposits can and do fluctuate substantially. While the loss of any combination of these depositors could have a material impact on the Bank’s results, the Bank expects, in the ordinary course of business, that these deposits will fluctuate and believes it is capable of mitigating this risk, as well as the risk of losing one of these depositors, through additional liquidity, and business generation in the future. However, if a significant number of these customers leave the Bank it could have a material adverse impact on the Bank.

If We Cannot Attract Deposits and Quality Loans Our Growth May Be Inhibited

Our ability to increase our asset base depends in large part on our ability to attract additional deposits at favorable rates. We seek additional deposits by providing outstanding customer service and offering deposit products that are competitive with those offered by other financial institutions in our markets. In addition, our income depends in large part in attracting quality loan customers and loans in which to invest the deposits.

SBA Lending is Subject to Government Funding Which can be Limited or Uncertain.

The Bank engages in SBA lending through programs designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loans. SBA lending is subject to federal legislation that can affect the availability and funding of the program. From time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued funding of such programs, which could potentially have an adverse financial impact on our business.

OPERATIONAL AND REPUTATIONAL RISK

We Have a Continuing Need to Adapt to Technological Changes

The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology allows us to:

 

   

serve our customers better;

 

   

increase our operating efficiency by reducing operating costs;

 

   

provide a wider range of products and services to our customers; and

 

   

attract new customers

Our future success will partially depend upon our ability to successfully use technology to provide products and services that will satisfy our customers’ demands for convenience, as well as to create additional operating efficiencies. Our larger competitors already have existing infrastructures or substantially greater resources to invest in technological improvements. We generally arrange for such services through service bureau arrangements or other arrangements with third parties.

Our Controls and Procedures Could Fail or Be Circumvented

Management regularly reviews and updates our internal controls, disclosure controls, procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met. Any failure or circumvention of our controls and procedures, and any failure to comply with regulations related to controls and procedures could adversely affect our business, results of operations and financial condition.

 

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The Occurrence of Fraudulent Activity, Breaches of Our Information Security or Cybersecurity-Related Incidents Could Have a Material Adverse Effect On Our Business, Financial Condition or Results of Operations.

As a financial institution, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our clients, denial or degradation of service attacks, and malware or other cyber-attacks. In recent periods, there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity, as well as attempts at security breaches and cybersecurity-related incidents in recent periods. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our clients may have been affected by these breaches, which increase their risks of identity theft, credit card fraud and other fraudulent activity that could involve their accounts with us.

Information pertaining to us and our clients is maintained, and transactions are executed, on the networks and systems of us, our clients and certain of our third party partners, such as our online banking or reporting systems. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our clients against fraud and security breaches and to maintain our clients’ confidence. Breaches of information security also may occur, and in infrequent cases have occurred, through intentional or unintentional acts by those having access to our systems or our clients’ or counterparties’ confidential information, including employees. Furthermore, our cardholders use their debit and credit cards to make purchases from third parties or through third party processing services. As such, we are subject to risk from data breaches of such third party’s information systems or their payment processors. Such a data security breach could compromise our account information. We may suffer losses associated with reimbursing our customers for such fraudulent transactions on customers’ card accounts, as well as for other costs related to data security breaches, such as replacing cards associated with compromised card accounts.

In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions, as well as the technology used by our clients to access our systems. Although we have developed, and continue to invest in, systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our clients; our loss of business and/or clients; damage to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability — any of which could have a material adverse effect on our business, financial condition and results of operations.

More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions. Such publicity may also cause damage to our reputation as a financial institution. As a result, our business, financial condition or results of operations could be adversely affected.

 

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We Could Be Liable For Breaches of Security In Our Online Banking Services. Fear of Security Breaches (including Cybersecurity breaches) Could Limit the Growth of Our Online Services

We offer various internet-based services to our clients, including online banking services. The secure transmission of confidential information over the Internet is essential to maintain our clients’ confidence in our online services. In certain cases, we are responsible for protecting customers’ proprietary information as well as their accounts with us. We have security measures and processes in place to defend against these cybersecurity risks but these cyber attacks are rapidly evolving (including computer viruses, malicious code, phishing or other information security breaches), and we may not be able to anticipate or prevent all such attacks, which could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information. Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology we use to protect client transaction data. In addition, individuals, groups or sovereign countries may seek to intentionally disrupt our online banking services or compromise the confidentiality of customer information with criminal intent. Although we have developed systems and processes that are designed to recognize and assist in preventing security breaches (and periodically test our security), failure to protect against or mitigate breaches of security could adversely affect our ability to offer and grow our online services, constitute a breach of privacy or other laws, result in costly litigation and loss of customer relationships, negatively impact the Bank’s reputation, and could have an adverse effect on our business, results of operations and financial condition. We may not be insured against all types of losses as a result of breaches and insurance coverage may be inadequate to cover all losses resulting from breaches of security. We may also incur substantial increases in costs in an effort to minimize or mitigate cyber security risks and to respond to cyber incidents.

Our Operations Could be Disrupted

The potential for operational risk exposure exists throughout our organization. Integral to our performance is the continued efficacy of our technology and information systems, operational infrastructure and relationships with third parties and our colleagues in our day-to-day and ongoing operations. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes, but is not limited to, operational or systems failures, disruption of client operations and activities, ineffectiveness or exposure due to interruption in third party support as expected, as well as, the loss of key colleagues or failure on the part of key colleagues to perform properly.

Managing Reputational Risk Is Important To Attracting and Maintaining Customers, Investors, and Employees

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable, illegal, or fraudulent activities of our customers. We have policies and procedures in place that seek to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors, and employees, costly litigation, a decline in revenues and increased governmental regulation.

We Rely On Communications, Information, Operating and Financial Control Systems Technology from Third-Party Service Providers

We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology, including customer relationship management, internet banking, website, general ledger, deposit, loan servicing and wire origination systems. Any failure or interruption or breach in security of these systems could result in failures or interruptions in our customer relationship management, internet banking, website, general ledger, deposit, loan servicing and/or wire origination systems.

 

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We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. The Company may not be insured against all types of losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from system failures or other disruptions. The occurrence of any failures or interruptions could have a material adverse effect on our business, financial condition, results of operations and cash flows. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

The Costs and Effects of Litigation, Investigations or Similar Matters, or Adverse Facts and Developments Related Thereto, Could Materially Affect Our Business, Operating Results and Financial Condition

We may be involved from time to time in a variety of litigation, investigations or similar matters arising out of our business. Our insurance may not cover all claims that may be asserted against it and indemnification rights to which we are entitled may not be honored, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation or investigation significantly exceed our insurance coverage, they could have a material adverse effect on our business, financial condition and results of operations. In addition, premiums for insurance covering the financial and banking sectors are rising. We may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms or at historic rates, if at all.

We May Incur Fines, Penalties And Other Negative Consequences From Regulatory Violations, Which Are Possibly Even Inadvertent Or Unintentional Violations.

We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations, but there can be no assurance that these will be effective. We may incur fines, penalties and other negative consequences from regulatory violations. We may suffer other negative consequences resulting from findings of noncompliance with laws and regulations, that may also damage our reputation, and this in turn might materially affect our business and results of operations.

Further, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there were in place at the time systems and procedures designed to ensure compliance.

We Are Subject to Losses Due to the Errors or Fraudulent Behavior of Employees or Third Parties.

We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical record keeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially adversely affected if one of our employees causes a significant operational breakdown or failure,

 

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either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. When we originate loans, we rely upon information supplied by loan applicants and third parties, including the financial and other information contained in the loan application package, property and collateral appraisals and valuations, and title information, if applicable, and employment and income documentation provided by third parties. If any of this information is misrepresented and such misrepresentation is not detected prior to loan funding, we generally bear the risk of loss associated with the misrepresentation. Any of these occurrences could result in a diminished ability of us to operate our business, potential liability to customers, reputational damage and regulatory intervention, which could negatively impact our business, financial condition and results of operations.

CU BANCORP RELATED RISKS

CU Bancorp is an Emerging Growth Company within the Meaning of the Securities Act. Certain Exemptions from Reporting Requirements that are Available to Emerging Growth Companies Could Make Its Common Stock Less Attractive to Investors.

The Company is an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012 ( the “JOBS Act”). CU Bancorp is eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, reduced disclosure about its executive compensation and omission of compensation discussion and analysis, and an exemption from the requirement of holding a non-binding advisory vote on executive compensation. CU Bancorp is also not subject to certain requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes- Oxley Act”), including the additional level of review of its internal control over financial reporting as may occur when outside auditors attest as to its internal control over financial reporting. As a result, its shareholders may not have access to certain information they may deem important.

Statutory Restrictions and Restrictions by Our Regulators on Dividends and Other Distributions from the Bank May Adversely Impact Us by Limiting the Amount of Distributions CU Bancorp May Receive

The ability of the Bank to pay dividends to us is limited by various regulations and statutes and our ability to pay dividends on our outstanding stock is limited by various regulations and statutes, including California law.

Various statutory provisions restrict the amount of dividends that the Bank can pay to us without regulatory approval.

The Federal Reserve Board has previously issued Federal Reserve Supervision and Regulation Letter SR-09-4 that states that bank holding companies are expected to inform and consult with the Federal Reserve supervisory staff prior to taking any actions that could result in a diminished capital base, including any payment or increase in the rate of dividends. Further, if we are not current in our payment of interest on our Subordinated Debentures, we may not pay dividends on our common stock.

If the Bank were to liquidate, the Bank’s creditors would be entitled to receive distributions from the assets of the Bank to satisfy their claims against the Bank before Bancorp, as a holder of the equity interest in the Bank, would be entitled to receive any of the assets of the Bank as a distribution or dividend.

The restrictions described above could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our Board of Directors. We have never paid cash dividends on our common stock.

 

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Our Series A Preferred Stock Diminishes the Cash Available To Our Common Shareholders.

On November 30, 2014, the Company entered into an Assignment and Assumption Agreement with the Secretary of the Treasury, pursuant to which the Company issued to the U.S. Treasury 16,400 shares of its Non-Cumulative Perpetual Preferred Stock, Series A, having a liquidation preference of $1,000 per share and the Company assumed the obligations of 1st Enterprise Bank in connection with its issuance of the same number and type of securities to the Treasury (which shares were retired in connection therewith). The issuance was pursuant to the Treasury’s SBLF program, a $30 billion fund established under the Small Business Jobs Act of 2010, which encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion.

The Series A Preferred Stock is entitled to receive non-cumulative dividends payable quarterly on each January 1, April 1, July 1 and October 1. The current dividend rate is fixed at the current rate of 1% through January 2016.

If the Series A Preferred Stock remains outstanding beyond January 2016, the dividend rate will be fixed at 9%. However, the dividend yield through November 30, 2018 approximates 7% as a result of business combination accounting. Depending on our financial condition at the time, this increase in the Series A Preferred Stock annual dividend rate could have a material adverse effect on our liquidity and could also adversely affect our ability to pay dividends on our common shares.

Our Accounting Policies and Processes Are Critical To How We Report Our Financial Condition and Results Of Operations. They Require Management To Make Estimates About Matters That Are Uncertain.

Accounting policies and processes are fundamental to how we record and report our financial condition and results of operations. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Several of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Pursuant to U.S. GAAP, we are required to make certain assumptions and estimates in preparing our financial statements, including in determining credit loss reserves, reserves related to litigation and the fair value of certain assets and liabilities, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses.

Management has identified certain accounting policies as being critical because they require management’s judgment to ascertain the valuations of assets, liabilities and contingencies. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, valuing an asset or liability, or recognizing or reducing a liability. We have established policies and control procedures that are intended to ensure these critical accounting estimates and judgments are controlled and applied consistently. Because of the uncertainty surrounding our judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust accounting policies or restate prior period financial statements. See “Critical Accounting Policies” in the MD&A and Note 1, “Significant Accounting Policies,” to the Consolidated Financial Statements in this Form 10-K.

Our Disclosure Controls and Procedures May Not Prevent or Detect All Errors or Acts of Fraud.

Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is accurately accumulated and communicated to management, and recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. We believe that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

 

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These inherent limitations include the realities that judgments in decision making can be faulty, that alternative reasoned judgments can be drawn, or that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected, which could result in a material weakness in our internal controls over financial reporting and the restatement of previously filed financial statements.

RISKS RELATED TO OUR STOCK

The Price of Our Common Stock May Be Volatile or May Decline

The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could adversely affect the market price of our common stock. Among the factors that could affect our stock price are:

 

   

actual or anticipated quarterly fluctuations in our operating results and financial condition;

 

   

publication of research reports and recommendations by financial analysts;

 

   

failure to meet analysts’ revenue or earnings estimates;

 

   

speculation in the press or investment community;

 

   

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

   

actions by institutional shareholders;

 

   

fluctuations in the stock price and operating results of our competitors;

 

   

general market conditions and, in particular, developments related to market conditions for the financial services industry;

 

   

proposed or adopted regulatory changes or developments;

 

   

anticipated or pending investigations, proceedings or litigation that involve or affect us;

 

   

deletion from a well known index; or

 

   

domestic and international economic factors unrelated to our performance.

The stock market and, in particular, the market for financial institution stocks, may experience significant volatility based on its history. As a result, the market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors identified above in “ Forward-Looking Statements.” A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.

The Holders Of Our Preferred Stock and Trust Preferred Securities Have Rights That Are Senior To Those Of Our Holders Of Common Stock And That May Impact Our Ability To Pay Dividends On Our Common Stock.

At December 31, 2015, our subsidiary trusts had outstanding $12.4 million of trust preferred securities. These securities are effectively senior to shares of common stock due to the priority of the underlying junior subordinated debt. As a result, we must make payments on our trust preferred securities before any dividends can

 

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be paid on our common stock; moreover, in the event of our bankruptcy, dissolution, or liquidation, the obligations outstanding with respect to our trust preferred securities must be satisfied before any distributions can be made to our shareholders. While we have the right to defer dividends on the trust preferred securities for a period of up to five years, if any such election is made, no dividends may be paid to our common or preferred shareholders during that time.

On November 30, 2014, the Company issued and sold 16,400 shares of Series A Preferred Stock to the Treasury in connection with the acquisition of 1st Enterprise Bank and in replacement for similar securities previously issued to the Treasury by 1st Enterprise pursuant to the Treasury’s SBLF program. The Series A Preferred Stock is entitled to receive non-cumulative dividends payable quarterly. Such dividends are not cumulative, but the Company may only declare and pay dividends on its common stock if it has declared and paid dividends for the current dividend period on the Series A Preferred Stock.

There Are Also Various Regulatory Restrictions On The Ability Of California United Bank To Pay Dividends Or Make Other Payments To CU Bancorp. In Particular, Federal And State Banking Laws Regulate The Amount Of Dividends That May Be Paid By California United Bank Without Prior Approval.

The Dodd-Frank Act requires federal banking agencies to establish more stringent risk-based capital guidelines and leverage limits applicable to banks and bank holding companies. In July 2013, the federal banking regulators issued final rules, which, among other things, are intended to implement in the United States the Basel Committee on Banking Supervision’s regulatory capital guidelines, including the reforms known as Basel III. The final Basel III capital standards issued by the FRB provide that distributions (including dividend payments and redemptions) on additional Tier 1 capital instruments may only be paid out of net income, retained earnings, or surplus related to other additional Tier 1 capital instruments. The final Basel III capital standards also introduce a new capital conservation buffer on top of the minimum risk-based capital ratios. Failure to maintain a capital conservation buffer above certain levels will result in restrictions on CU Bancorp’s ability to make dividend payments, redemptions or other capital distributions. These requirements, and any other new regulations or capital distribution constraints, could adversely affect the ability of California United Bank to pay dividends to CU Bancorp and, in turn, affect CU Bancorp’s ability to pay dividends on the CU Bancorp common stock and/or the CU Bancorp preferred stock.

The Federal Reserve Board may also, as a supervisory matter, otherwise limit CU Bancorp’s ability to pay dividends on the CU Bancorp common stock and/or the CU Bancorp preferred stock.

In addition, the CU Bancorp common stock and the CU Bancorp preferred stock may be fully subordinate to interests held by the U.S. government in the event of a receivership, insolvency, liquidation, or similar proceeding, including a proceeding under the “orderly liquidation authority” provisions of the Dodd-Frank Act.

CU Bancorp May Be Unable To, Or Choose Not To, Pay Dividends On Its Common Stock.

To date, CU Bancorp has not paid any cash dividends. Payment of stock or cash dividends in the future will depend on the following factors, among others:

 

   

CU Bancorp may not have sufficient earnings since its primary source of income, the payment of dividends to it by California United Bank, is subject to federal and state laws that limit the ability of California United Bank to pay dividends;

 

   

Federal Reserve Board policy requires bank holding companies to pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition;

 

   

Before dividends may be paid on CU Bancorp’s common stock in any year, payments must be made on its subordinated debentures or the CU Bancorp preferred stock issued in connection with the merger with 1st Enterprise;

 

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CU Bancorp’s board of directors may determine that, even though funds are available for dividend payments, retaining the funds for internal uses, such as expansion of its operations, is a better strategy;

If CU Bancorp fails to pay dividends, capital appreciation, if any, of its common stock may be the sole opportunity for gains on an investment in its common stock. In addition, in the event California United Bank becomes unable to pay dividends to it, CU Bancorp may not be able to service its debt, pay its other obligations or pay dividends on its common stock. Accordingly, CU Bancorp’s inability to receive dividends from its bank subsidiary could also have a material adverse effect on its business, financial condition and results of operations and the value of CU Bancorp common stock. Further, the terms of the CU Bancorp preferred stock that was exchanged for 1st Enterprise preferred stock in the merger limit CU Bancorp’s ability to pay dividends on its common stock.

CU Bancorp’s Stock Trading Volume May Not Provide Adequate Liquidity for Investors.

Although shares of CU Bancorp’s common stock are listed for trading on The NASDAQ Capital Market, the average daily trading volume in the common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of a sufficient number of willing buyers and sellers of the common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which CU Bancorp has no control. Given the daily average trading volume of CU Bancorp’s common stock, significant sales of the common stock in a brief period of time, or the expectation of these sales, could cause a decline in the price of its common stock.

ITEM 2 — PROPERTIES

The principal executive offices of the Company are located in Los Angeles, California, and are leased by the Company. All of our branch locations are leased from unaffiliated parties.

We believe that our existing facilities are adequate for our present purposes. The Company leases all its facilities and believes that if necessary, it could secure suitable alternative facilities on similar terms without adversely affecting operations. For additional information on properties, see Note 7 to the Consolidated Financial Statements included in Item 8 of this Form 10-K.

ITEM 3 — LEGAL PROCEEDINGS

The Company is not a defendant in any material pending legal proceedings and no such proceedings are known to be contemplated. No director, officer, affiliate, more than 5.0% shareholder of the Company or any associate of these persons is a party adverse to the Company or has a material interest adverse to the Company in any material legal proceeding. See Note 21 — Commitments and Contingencies to the Consolidated Financial Statements included in Item  8 of this 10-K.

ITEM 4 — MINE SAFETY DISCLOSURES

Not applicable

 

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PART II

ITEM 5 — MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock

The Company’s shares of common stock trade on the NASDAQ Capital Market under the symbol “CUNB”. The Company’s common stock began trading on the NASDAQ exchange on October 10, 2012, prior to that date the stock traded on the OTCBB.

There are 75,000,000 shares of common stock authorized at no par value, of which 17,175,389 and 16,683,856 shares were issued and outstanding at December 31, 2015 and 2014, respectively.

Preferred Stock

The Company has 50,000,000 shares of serial preferred stock authorized. At December 31, 2015 and 2014, the Company has 16,400 shares of Series A, non-cumulative perpetual preferred stock authorized, issued and outstanding. Each Series A preferred stock has a liquidation preference of $1,000 per share.

Sales Price Information

The information in the following table indicates the highest and lowest sales prices and volume of trading for the Company’s common stock for the two year period starting January 1, 2014 through December 31, 2015 for each quarterly period, and is based upon information provided by NASDAQ. The information does not include transactions for which no public records are available. The bid and ask trading prices of the stock may be higher or lower than the prices reported below. These prices are based on the actual prices of stock transactions without retail mark-ups, mark-downs, commissions or adjustments.

 

Period Ended

   High Price      Low Price      Approximate Number of
Shares Traded
 

March 31, 2014

   $ 18.50       $ 17.00         1,320,746   

June 30, 2014

   $ 19.50       $ 17.87         1,152,051   

September 30, 2014

   $ 19.50       $ 16.49         1,160,006   

December 31, 2014

   $ 22.45       $ 18.50         1,172,521   

March 31, 2015

   $ 23.00       $ 20.06         1,562,718   

June 30, 2015

   $ 23.00       $ 18.52         2,229,554   

September 30, 2015

   $ 23.48       $ 20.59         1,501,514   

December 31, 2015

   $ 27.66       $ 21.82         2,112,266   

According to information provided by NASDAQ, the most recent trade in our common stock prior to the date of finalizing this Form 10-K occurred on March 8, 2016 at a sales price of $22.51 per share. The high “bid” and low “asked” prices as of March 8, 2016 were $23.07 and $22.46, respectively.

Shareholders

As of March 8, 2016, the Company had 682 common shareholders of record, as listed with its transfer agent.

Dividends

In December 2015, the Board of Directors approved a quarterly dividend payment on the preferred stock in the amount of $41 thousand to the United States Department of the Treasury. To date, the Company has not paid any cash dividends on common stock.

 

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The applicable limitations on the payment of dividends are further discussed in Part II, Item 8, Financial Statements and Supplementary Data, Note 22, Regulatory Matters.

Common Stock Redemptions

In 2015 and 2014, the Company redeemed 44,311 and 26,317 shares respectively, of employee restricted stock to pay the tax obligation of employees in connection with their restricted stock vesting. The total value of the employee tax obligation remitted by the Company was $971 thousand and $471 thousand for the years ending December 31, 2015 and 2014, respectively. The Company purchased 4,451 shares of common stock at an average price per share of $25.82 during the 2015 fourth quarter.

The following table represents stock repurchases made by the Company as of December 31, 2015:

 

Purchase Dates:    Total
Number of Shares
Purchased (1)
     Average Price
Paid Per Share
 

January 1 – January 31

     6,530       $ 20.51   

February 1 – February 28

     328         20.89   

March 1 – March 31, 2015

     274         20.99   

April 1 – April 30, 2015

     7,297         21.05   

May 1 – May 31, 2015

     9,329         21.26   

June 1 – June 30, 2015

     229         21.65   

July 1 – July 31, 2015

     —           —     

August 1 – August 31, 2015

     8,091         22.56   

September 1 – September 30, 2015

     7,782         21.88   

October 1 – October 31, 2015

     —           —     

November 1 – November 30, 2015

     —           —     

December 1– December 31, 2015

     4,451         25.82   
  

 

 

    

Total

     44,311       $ 21.92   
  

 

 

    

 

(1) Shares repurchased pursuant to net settlement by employees, in satisfaction of minimum income tax withholding obligations incurred through the vesting of Company restricted stock. We did not repurchase any shares as part of publicly announced plans or programs.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2015 with respect to the shares of our common stock that may be issued under existing equity compensation plans. This table does not reflect the number of restricted shares of stock that have been issued under the Company’s equity compensation plans. The number of shares of common stock remaining available for future issuance under the equity compensation plans has been reduced by both stock option grants and restricted stock issued under the plans.

 

Plan

   Number of securities to
be issued upon exercise
of outstanding options
     Weighted-average
exercise price of
outstanding options
     Number of securities remaining available for
future issuance under equity compensation
plans (excluding securities reflected in the
second column)
 

Equity Compensation Plans Approved by Security Holders:

        

Employee Plan (2005) (terminated)

     108,180         18.63         —     

2007 Equity and Incentive Compensation Plan

     449,291         8.62         576,505   
  

 

 

    

 

 

    

 

 

 

Total

     557,471         10.57         576,505   
  

 

 

    

 

 

    

 

 

 

As part of the merger with 1st Enterprise, CU Bancorp adopted the 1st Enterprise Bank 2006 Stock Incentive Plan, as amended (“2006 Stock Incentive Plan”), as its own equity plan and all stock options granted by 1st Enterprise thereunder were fully vested and exercisable and were converted to CU Bancorp stock options on

 

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substantially the same terms but adjusted to reflect the exchange ratio set forth in the Merger Agreement. At December 31, 2015, there are 404,958 options outstanding under the 2006 Stock Incentive Plan with a weighted-average exercise price of $8.01 per share. No new equity awards will be granted under the 2006 Stock Incentive Plan.

Performance Graph

The following Performance Graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing. The following Performance Graph was prepared for the Company by SNL Financial.

The following graph compares the yearly percentage change in CU Bancorp’s cumulative total shareholder return on common stock, the cumulative total return of the NASDAQ Composite and the SNL Bank and Thrift Index.

The graph assumes an initial investment value of $100 on December 31, 2010. Points on the graph represent the performance as of the last business day of each of the quarters indicated. The graph is not necessarily indicative of future price performance.

 

LOGO

 

     Period Ending  

Index

   12/31/10      12/31/11      12/31/12      12/31/13      12/31/14      12/31/15  

CU Bancorp

     100.00         81.38         94.82         141.54         175.63         205.34   

NASDAQ Composite

     100.00         99.21         116.82         163.75         188.03         201.40   

SNL Bank and Thrift

     100.00         77.76         104.42         142.97         159.60         162.83   

 

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ITEM 6 — SELECTED FINANCIAL DATA

The following tables set forth selected historical financial data for CU Bancorp and its wholly-owned subsidiary, California United Bank, for the dates indicated (dollars in thousands except per share and other data). This data should be read in conjunction with CU Bancorp’s consolidated financial statements and related footnotes included in “ITEM 15 — EXHIBITS AND FINANCIAL STATEMENT SCHEDULES” contained herein. Historical information can be found in CU Bancorp’s Annual Report on Form 10-K for the years ended December 31, 2014 and 2013, and in reports filed by California United Bank with the FDIC for the previous years.

 

    As of and for the Years ended December 31,  
    2015     2014     2013     2012     2011  

Statements of Operations:

         

Interest income

  $ 90,142      $ 55,177      $ 50,846      $ 37,496      $ 28,756   

Interest expense

    2,723        1,922        2,079        1,797        1,316   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    87,419        53,255        48,767        35,699        27,440   

Provision for loan losses

    5,080        2,239        2,852        1,768        1,442   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    82,339        51,016        45,915        33,931        25,998   

Non-interest income

    11,730        7,709        6,518        3,961        2,362   

Non-interest expense

    (59,965     (43,385     (37,640     (34,500     (25,746
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income before provision for income tax expense

    34,104        15,340        14,793        3,392        2,614   

Provision for income tax expense

    12,868        6,432        5,008        1,665        1,147   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

  $ 21,236      $ 8,908      $ 9,785      $ 1,727      $ 1,467   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share and Other Data:

         

Basic earnings per share

  $ 1.21      $ 0.77      $ 0.93      $ 0.21      $ 0.23   

Diluted earnings per share

    1.18        0.75        0.90        0.21        0.22   

Book value per common share (1)

    16.87        15.78        12.45        11.68        11.63   

Tangible book value per common share (2)

    12.67        11.37        11.11        10.37        10.61   

Weighted average shares outstanding — Basic

    16,543,787        11,393,445        10,567,436        8,283,599        6,460,104   

Weighted average shares outstanding — Diluted

    16,983,221        11,667,733        10,836,861        8,410,749        6,635,862   

Balance Sheet Data:

         

Investment securities available-for-sale

  $ 315,785      $ 226,962      $ 106,488      $ 118,153      $ 114,091   

Investment securities held-to-maturity

    42,036        47,147        —          —          —     

Loans, net

    1,817,481        1,612,113        922,591        846,082        481,765   

Total Assets

    2,634,642        2,265,117        1,407,816        1,249,637        800,204   

Deposits

    2,286,791        1,947,693        1,232,423        1,078,076        690,756   

Non-interest bearing demand deposits

    1,288,085        1,032,634        632,192        543,527        381,492   

Securities sold under agreements to repurchase

    14,360        9,411        11,141        22,857        26,187   

Shareholders’ equity

    306,807        279,192        137,924        125,623        80,844   

Selected Financial Ratios

         

Return on Average Assets (3)

    0.80     0.59     0.74     0.16     0.19

Return on Average Equity (4)

    7.12     5.76     7.46     1.57     1.91

Equity to Assets Ratio (5)

    11.65     12.33     9.80     10.05     10.10

Tangible Common Equity to Tangible Asset Ratio (6)

    8.49     8.66     8.84     9.03     9.30

Loans to Deposits Ratio

    80.16     83.42     75.72     79.30     70.83

Efficiency Ratio (7)

    61     71     68     87     86

Net Interest Margin (8)

    3.83     3.79     3.96     3.63     3.70

Asset Quality

         

Allowance for loan loss as a % of total loans

    0.86     0.78     1.14     1.03     1.53

Allowance for loan loss as a % of total loans (excluding loans acquired in acquisitions)

    1.25     1.39     1.50     1.54     1.75

Non Performing Assets to Total Assets

    0.09     0.21     0.68     1.09     1.19

Net Charge-offs/(Recoveries) to Average Loans

    0.12     0.02     0.12     0.08     (0.04 )% 

Regulatory Capital Ratios (California United Bank)

         

Total Risk-Based Capital Ratio

    11.2     11.2     12.0     11.6     12.1

Tier 1 Risk-Based Capital Ratio

    10.5     10.6     11.0     10.7     11.0

Common Equity Tier 1 Ratio

    10.47     —       —       —       —  

Tier 1 Leverage Ratio

    9.3     12.4     8.9     8.6     9.5

Regulatory Capital Ratios (CU Bancorp Consolidated)

         

Total Risk-Based Capital Ratio

    11.5     11.6     12.8     12.4  

Tier 1 Risk-Based Capital Ratio

    10.9     11.0     11.8     11.5  

Common Equity Tier 1 Ratio

    9.61     —       —       —    

Tier 1 Leverage Ratio

    9.7     12.9     9.6     9.1  

 

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(1) Book value per common share is calculated by dividing shareholders’ equity of $307 million by the total number of shares issued and outstanding (17,175,389 shares) at December 31, 2015, shareholder’s equity of $279 million by the total number of shares issued and outstanding (16,683,856 shares) at December 31, 2014, shareholder’s equity of $138 million by the total number of shares issued and outstanding (11,081,364 shares) at December 31, 2013, shareholders’ equity of $126 million by the total number of shares issued and outstanding (10,758,674 shares) at December 31, 2012, and shareholders’ equity of $81 million by the total number of shares issued and outstanding (6,950,098 shares) at December 31, 2011.
(2) Tangible book value per common share is calculated by dividing tangible shareholders’ equity (shareholders’ equity less preferred stock, goodwill and core deposit and leasehold right intangibles) of $218 million by the total number of shares issued and outstanding (17,175,389 shares) at December 31, 2015, $190 million by the total number of shares issued and outstanding (16,683,856 shares) at December 31, 2014, $123 million by the total number of shares issued and outstanding (11,081,364 shares) at December 31, 2013, $112 million by the total number of shares issued and outstanding (10,758,674 shares) at December 31, 2012, $74 million by the total number of shares issued and outstanding (6,950,098 shares) at December 31, 2011.
(3) Return on average assets is calculated by dividing the net income available to common shareholders by the average assets for the period. The average assets used in the calculations were based on the daily average outstanding assets of the Company for the years ending December 31, 2015, 2014, 2013, 2012, and 2011.
(4) Return on average equity is calculated by dividing the Company’s net income available to common shareholders by the average equity for the period. The average equity used in the calculations was based on the daily average outstanding equity of the Company for the years ending December 31, 2015, 2014, 2013, 2012, and 2011.
(5) The equity to assets ratio was calculated by dividing the Company’s shareholders’ equity by the Company’s total assets for the period.
(6) The tangible common equity to assets ratio was calculated by dividing the Company’s shareholders’ equity less preferred stock, goodwill and core deposit and leasehold right intangibles by the Company’s total tangible assets (total assets less goodwill and core deposit and leasehold right intangibles) for the appropriate period.
(7) The efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net.
(8) The net interest margin represents net interest income as a percent of interest earning assets.

 

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ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes in trends relating to the Company’s financial condition, results of operation, liquidity and interest rate sensitivity. This section should be read in conjunction with the disclosures regarding “Forward-Looking Statements” set forth in “Item I. Business — Forward-Looking Statements,” as well as the discussion set forth in “Item 8. Financial Statements and Supplementary Data,” including the notes to consolidated financial statements.

OVERVIEW

The year 2015 marks the first full year of combined operations since the merger of California United Bank (wholly owned subsidiary of CU Bancorp) and 1st Enterprise. The integration of the two high-performing business banks was virtually seamless and the expected synergies of the merger have been realized, as seen in both the improvement in the Company’s efficiency ratio and double-digit loan growth in every quarter of 2015. The Company had built an efficient low-cost funding platform with an average cost of deposits of 0.10% and an average deposit balance of $254 million per branch. Throughout 2015 the Company remained focused on its relationship-based, business-banking franchise model, which resulted in increases in total commercial and industrial lines of credit commitments for the year. While commercial and industrial loan balances outstanding are up only modestly for the year, this reflects the Company’s commitment to disciplined underwriting, which management believes it helps to maintain a low risk profile throughout the business cycle. Loan growth during the year primarily came from owner-occupied nonresidential properties, an important element of the Company’s business banking focus, and from the construction lending portfolio, which is largely made up of long-term relationships with the Bank.

The comparability of financial information for the full year of 2015 to 2014 is affected by the Company’s acquisition of 1st Enterprise effective November 30, 2014. Operating results for 2014 include the combined operations of both entities from December 1, 2014.

Full Year 2015 Highlights

 

   

Net income in 2015 was $21 million, up 138% from the prior year

 

   

Return on average tangible common equity of 9.86%, up from 6.50% in the prior year

 

   

Efficiency ratio improved to 61%, from 71% in the prior year

 

   

Tangible book value per share increased $1.30 per share, or 11.4% to $12.67 from the prior year

 

   

Total assets increased $370 million from 2014 to $2.6 billion

 

   

Record net organic loan growth of $349 million in 2015

 

   

Total loans increased to $1.8 billion, an increase of $208 million or 13% from 2014

 

   

Total deposits at year-end 2015 increased to $2.3 billion, an increase of $339 million or 17% from 2014

 

   

Non-interest bearing demand deposits were 56% of total deposits at year-end 2015

 

   

Year-end average deposits per branch increased to $254 million

 

   

Nonperforming assets to total assets decreased to 0.09%, at December 31, 2015, from 0.21% at December 31, 2014

 

   

Continued status as well-capitalized, the highest regulatory category

 

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Total assets increased $370 million or 16% from December 31, 2014 to $2.6 billion, mainly due to deposit growth of $339 million and earnings of $21 million. Loan growth during 2015 was primarily in Owner-Occupied Nonresidential Properties of $69 million, Other Nonresidential Property loans of $52 million and Construction, Land Development and Other Land of $54 million. Deposit growth during the same period consisted of an increase in non-interest bearing demand deposits of $255 million, interest bearing deposits of $55 million and money markets and savings deposits of $35 million. At December 31, 2015 and December 31, 2014, non-interest bearing deposits represented 56% and 53% of total deposits, respectively.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions, and other subjective assessments. We have identified several accounting policies that, due to judgments, estimates, and assumptions inherent in those policies, are essential to an understanding of our consolidated financial statements. These policies relate to the accounting for business combinations, evaluation of goodwill for impairment, methodologies that determine our allowance for loan loss, the valuation of impaired loans, the classification and valuation of investment securities, accounting for derivatives financial instruments and hedging activities, and accounting for income taxes.

We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessment, are as follows:

Business Combinations

The Company has a number of fair value adjustments recorded within the consolidated financial statements at December 31, 2015 that relate to the business combinations with California Oaks State Bank “COSB”, Premier Commercial Bancorp “PC Bancorp” and 1st Enterprise Bank “1st Enterprise” on December 31, 2010, July 31, 2012 and November 30, 2014, respectively. These fair value adjustments includes goodwill, fair value adjustments on loans, core deposit intangible assets, other intangible assets, fair value adjustments to acquired lease obligations, fair value adjustments to certificates of deposit and fair value adjustments on derivatives. The assets and liabilities acquired through acquisitions have been accounted for at fair value as of the date of the acquisition. The goodwill that was recorded on the transactions represented the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized and is reviewed for impairment on October 1st of each year. If an event occurs or circumstances change that result in the Company’s fair value declining below its book value, the Company would perform an impairment analysis at that time.

Based on the Company’s 2015 goodwill impairment analysis, no impairment to goodwill has occurred. The Company is a sole reporting unit for evaluation of goodwill.

The core deposit intangibles on non-maturing deposits, which represent the intangible value of depositor relationships resulting from deposit liabilities assumed through acquisitions, are being amortized over the projected useful lives of the deposits. The weighted average remaining life of the core deposit intangible is estimated at approximately 7.9 years at December 31, 2015. Core deposit intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

 

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Loans acquired through acquisition are recorded at fair value at acquisition date without a carryover of the related Allowance. Purchased Credit Impaired (“PCI”) loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable, at the acquisition date, that the Company will not be able to collect all contractually required amounts. When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans. The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans. For non-PCI loans, loan fair value adjustments consist of an interest rate premium or discount on each individual loan and are amortized to loan interest income based on the effective yield method over the remaining life of the loans. Subsequent decreases to the expected cash flows for both PCI and non-PCI loans will result in a provision for loan losses.

Allowance for Loan Loss

The allowance for loan loss (“Allowance”) is established by a provision for loan losses that is charged against income, increased by charges to expense and decreased by charge-offs (net of recoveries). Loan charge-offs are charged against the Allowance when management believes the collectability of loan principal becomes unlikely. Subsequent recoveries, if any, are credited to the Allowance.

The Allowance is an amount that management believes will be adequate to absorb estimated charge-offs related to specifically identified loans, as well as probable loan charge-offs inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. Management carefully monitors changing economic conditions, the concentrations of loan categories and collateral, the financial condition of the borrowers, the history of the loan portfolio, as well as historical peer group loan loss data to determine the adequacy of the Allowance. The Allowance is based upon estimates, and actual charge-offs may vary from the estimates. No assurance can be given that adverse future economic conditions will not lead to delinquent loans, increases in the provision for loan losses and/or charge-offs. These evaluations are inherently subjective, as they require estimates that are susceptible to significant revisions as conditions change. In addition, regulatory agencies, as an integral part of their examination process, may require additions to the Allowance based on their judgment about information available at the time of their examinations. Management believes that the Allowance as of December 31, 2015 is adequate to absorb known and probable losses in the loan portfolio.

The Allowance consists of specific and general components. The specific component relates to loans that are categorized as impaired. For loans that are categorized as impaired, a specific allowance is established when the realizable value of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on the type of loan and historical charge-off experience adjusted for qualitative factors.

While the general allowance covers all non-impaired loans and is based on historical loss experience adjusted for the various qualitative factors as discussed in Note 6 — Loans, the change in the Allowance from one reporting period to the next may not directly correlate to the rate of change of nonperforming loans for the following reasons:

 

   

A loan moving from the impaired performing status to an impaired non-performing status does not mandate an automatic increase in allowance. The individual loan is evaluated for a specific allowance requirement when the loan moves to the impaired status, not when the loan moves to non-performing status. In addition, the impaired loan is reevaluated at each subsequent reporting period. Impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

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Not all impaired loans require a specific allowance. The payment performance of the borrower may require an impaired classification, but the collateral evaluation may support adequate collateral coverage. For a number of impaired loans in which borrower performance is in question, the collateral coverage may be sufficient. In those instances, neither a general allowance nor a specific allowance is assessed.

Investment Securities

The Company currently classifies its investment securities under the available-for-sale and held-to-maturity classification. Under the available-for-sale classification, securities can be sold in response to certain conditions, such as changes in interest rates, changes in the credit quality of the securities, when the credit quality of a security does not conform with current investment policy guidelines, fluctuations in deposit levels or loan demand or need to restructure the portfolio to better match the maturity or interest rate characteristics of liabilities with assets. Securities classified as available-for-sale are accounted for at their current fair value rather than amortized cost. Unrealized gains or losses are excluded from net income and reported as a separate component of accumulated other comprehensive income (loss) included in shareholders’ equity. Under the held-to-maturity classification, if the Company has the intent and the ability at the time of purchase to hold these securities until maturity, they are classified as held-to-maturity and are stated at amortized cost.

As of each reporting date, the Company evaluates the securities portfolio to determine if there has been an other-than-temporary impairment (“OTTI”) on each of the individual securities in the investment securities portfolio. If it is probable that the Company will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an OTTI shall be considered to have occurred. Once an OTTI is considered to have occurred, the credit portion of the loss is required to be recognized in current earnings, while the non-credit portion of the loss is recorded as a separate component of shareholders’ equity.

In estimating whether an other-than-temporary impairment loss has occurred, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) the current liquidity and volatility of the market for each of the individual security categories, (iv) the current slope and shape of the Treasury yield curve, along with where the economy is in the current interest rate cycle, (v) the spread differential between the current spread and the long-term average spread for that security category, (vi) the projected cash flows from the specific security type, (vii) any financial guarantee and financial condition of the guarantor and (viii) the intent and ability of the Company to retain its investment in the issue for a period of time sufficient to allow for any anticipated recovery in fair value.

If it’s determined that an OTTI exists on a debt security, the Company then determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Company will recognize the amount of the OTTI in earnings equal to the difference between the security’s fair value and its adjusted cost basis. If neither of the conditions is met, the Company determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss is the portion of the other-than-temporary impairment that is recognized in earnings and is a reduction to the cost basis of the security. The portion of total impairment related to all other factors is included in other comprehensive income. Significant judgment is required in this analysis that includes, but is not limited to assumptions regarding the collectability of principal and interest, future default rates, future prepayment speeds, the amount of current delinquencies that will result in defaults and the amount of eventual recoveries expected on the underlying collateral.

Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the interest method over the expected maturity term of the securities. For mortgage-backed securities, the

 

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amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. The amount of prepayments varies from time to time based on the interest rate environment and the rate of turnover of mortgages. The Company’s investment in the common stock of the FHLB, Pacific Coast Bankers Bank (“PCBB”) and The Independent Banker’s Bank (“TIB”) is carried at cost and is included in other assets on the accompanying consolidated balance sheets.

Derivative Financial Instruments and Hedging Activities

All derivative instruments (interest rate swap contracts) were recognized on the consolidated balance sheet at their current fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and hedged item related to the hedged risk are recognized in earnings. Accounting Standards Codification (“ASC”) Topic 815 establishes the accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. ASC Topic 815 requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

On the date a derivative contract is entered into by the Company, the Company will designate the derivative contract as either a fair value hedge (i.e. a hedge of the fair value of a recognized asset or liability), a cash flow hedge (i.e. a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability), or a stand-alone derivative (i.e. an instrument with no hedging designation). For a derivative designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as other non-interest income. At inception and on an ongoing basis, the derivatives that are used in hedging transactions are evaluated as to how effective they are in offsetting changes in fair values or cash flows of hedged items.

The Company will discontinue hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting change in the fair value of the hedged item, the derivative expires or is sold, is terminated, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company will continue to carry the derivative on the balance sheet at its fair value (if applicable), but will no longer adjust the hedged asset or liability for changes in fair value. The adjustments of the carrying amount of the hedged asset or liability will be accounted for in the same manner as other components of the carrying amount of that asset or liability, and the adjustments are amortized to interest income over the remaining life of the hedged item upon the termination of hedge accounting.

Income Taxes

The Company provides for current federal and state income taxes payable and for deferred taxes that result from differences between financial accounting rules and tax laws governing the timing of recognition of various income and expense items. The Company recognizes deferred income tax assets and liabilities for the future tax effects of such temporary differences based on the difference between the financial statement and tax bases of the existing assets and liabilities using the statutory rate expected in the years in which the differences are expected to reverse. The effect on deferred taxes of any enacted change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established to the extent necessary to reduce the

 

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deferred tax asset to the level at which it is “more likely than not” that the tax assets or benefits will be realized. Realization of tax benefits for deductible temporary differences and loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryback and carryforward period and that current tax law will allow for the realization of those tax benefits.

The Company is required to account for uncertainty associated with the tax positions it has taken or expects to be taken on past, current and future tax returns. Where there may be a degree of uncertainty as to the tax realization of an item, the Company may only record the tax effects (expense or benefits) from an uncertain tax position in the consolidated financial statements if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. The Company does not believe that it has any material uncertain tax positions taken to date that are not more likely than not to be realized. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

Recent Accounting Pronouncements

See Note 1, Summary of Significant Accounting Policies in Item 8, Financial Statements and Supplementary Data.

RESULTS OF OPERATIONS

Key Profitability Measures

The following table presents key profitability measures for the periods indicated and the dollar and percentage changes between the periods (dollars in thousands, except per share data):

 

     Years Ended December 31,     Increase / (Decrease)  
     2015     2014     $     %  

Net Income Available to Common Shareholders

   $ 20,062      $ 8,784      $ 11,278        128.4
  

 

 

   

 

 

   

 

 

   

Earnings per share

        

Basic

   $ 1.21      $ 0.77      $ 0.44        57.1

Diluted

   $ 1.18      $ 0.75      $ 0.43        57.3

Return on average assets (1)

     0.80     0.59     0.21     35.6

Return on average tangible common equity (2)

     9.86     6.50     3.36     51.7

Net interest rate spread (3)

     3.69     3.62     0.07     1.9

Net interest margin (4)

     3.83     3.79     0.04     1.1

Efficiency ratio (5)

     61.00     71.00     (10.00)     (14.1)

 

     Years Ended December 31,     Increase / (Decrease)  
     2014     2013     $     %  

Net Income Available to Common Shareholders

   $ 8,908      $ 9,785      $ (877)        (9.0)
  

 

 

   

 

 

   

 

 

   

Earnings per share

        

Basic

   $ 0.77      $ 0.93      $ (0.16)        (17.2)

Diluted

   $ 0.75      $ 0.90      $ (0.15)        (16.7)

Return on average assets (1)

     0.59     0.74     (0.15)     (20.3)

Return on average tangible common equity (2)

     6.50     8.34     (1.84)     (22.1)

Net interest rate spread (3)

     3.62     3.78     (0.33)     (8.4)

Net interest margin (4)

     3.79     3.96     (0.17)     (4.3)

Efficiency ratio (5)

     71.00     68.00     3.00     4.4

 

(1) Return on average assets is calculated by dividing the net income available to common shareholders by the average assets for the period.
(2) Return on average tangible common equity is calculated by dividing the Company’s net income available to common shareholders by the average tangible common equity for the period. See the tables for return on average tangible common equity calculation and reconciliation to average common equity.

 

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(3) Net interest rate spread represents the yield earned on average total interest earning assets less the rate paid on average total interest bearing liabilities.
(4) The net interest margin represents net interest income as a percent of interest bearing assets
(5) Efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net.

The Company’s increase in total assets over the last 10 years is due to the Company’s execution of its primary business model focusing on businesses, non-profits, entrepreneurs, professionals and investors, supplemented by the mergers with 1st Enterprise in November 2014, PC Bancorp in July of 2012 and COSB in December of 2010. The Company is organized and operated as a single reporting segment, principally engaged in commercial business banking. At December 31, 2015, the Company conducted its lending and deposit operations through nine branch offices, located in the counties of Los Angeles, Ventura, Orange and San Bernardino in Southern California. The consolidated financial statements, as they appear in this document, represent the grouping of revenue and expense items as they are presented to executive management for use in strategically directing the Company’s operations. The Company’s growth in loans and deposit liabilities during 2015 was the direct result of the successful execution of its high touch strategy with an emphasis on maintaining strong ties to existing customer relationships, as well as developing new customer relationships. New customer relationships are developed from referrals from regional advisory board members, current customers, and the local business communities the Company actively supports. In addition, the Company targets potential customers whose current bank may be unable to provide the same level of customer support that the customer has come to desire.

Operations Performance Summary

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Net income available to common shareholders for the year ended December 31, 2015 was $20 million, or $1.18 per diluted share, compared to $8.8 million, or $0.75 per diluted share for the year ended December 31, 2014. The $11 million increase, or 128%, was primarily due to $31 million increase in net interest income after provision for loan losses and a $4.0 million increase in non-interest income, offset by a $17 million increase in non-interest expense and a $6.4 million increase in provision for income tax expense. These increases were primarily related to the successful execution of the merger with 1st Enterprise at the end of November 2014 coupled with a strong net organic loan growth of $349 million in 2015. Salaries and employee benefits increased $10 million in 2015, due to a full year of a larger employee base as a result of the merger. Occupancy expense also increased $1.7 million for the same period due to a full year of additional locations. Further, core deposit intangible amortization increased $1.3 million in 2015, mainly due to a full year of amortization of a $7.1 million core deposit intangible recognized from the 1st Enterprise merger. Provision for loan losses also increased $2.8 million, as a result of strong organic loan growth and net charge-offs of $2.0 million in 2015. Merger expenses were lower by $1.8 million compared to 2014. Each of these increases and or decreases is more fully described below.

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

Net income available to common shareholders for the year ended December 31, 2014 was $8.9 million, or $0.75 per diluted share, compared to $9.8 million, or $0.90 per diluted share for the year ended December 31, 2013. The $877 thousand decrease, or 9.0%, was primarily due to $3.5 million ($2.6 million, net of taxes) in charges related to the 1st Enterprise merger. Operating results for the full year of 2014 include the combined operations of both California United Bank and 1st Enterprise Bank from December 1, 2014. Despite charges related to the merger during 2014, net interest income increased $4.5 million, provision for loan losses decreased $613 thousand, non-interest income increased $1.2 million, offset by an increase in non-interest expense of $2.2 million excluding the $3.5 million merger-related charge discussed above. The increase in the tax provision of $1.4 million and a higher effective tax rate is primarily due to the inclusion of significant non-deductible merger costs in 2014 related to the 1st Enterprise merger which were not subject to the same percentage of tax deductibility. Each of these increases and or decreases is more fully described below.

 

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Average Balances, Interest Income and Expense, Yields and Rates

Years Ended December 31, 2015 and 2014

The following table presents the Company’s average balance sheets, together with the total dollar amounts of interest income and interest expense and the weighted average interest yield/rate for the periods presented. All average balances are daily average balances (dollars in thousands).

 

    Years Ended December 31,  
    2015     2014  
    Average
Balance
    Interest
Income/
Expense
    Average
Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
    Average
Yield/
Rate
 

Interest earning Assets:

           

Deposits in other financial institutions

  $ 289,364      $ 1,087        0.37     265,076      $ 926        0.34

Investment securities (1)

    287,436        4,518        1.57     129,841        2,369        1.82

Loans (2)

    1,707,654        84,537        4.95     1,010,030        51,882        5.14
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest earning assets

    2,284,454        90,142        3.95     1,404,947        55,177        3.93
   

 

 

       

 

 

   

Non-interest earning assets

    210,736            95,818       
 

 

 

       

 

 

     

Total assets

  $ 2,495,190          $ 1,500,765       
 

 

 

       

 

 

     

Interest bearing Liabilities:

           

Interest bearing transaction accounts

  $ 258,444      $ 413        0.16   $ 153,327      $ 278        0.18

Money market and savings deposits

    690,065        1,652        0.24     390,185        963        0.25

Certificates of deposit

    61,275        190        0.31     61,048        216        0.35
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest bearing deposits

    1,009,784        2,255        0.22     604,560        1,457        0.24

Securities sold under agreements to repurchase

    13,966        30        0.21     13,579        34        0.25

Subordinated debentures

    9,637        438        4.48     9,556        431        4.45
 

 

 

   

 

 

     

 

 

   

 

 

   

Total borrowings

    23,603        468        1.98     23,135        465        2.01
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest bearing liabilities

    1,033,387        2,723        0.26     627,695        1,922        0.31
   

 

 

       

 

 

   

Non-interest bearing demand deposits

    1,151,075            704,437       
 

 

 

       

 

 

     

Total funding sources

    2,184,462            1,332,132       

Non-interest bearing liabilities

    18,151            16,133       

Shareholders’ equity

    292,577            152,500       
 

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 2,495,190          $ 1,500,765       
 

 

 

       

 

 

     

Excess of interest-earning assets over funding sources

    $ 87,419          $ 53,255     
   

 

 

       

 

 

   

Net interest rate spread (3)

        3.69         3.62

Net interest margin (4)

        3.83         3.79

Core net interest margin (5)

        3.69         3.64

 

(1) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.
(2) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(3) Net interest rate spread represents the yield earned on average total interest earning assets less the rate paid on average total interest bearing liabilities.
(4) Net interest margin is computed by dividing net interest income by average total interest earning assets.
(5) Core net interest margin is computed by dividing net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and other associated payoff benefits, and interest recovered or reversed on non-accrual loans, by average total interest-earning assets. See the reconciliation table for core net interest margin.

 

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Average Balances, Interest Income and Expense, Yields and Rates

Years Ended December 31, 2014 and 2013

The following table presents the Company’s average balance sheets, together with the total dollar amounts of interest income and interest expense and the weighted average interest yield/rate for the periods presented. All average balances are daily average balances (dollars in thousands).

 

    Years Ended December 31,  
    2014     2013  
    Average
Balance
    Interest
Income/
Expense
    Average
Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
    Average
Yield/
Rate
 

Interest earning Assets:

           

Deposits in other financial institutions

  $ 265,076      $ 926        0.34     245,102      $ 732        0.29

Investment securities (1)

    129,841        2,369        1.82     106,806        1,913        1.79

Loans (2)

    1,010,030        51,882        5.14     878,705        48,201        5.49
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest earning assets

    1,404,947        55,177        3.93     1,230,613        50,846        4.13
   

 

 

       

 

 

   

Non-interest earning assets

    95,818            91,975       
 

 

 

       

 

 

     

Total assets

  $ 1,500,765          $ 1,322,588       
 

 

 

       

 

 

     

Interest bearing Liabilities:

           

Interest bearing transaction accounts

  $ 153,327      $ 278        0.18   $ 130,247      $ 238        0.18

Money market and savings deposits

    390,185        963        0.25     361,486        1,027        0.28

Certificates of deposit

    61,048        216        0.35     65,943        255        0.39
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest bearing deposits

    604,560        1,457        0.24     557,676        1,520        0.27

Securities sold under agreements to repurchase

    13,579        34        0.25     24,376        74        0.30

Subordinated debentures

    9,556        431        4.45     9,368        485        5.11
 

 

 

   

 

 

     

 

 

   

 

 

   

Total borrowings

    23,135        465        2.01     33,744        559        1.66
 

 

 

   

 

 

     

 

 

   

 

 

   

Total interest bearing liabilities

    627,695        1,922        0.31     591,420        2,079        0.35
   

 

 

       

 

 

   

Non-interest bearing demand deposits

    704,437            587,637       
 

 

 

       

 

 

     

Total funding sources

    1,332,132            1,179,057       

Non-interest bearing liabilities

    16,133            12,244       

Shareholders’ equity

    152,500            131,244       
 

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 1,500,765          $ 1,322,588       
 

 

 

       

 

 

     

Excess of interest-earning assets over funding sources

    $ 53,255          $ 48,767     
   

 

 

       

 

 

   

Net interest rate spread (3)

        3.62         3.78

Net interest margin (4)

        3.79         3.96

Core net interest margin (5)

        3.64         3.78

 

(1) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.
(2) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(3) Net interest rate spread represents the yield earned on average total interest earning assets less the rate paid on average total interest bearing liabilities.
(4) Net interest margin is computed by dividing net interest income by average total interest earning assets.
(5) Core net interest margin is computed by dividing net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans, by average total interest-earning assets. See the reconciliation table for core net interest margin.

 

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Reconciliation of Core Net Interest Margin to Net Interest Margin

The following table represents a reconciliation of GAAP net interest margin to core net interest margin used by the Company. The table presents the information for the periods indicated (dollars in thousands):

 

     Years Ended
December 31,
 
     2015     2014     2013  

Net Interest Income

   $ 90,142      $ 53,255      $ 48,767   

Less:

Interest recovered (reversed) on non-accrual loans

     95        227        (5

Accelerated accretion of fair value adjustments on early loan payoffs and other associated payoff benefits

     2,896        1,789        2,234   
  

 

 

   

 

 

   

 

 

 

Core Net Interest Income

   $ 87,151      $ 51,239      $ 46,538   
  

 

 

   

 

 

   

 

 

 

Net interest margin

     3.83     3.79     3.96

Core net interest margin

     3.69     3.64     3.78

Composition of Net Deferred Loan Fees, Costs and Fair Value Discount

The following table reflects the composition of the net deferred loan fees, costs and fair value discounts at December 31, 2015 and 2014 (dollars in thousands):

 

     Years Ended
December 31,
 
     2015      2014  

Accretable loan discount

   $ 14,856       $ 21,726   

Non-Accretable loan discount

     2,061         567   
  

 

 

    

 

 

 

Remaining loan discount on acquired loans

     16,917         22,293   

Net deferred loan fees on organic loans

     4,575         3,471   
  

 

 

    

 

 

 

Total

   $ 21,492       $ 25,764   
  

 

 

    

 

 

 

Average Tangible Common Equity (TCE) Calculation and Reconciliation to Total Average Shareholders’ Equity

The Company utilizes the term TCE, a non-GAAP financial measure. CU Bancorp’s management believes TCE is useful because it is a measure utilized by both regulators and market analysts in evaluating a consolidated bank holding company’s financial condition and capital strength. TCE represents common shareholders’ equity less goodwill and certain intangible assets. Return on Average Tangible Common Equity represents year-to-date net income available to common shareholders as a percent of average tangible common equity. A calculation of CU Bancorp’s Return on Average Tangible Common Equity is provided in the table below for the periods indicated (dollars in thousands):

 

     Year Ended December 31,  
     2015     2014     2013  

Average Tangible Common Equity Calculation

      

Total average shareholders’ equity

   $ 292,577      $ 152,500      $ 131,244   

Less: Average serial preferred stock

     16,457        1,390        —     

Less: Average goodwill

     64,014        13,659        12,292   

Less: Average core deposit and leasehold right intangibles

     8,644        2,366        1,628   
  

 

 

   

 

 

   

 

 

 

Average Tangible Common Equity

   $ 203,462      $ 135,085      $ 117,324   
  

 

 

   

 

 

   

 

 

 

Net Income Available to Common Shareholders

   $ 20,062      $ 8,784      $ 9,785   

Return on Average Tangible Common Equity

     9.86     6.50     8.34

 

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Net Changes in Average Balances, Composition, Yields and Rates

Years Ended December 31, 2015 and 2014

The following table set forth the composition of average interest earning assets and average interest bearing liabilities by category and by the percentage of each category to the total for the periods indicated, including the change in average balance, composition, and yield/rate between these respective periods (dollars in thousands):

 

   

Years Ended December 31,

       
   

2015

    2014     Increase (Decrease)  
   

Average
Balance

  %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
 

Interest earning Assets:

                 

Deposits in other financial institutions

  $289,364     12.7     0.37   $ 265,076        18.9     0.34   $ 24,288        (6.2 )%      0.03

Investment securities

  287,436     12.6     1.57     129,841        9.2     1.82     157,595        3.3     (0.25 )% 

Loans

  1,707,654     74.7     4.95     1,010,030        71.9     5.14     697,624        2.9     (0.19 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total interest earning assets

  $2,284,454     100.0     3.95   $ 1,404,947        100.0     3.93   $ 879,507        —       0.02
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Interest-Bearing Liabilities:

                 

Non-interest bearing demand deposits

  $1,151,075     52.7     —     $ 704,437        52.9     —     $ 446,638        (0.2 )%      —  

Interest bearing transaction accounts

  258,444     11.9     0.16     153,327        11.5     0.18     105,117        0.4     (0.02 )% 

Money market and savings deposits

  690,065     31.6     0.24     390,185        29.3     0.25     299,880        2.3     (0.01 )% 

Certificates of deposit

  61,275     2.8     0.31     61,048        4.6     0.35     227        (1.8 )%      (0.04 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total deposits

  2,160,859     99.0     0.10     1,308,997        98.3     0.11     851,862        0.7     (0.01 )% 

Subordinated debentures

  9,637     0.4     4.48     9,556        0.7     4.45     81        (0.3 )%      0.03

Securities sold under agreements to repurchase

  13,966     0.6     0.21     13,579        1.0     0.25     387        (0.4 )%      (0.04 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total borrowings

  23,603     1.0     1.98     23,135        1.7     2.01     468        (0.7 )%      (0.03 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Total funding sources

  $2,184,462     100.0     0.12   $ 1,332,132        100.0     0.14   $ 852,330          %      (0.02 )% 
 

 

 

 

 

     

 

 

   

 

 

     

 

 

     

Excess of interest earning assets over funding sources

  $99,992       $ 72,815          $ 27,177       

Net interest rate spread

        3.69         3.62         0.07

Net interest margin

        3.83         3.79         0.04

Core net interest margin

        3.69         3.64         0.05

 

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Net Changes in Average Balances, Composition, Yields and Rates

Years Ended December 31, 2014 and 2013

The following table sets forth the composition of average interest earning assets and average interest bearing liabilities by category and by the percentage of each category to the total for the periods indicated, including the change in average balance, composition and yield/rate between these respective periods (dollars in thousands):

 

     Years Ended December 31,                    
     2014     2013     Increase (Decrease)  
     Average
Balance
     %
of
Total
    Average
Yield/
Rate
    Average
Balance
     %
of
Total
    Average
Yield/
Rate
    Average
Balance
    %
of
Total
    Average
Yield/
Rate
 

Interest earning Assets:

                    

Deposits in other financial institutions

   $ 265,076         18.9     0.34   $ 245,102         19.9     0.29   $ 19,974        (1.0 )%      0.05

Investment securities

     129,841         9.2     1.82     106,806         8.7     1.79     23,035        0.6     0.03

Loans

     1,010,030         71.9     5.14     878,705         71.4     5.49     131,325        0.5     (0.35 )% 
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total interest earning assets

   $ 1,404,947         100.0     3.93   $ 1,230,613         100.0     4.13   $ 174,334          (0.20 )% 
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Interest-Bearing Liabilities:

                    

Non-interest bearing demand deposits

   $ 704,437         52.9     $ 587,637         49.8     $ 116,800        3.0  

Interest bearing transaction accounts

     153,327         11.5     0.18     130,247         11.0     0.18     23,080        0.5     0.00

Money market and savings deposits

     390,185         29.3     0.25     361,486         30.7     0.28     28,699        (1.4 )%      (0.03 )% 

Certificates of deposit

     61,048         4.6     0.35     65,943         5.6     0.39     (4,895     (1.0 )%      (0.04 )% 
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

   

 

 

   

Total deposits

     1,308,997         98.3     0.11     1,145,313         97.1     0.13     163,684        1.1     (0.02 )% 

Subordinated debentures

     9,556         0.7     4.45     9,368         0.8     5.11     188        (0.1 )%      (0.66 )% 

Securities sold under agreements to repurchase

     13,579         1.0     0.25     24,376         2.1     0.30     (10,797     (1.0 )%      (0.05 )% 
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total borrowings

     23,135         1.7     2.01     33,744         2.9     1.66     (10,609     (1.1 )%      0.35
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total funding sources

   $ 1,332,132         100.0     0.14   $ 1,179,057         100.0     0.18   $ 153,075          (0.04 )% 
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Excess of interest earning assets over funding sources

   $ 72,815           $ 51,556           $ 21,259       

Net interest rate spread

          3.62          3.78         (0.16 )% 

Net interest margin

          3.79          3.96         (0.17 )% 

Core net interest margin

          3.64          3.78         (0.15 )% 

 

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Volume and Rate Variance Analysis of Net Interest Income

Years Ended December 31, 2015, 2014 and 2013

The following table presents the dollar amount of changes in interest income and interest expense due to changes in average balances of interest earning assets and interest bearing liabilities and changes in interest rates. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to: (i) changes in volume (i.e. changes in average balance multiplied by prior period rate) and (ii) changes in rate (i.e. changes in rate multiplied by prior period average balance). For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately based on the absolute dollar amounts of the changes due to volume and rate (dollars in thousands):

 

     December 31,
2015 vs. 2014
    December 31,
2014 vs. 2013
 
     Volume      Rate     Total     Volume     Rate     Total  

Interest Income:

             

Deposits in other financial institutions

   $ 77       $ 84      $ 161      $ 60      $ 134      $ 194   

Investment securities

     2,867         (718     2,149        417        39        456   

Loans

     35,904         (3,249     32,655        7,377        (3,696     3,681   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     38,848         (3,883     34,965        7,854        (3,523     4,331   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest Expense:

             

Interest bearing transaction accounts

     185         (50     135        40        —          40   

Money market and savings deposits

     759         (70     689        74        (138     (64

Certificates of deposit

     —           (26     (26     (16     (23     (39
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total deposits

     944         (146     798        98        (161     (63
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subordinated debentures

     4         3        7        9        (63     (54

Securities sold under agreements to repurchase

     1         (5     (4     (33     (7     (40
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total borrowings

     5         (2     3        (24     (70     (94
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     949         (148     801        74        (231     (157
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income

   $ 37,899       $ (3,735   $ 34,164      $ 7,780      $ (3,292   $ 4,488   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

The net interest margin increased 4 basis points to 3.83% for the year ended December 31, 2015, compared to 3.79% for the year ended December 31, 2014. While the Company has continued to experience compression in the loan yields as new loans have been originated at lower interest rates than those loans that have been paid off in 2014 and 2015, growth in the average loans and a shift to more loans in the mix of interest earning assets, has helped support the slight increase in net interest margin. The Company’s net interest income was positively impacted in both 2015 and 2014 by the recognition of fair value discount earned on early payoffs of acquired loans. In 2015, the Company recorded $2.2 million in discount earned on early payoffs of acquired loans and other associated payoff benefits aggregating to $816 thousand, with a positive impact on the net interest margin of 14 basis points. In 2014 the Company recorded $1.8 million in discount earned on early loan payoffs of acquired loans and a $227 thousand recovery of interest income on an acquired loan that was on non-accrual status, with a positive impact on the net interest margin of 15 basis points.

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

The net interest margin declined 17 basis points to 3.79% for the year ended December 31, 2014, compared to 3.96% for the year ended December 31, 2013. The decline in net interest margin is primarily due to a 35 basis point decrease in loan yield, offset by a 3 and 4 basis point decline in the money market and savings deposits rate, and certificates of deposits rate, respectively. The lower net interest margin in 2014 is attributable to the

 

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continued low interest rate environment, as new loans have been originated at lower interest rates than those loans that have been paid off. This is in addition to a lower level of fair value discounts earned on early payoffs of acquired loans in 2014 compared to 2013. Fair value discounts earned on early payoffs of acquired loans were $1.8 million compared to $2.2 million for 2014 and 2013, respectively. Despite a decline in the net interest margin, net interest income increased $4.5 million mainly due to a higher average loan balance. However, net interest income also included the recovery of $227 thousand of interest income on an acquired loan that was on non-accrual status in 2014 and a reversal of $5 thousand of interest income on another acquired loan that was put on non-accrual status in 2013. The impact to the Company’s net interest margin from the accelerated accretion and the recovery or reversal of interest income for 2014 and 2013 was 15 basis points and 18 basis points, respectively.

Provision for Loan Losses

The Company maintains an allowance for loan loss (“Allowance”) to provide for probable losses in the loan portfolio. Additions to the Allowance are made by charges to operating expense in the form of a provision for loan losses. Loan charge-offs are charged against the Allowance when management believes the collectability of the loan principal becomes unlikely. Subsequent recoveries, if any, are credited to the Allowance.

Provision for loan losses was $5.1 million, $2.2 million and $2.9 million for the year ended December 31, 2015, 2014 and 2013, respectively. The Company had $ 349 million, $197 million and $137 million of net organic loan growth for 2015, 2014 and 2013, respectively. Net charge-offs were $2.0 million, $232 thousand and $1.1 million in 2015, 2014 and 2013, respectively. See further discussion in Balance Sheet Analysis, Allowance for Loan Loss.

Non-interest Income

The following table lists the major components of the Company’s non-interest income (dollars in thousands):

 

     Years Ended
December 31,
    Increase
(Decrease)
    Years Ended
December 31,
     Increase
(Decrease)
 
     2015      2014     $     %     2014     2013      $     %  

Gain (Loss) on sale of securities, net

   $ 112       $ (47   $ 159        338.3   $ (47   $ 47       $ (94     (200.0 )% 

Gain on sale of SBA loans, net

     1,797         1,221        576        47.2     1,221        1,087         134        12.3

Deposit account service charge income

     4,644         2,744        1,900        69.2     2,744        2,377         367        15.4

Letters of credit income

     743         400        343        85.8     400        258         142        55.0

Transaction referral income

     516         570        (54     (9.5 )%      570        —           570        —  

BOLI Income

     1,295         660        635        96.2     660        618         42        6.8

Dividend income in equity securities

     1,324         446        878        196.9     446        383         63        16.4

Other non-interest income

     1,299         1,715        (416     (24.3 )%      1,715        1,748         (33     (1.9 )% 
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total Non-Interest Income

   $ 11,730       $ 7,709      $ 4,021        52.2   $ 7,709      $ 6,518       $  1,191        18.3
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Non-interest income increased $4.0 million or 52% mainly due to a $576 thousand increase in gain on sale of SBA loans, a $1.9 million increase in deposit account service charge income, a $635 thousand increase in BOLI income and a $878 thousand increase in dividend income on equity securities. The increase in the gain on sale of SBA loan is driven by a higher volume of SBA loan sales in 2015 with a premium range of 106.77% to 118.38%. The increase in deposit account service charge income is almost entirely driven by the increase in DDA account analysis fees. The increase in dividend income is from the Federal Home Loan Bank of San Francisco due to a special dividend of $296 thousand received in the second quarter of 2015 and a consistent increase in the quarterly dividend rate throughout 2015.

 

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Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

Non-interest income increased $1.2 million or 18.3% mainly due to an improvement in deposit account service charge income of $367 thousand, $134 thousand increase in gain on sale of SBA loans, and an increase of $784 thousand in other non-interest income. Included in other non-interest income in 2014 were increases of $339 thousand in transaction referral fees, $132 thousand in letters of credit fees, and a $225 thousand settlement in the second quarter related to an other real estate owned property sold in 2013.

Non-Interest Expense

The following table lists the major components of the Company’s non-interest expense (dollars in thousands):

 

            2015 vs. 2014     2014 vs. 2013  
     Years Ended December 31,      Increase
(Decrease)
    Increase
(Decrease)
 
     2015      2014      2013      $     %     $     %  

Salaries and employee benefits

   $ 34,989       $ 24,820       $ 21,782       $ 10,169        41.0   $ 3,038        13.9

Stock based compensation expense

     2,966         1,699         1,088         1,267        74.6     611        56.2

Occupancy

     5,792         4,112         4,194         1,680        40.9     (82     (2.0 )% 

Data processing

     2,495         1,968         1,868         527        26.8     100        5.4

Legal and professional

     2,411         2,006         2,166         405        20.2     (160     (7.4 )% 

FDIC deposit assessment

     1,466         844         880         622        73.7     (36     (4.1 )% 

Merger related expenses

     498         2,302         43         (1,804     (78.4 )%      2,259        5,253.5

OREO valuation write-downs and expenses

     245         15         95         230        1,533.3     (80     (84.2 )% 

Office services expenses

     1,526         1,026         1,034         500        48.7     (8     (0.8 )% 

Core deposit intangible amortization

     1,680         391         309         1,289        329.7     82        26.5

Other operating expenses

     5,897         4,202         4,181         1,695        40.3     21        0.5
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

   $ 59,965       $ 43,385       $ 37,640       $ 16,580        38.2   $ 5,745        15.3
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Non-interest expense increased by $17 million, or 38.2% mainly due to the acquisition of 1st Enterprise late in the fourth quarter of 2014. This resulted in a $10 million increase in salaries and employee benefits, a $1.3 million increase in stock based compensation expense, a $1.7 million increase in occupancy expenses, a $1.3 million increase in core deposit intangible amortization, and a $1.7 million increase in other operating expenses, offset by a decrease in merger expenses of $1.8 million. The increase in salaries and employee benefits was attributable to the merger. The number of active full time employees increased from 250 at December 31, 2014 to 265 at December 31, 2015. The increase in stock compensation expense in 2015 reflects the larger senior talent pool after the 1st Enterprise merger.

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

Non-interest expense increased by $5.7 million, or 15.3% mainly due to a $3.0 million increase in salaries and employee benefits, a $611 thousand increase in stock based compensation expense and a $2.3 million increase in merger related expenses related to the 1st Enterprise merger. The increase in salaries and employee benefits was attributable to the accrual of bonus and retention incentives related to the 1st Enterprise merger, as well as an increase in the number of full time employees from 175 at December 31, 2013 to 250 at December 31, 2014. The increase in stock based compensation expense reflects the delay in the annual granting of stock-based compensation in 2013 and additional expense from the granting of stock awards to new executives and employees after the 1st Enterprise merger in 2014. Merger expenses included legal fees, investment banking fees, professional fees and contract termination fees.

 

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Income Taxes

The effective tax rate was 37.7%, 41.9% and 33.9% for the years ended December 31, 2015, 2014 and 2013, respectively. The Company’s effective tax rate for all years is impacted by the increase in cash surrender value of bank owned life insurance policies which is excluded from taxable income, tax exempt interest income, and investments in Qualified Affordable Housing Projects “LIHTC” that generate tax credits and benefits for the Company. The variance between 2015 and 2014 is primarily related to non-deductible merger cost as a result of the acquisition of 1st Enterprise. The lower effective tax rate in 2013 is due to a one-time tax rate benefit adjustment of the Company’s deferred tax assets due to increased profitability which causes the federal tax rate to move to the maximum bracket. The Company operates in the Federal and California jurisdictions and the blended statutory tax rate for Federal and California income taxes is 42.05%.

Reconciliation of Core Net Income Available to Common Shareholders to Net Income Available to Common Shareholders

The Company utilizes the term Core Net Income Available to Common Shareholders, a non-GAAP financial measure. CU Bancorp’s management believes Core Net Income Available to Common Shareholders is useful because it is a measure utilized by market analysts to understand the effects of merger-related expenses and provides an alternative view of the Company’s performance over time and in comparison to the Company’s competitors. Core Net Income Available to Common Shareholders should not be viewed as a substitute for Net Income Available to Common Shareholders. A reconciliation of CU Bancorp’s Net Income Available to Common Shareholders to Core Net Income Available to Common Shareholders is presented in the table below for the periods indicated (dollars in thousands):

 

     Years Ended
December 31,
 
     2015      2014  

Net Income Available to Common Shareholders

   $ 20,062       $ 8,784   

Add back: Merger expenses, net

     293         1,952   

Add back: Severance and retention, net

     245         693   
  

 

 

    

 

 

 

Core Net Income Available to Common Shareholders

   $ 20,600       $ 11,429   
  

 

 

    

 

 

 

Core net income available to common shareholders increased by $9.2 million compared to 2014. The increase in the Company’s core net income available to common shareholders during 2015 represented a significant increase in the level of profitability that was driven by a successful execution of the merger with 1st Enterprise at the end of November 2014 and a strong organic loan growth of $349 million. These results for 2015 reflect the benefit of the Company’s increased scale, which provided the Company the opportunity to realize additional operating leverage, as the loan portfolio expanded from both acquisition and organic loan growth in 2015.

 

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FINANCIAL CONDITION

Balance Sheet Analysis

Total assets increased $370 million from $2.3 billion at December 31, 2014 to $2.6 billion at December 31, 2015 with an increase of $89 million in cash and cash equivalents and an increase of $208 million in loans, mainly driven by a $339 million increase in total deposits during the period. The increase in loans from the prior year was due to strong organic loan growth. Net organic loan growth during the period was $349 million, partially offset by $141 million in pay downs and pay offs in the acquired loan portfolios. Loan growth during the period was concentrated primarily in Owner-Occupied Nonresidential Property loans of $69 million, Other Nonresidential Property loans of $52 million, and Construction Land Development and Other Land loans of $54 million.

Funding the asset growth for the Company in 2015 was the growth in deposits of $339 million, increase in securities sold under agreements to repurchase of $4.9 million and earnings of $20 million. Further, the deposit growth of $339 million is the result of a $255 million increase in non-interest bearing demand deposits, a $55 million increase in interest bearing transaction accounts and a $35 million increase in money market and savings deposits, offset by a decrease of $6 million in certificates of deposit. Non-interest bearing deposits represented 56% and 53% of total deposits at December 31, 2015 and 2014, respectively.

Investment Securities

In order to maintain the Company’s goal of maintaining a high degree of both on-balance sheet and off-balance sheet liquidity, the Company maintains a portion of its investment securities in both readily saleable securities and/or securities that can be pledged as collateral for one or a combination of the Company’s credit facilities. The Company invests in U.S. Treasury Notes, U.S. Agency and U.S. Sponsored Agency issued AAA and AA rated investment-grade callable and non-callable bonds, mortgage-backed pass through securities, asset backed securities and collateralized mortgage obligation “CMO” securities, investment grade corporate bond securities and investment grade municipal securities.

The Company also maintains investable funds with other financial institutions in the form of overnight interest bearing money market accounts and short term maturity certificates of deposit with insured financial institutions. Throughout both 2015 and 2014, the Company has maintained a significant portion of its overnight liquidity directly with the Federal Reserve Bank. At December 31, 2015 the Company had $102 million on deposit with the Federal Reserve.

Securities owned by the Company may also be pledged in connection with the Company’s securities sold under agreements to repurchase program that is offered to the Company’s business deposit customers in which a minimum of 102% of the borrowings are collateralized by the fair market value of the investment securities. As of December 31, 2015 and 2014, the carrying value of securities pledged in connection with securities sold under agreements to repurchase was $47 million and $32 million, respectively. Securities with a market value of $12 million and $13 million were pledged to secure a certificate of deposit of $10 million with the State of California Treasurer’s office throughout 2015 and 2014. Securities with a market value of $81 million and $42 million were pledged to secure outstanding standby letters of credit confirmed/issued by a correspondent bank for the benefit of our customers in the amounts of $45 million and $34 million at December 31, 2015 and December 31, 2014, respectively. Securities with a market value of $893 thousand and $1.1 million were pledged to secure local agency deposits at December 31, 2015 and 2014, respectively. Securities with a market value of $19 million and $18 million were pledged to secure our Federal Reserve credit facility at December 31, 2015 and 2014, respectively. Securities with a market value of $19 million were pledged in connection with its credit facility with the Federal Home Loan Bank “FHLB” at December 31, 2015. Securities with a market value of $16 million were pledged in connection with bankruptcy accounts in December 2015. Securities with a market value of $2.0 million were pledged in connection with interest rate swaps acquired from the 1st Enterprise merger.

 

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As of December 31, 2015 and 2014, the Company’s investment securities portfolio consisted of the following, by issuer (dollars in thousands):

Securities Portfolio at Fair Value, by Issuer

 

     December 31,
2015
     December 31,
2014
 

Small Business Administration “SBA”

   $ 93,490       $ 54,487   

U.S. Treasury

     80,746         20,025   

Government National Mortgage Association “GNMA”

     58,765         62,108   

Corporate Bonds — Various Companies

     4,023         4,120   

Federal National Mortgage Association “FNMA”

     57,759         64,106   

Municipals — Various State and Political Subdivisions

     43,001         48,208   

Federal Home Loan Bank “FHLB”

     1,014         1,030   

Federal Home Loan Mortgage Corporation “FHLMC”

     11,331         9,649   

Federal Farm Credit Bank “FFCB”

     —           1,008   

Federal Deposit Insurance Corporation “FDIC”

     348         708   

Sallie Mae “SLMA”

     7,647         8,672   
  

 

 

    

 

 

 

Total

   $ 358,124       $ 274,121   
  

 

 

    

 

 

 

The Corporate Bonds in the above table were issued by two individual companies, and the Municipals include securities issued by one hundred and sixteen separate municipalities.

The securities issued by the U.S. Treasury of $81 million, SBA of $94 million and GNMA of $59 million, are fully guaranteed as to the timely payment of both principal and interest by the United States Government. The security issued by the FDIC of $348 thousand is fully guaranteed as to the payment of principal and interest by the FDIC.

The Company recognized net gains in the amount of $112 thousand from the sale of available for sale securities with net proceeds of $5.7 million during the year ended December 31, 2015.

As of December 31, 2015, the Company had unrealized gains of $1.2 million and unrealized losses of $2.3 million on its investment securities portfolio. The Company regularly evaluates the unrealized losses on its securities as to whether they are temporary or other-than-temporary. At December 31, 2015, the Company determined that there was no Other-Than-Temporary-Impairment (OTTI) within its investment securities portfolio. The Company regularly assesses its securities portfolio and there can be no assurance that there will not be impairment charges in the future.

 

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Composition of Securities Available-for-Sale and Held-to-Maturity, at Fair Value

 

     At December 31,  

(Dollars in thousands)

   2015     2014     2013  
Available-for-Sale    Amount     Percent     Amount     Percent     Amount      Percent  

U.S. Govt Agency and Sponsored Agency — Note Securities

   $ 1,014        0.28   $ 2,038        0.7   $ 4,152         3.9

U.S. Treasury Note

     80,746        22.55     20,025        7.3     —           —  

U.S. Govt Agency — SBA Securities

     93,490        26.11     54,487        19.9     50,905         47.8

U.S. Govt Agency — GNMA Mortgage-Backed Securities

     30,700        8.57     29,342        10.7     27,378         25.7

U.S. Govt Sponsored Agency — CMO & Mortgage-Backed Securities

     97,154        27.13     107,228        39.12     15,214         14.3

Corporate Securities

     4,023        1.12     4,120        1.5     5,211         4.9

Municipal Securities

     1,011        0.28     1,050        0.4     3,628         3.4

Asset Backed Securities

     7,647        2.14     8,672        3.2     —           —  

Held-to-Maturity

          

Municipal Securities

     42,339        11.82     47,159        17.2     —           —  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 358,124        100.00   $ 274,121        100.0   $ 106,488         100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The amortized cost, estimated fair value and average yield of debt securities at December 31, 2015, are reflected in the table below. Maturity categories are determined as follows:

 

   

U.S. Govt. Agency, U.S. Treasury Notes and U.S. Govt. Sponsored Agency — bonds and notes — maturity date

 

   

U.S. Gov. Sponsored Agency CMO or Mortgage-Backed Securities, U.S. Govt. Agency GNMA Mortgage-Backed Securities, Asset Backed Securities and U.S. Govt. Agency SBA Securities, — estimated cash flow taking into account estimated pre-payment speeds

 

   

Investment grade Corporate Bonds and Municipal securities — the earlier of the maturity date or the expected call date.

 

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Although U.S. Government Agency, U.S. Government Sponsored Agency mortgage-backed and CMO securities have contractual maturities through 2048, the expected maturity will differ from the contractual maturities because borrowers or issuers may have the right to prepay such obligations without penalties.

 

(Dollars in thousands)   Maturing  
Available-for-Sale   One
year or
less
    Weighted
Average
Yield
    After one
year thru
five years
    Weighted
Average
Yield
    After five
years thru
ten years
    Weighted
Average
Yield
    After
ten
years
    Weighted
Average
Yield
    Balance as of
December 31,

2015
    Weighted
Average
Yield
    % to
total
 

U.S. Government Agency Securities

    1,014        0.80     —          —       —          —       —          —       1,014        0.80     0.28   

U.S. Government SBA Securities

    12,700        0.89     38,582        1.32     42,208        1.75     —          —       93,490        1.46     26.11   

U.S. Government GNMA Mortgage-Backed Securities

    5,448        1.22     11,792        1.58     6,028        1.93     7,432        2.52     30,700        1.82     8.57   

U.S. Government Agency CMO & Mortgage-Backed Securities

    15,001        1.76     38,264        1.95     30,460        2.16     13,429        3.02     97,154        2.13     27.13   

Corporate Securities

    4,023        2.18     —          —       —          —       —          —       4,023        2.18     1.12   

Municipal Securities

    1,011        1.81     —          —       —          —       —          —       1,011        1.81     0.28   

U.S. Treasury Note

    26,988        0.56     53,758        0.76     —          —       —          —          80,746        0.69     22.55   

Asset Backed Securities

    —          —       4,719        0.75     2,928        0.57     —          —          7,647        0.68     2.14   
Held-to-Maturity                                                            

Municipal Securities

    2,243        1.77     34,506        1.58     5,590        1.96     —          —          42,339        1.64     11.82   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Total

  $ 68,428        1.09   $ 18,621        1.33   $ 87,214        1.88   $ 20,861        2.84   $ 358,124        1.5     100.0
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Lending

The following table presents the composition of the loan portfolio at the dates indicated (dollars in thousands):

 

    December 31,  
    2015     2014     2013     2012     2011  

Commercial and Industrial Loans:

  $ 537,368      $ 528,517      $ 299,473      $ 262,637      $ 185,629   

Loans Secured by Real Estate:

         

Owner-Occupied Nonresidential Properties

    407,979        339,309        197,605        181,844        85,236   

Other Nonresidential Properties

    533,168        481,517        271,818        246,450        97,730   

Construction, land development and other land

    125,832        72,223        47,074        48,528        34,380   

1-4 Family Residential Properties

    114,525        121,985        65,711        62,037        38,674   

Multifamily Residential Properties

    71,179        52,813        33,780        31,610        25,974   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Loans Secured by Real Estate

    1,252,683        1,067,847        615,988        570,469        281,994   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Loans:

    43,112        28,359        17,733        21,779        21,637   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Loans

  $ 1,833,163      $ 1,624,723      $ 933,194      $ 854,885      $ 489,260   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table is a breakout of the Company’s gross loans stratified by the industry concentration of the borrower by their respective NAICS code at the dates indicated (dollars in thousands):

 

     December 31,
2015
    December 31,
2014
 
     Amount      % of Total     Amount      % of Total  

Real Estate

   $ 857,021         47   $ 744,663         46

Manufacturing

     174,773         10     161,233         10

Construction

     161,618         9     113,763         7

Wholesale

     134,093         7     124,336         8

Hotel/Lodging

     105,741         6     88,269         5

Finance

     87,734         5     96,074         6

Professional Services

     60,952         3     64,215         4

Healthcare

     47,293         3     43,917         3

Other Services

     45,002         3     45,781         3

Retail

     38,928         2     35,503         2

Restaurant/Food Service

     26,226         1     24,525         2

Administrative Services

     23,736         1     28,016         2

Transportation

     22,237         1     18,158         1

Information

     20,171         1     15,457         1

Education

     9,244         1     10,253         1

Management

     8,137         0     1,606         0

Entertainment

     6,188         0     8,284         1

Other

     4,069         0     670         0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Loans

   $ 1,833,163         100   $ 1,624,723         100
  

 

 

    

 

 

   

 

 

    

 

 

 

The Company’s loan origination and lending activities continue to be focused primarily on direct contact with its borrowers through the Company’s relationship managers and/or executive officers. Total loans were $1.8 billion at December 31, 2015, an increase of $208 million or 13% from $1.6 billion at December 31, 2014. The Company had approximately $349 million of net organic loan growth which was partially offset by approximately $141 million in loan pay downs and pay offs from the acquired loan portfolios. The increase in total loans from the end of the prior year included a $9 million increase in the commercial and industrial loan portfolio, a $69 million increase in the owner-occupied nonresidential properties, a $52 million increase in the other nonresidential real estate properties portfolio, a $54 million increase in the construction, land development and other land properties portfolio, a $18 million increase in the multifamily residential properties portfolio and a $14 million increase in the other loans portfolio, offset by a $8 million decrease in the 1-4 family residential properties portfolio.

The Company’s loan customers are primarily based in the Southern California area with geographical distribution primarily in Los Angeles County, Orange County, Ventura County and San Bernardino County.

At least on a quarterly basis, management reviews a report of loan relationships with balances over $6.5 million which constitute 30% and 31% of the Company’s total loan portfolio as of December 31, 2015 and 2014, respectively. At December 31, 2015, there were four loan relationships with balances over $20 million, eighteen loan relationships of more than $10 million and less than $20 million and twenty-seven loan relationships of more than $6.5 million and less than $10 million. Of the four largest loan relationships, three were real estate lending relationships and one was a commercial and industrial lending relationship. Compared to December 31, 2014, there were two loan relationships with balances over $20 million, fifteen loan relationships of more than $10 million and less than $20 million and eleven loan relationships of more than $6.5 million and less than $10 million. Of the two largest loan relationships, one was a real estate lending relationship and one was a commercial and industrial lending relationship. The growth in the relationships over $10 million and less

 

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than $20 million was primarily from existing customers whose business expanded in the year. As of December 31, 2015 and 2014, the average outstanding loan principal balance was $869 thousand compared to $829 thousand.

The Company had 53 commercial banking relationship managers and 9 commercial real estate relationship managers at December 31, 2015, compared to 51 commercial banking relationship managers and 9 commercial real estate relationship managers at December 31, 2014. The Company’s commercial and industrial line of credit utilization was approximately 46% and 47% as of December 31, 2015 and 2014, respectively.

The Company provides commercial loans, including working capital and equipment financing, real estate loans, including residential and construction and consumer loans, generally to business principals, entrepreneurs and professionals. The Company currently does not offer residential mortgages to consumers other than home equity lines of credit. The Company’s lending has been originated primarily through direct contact with the borrowers by the Company’s relationship managers and/or executive officers. The Company’s credit approval process includes an examination of the collateral, cash flow and debt service coverage of the loan, as well as the financial condition and credit references of the borrower and guarantors, where applicable. The Company’s senior management is actively involved in its lending activities, collateral valuation and review process. The Company obtains independent third party appraisals of loans secured by real property as required by applicable federal law and regulations. There is also a loan committee comprised of senior management and outside directors that monitors the loan portfolio on at least a quarterly basis.

The Company believes that it manages credit risk closely in its loan portfolio and uses a variety of policy and procedure guidelines and analytical tools to achieve its asset quality objectives.

The Company’s real estate construction loans are primarily short-term loans made to finance the construction of commercial real estate and multifamily residential property. On occasion, we make loans to finance the construction of single family residences to established developers and owner-occupiers. We do not engage in any single family tract development lending to real estate developers. Our construction lending is to relationships we know, doing projects the builder/developer has experience with, the majority are with recourse and are rarely speculative in nature. In 2015, due to the improving state of the southern California economy and increased demand for new in-fill development projects, there existed enhanced opportunities for the Company to make good quality construction loans. The Company’s portfolio consisted predominantly of multifamily/residential construction projects in Los Angeles County undertaken by customers that have long-term relationships with the Company. Construction quality and exposure is consistently monitored via quarterly reporting and the entire portfolio is Pass rated as of December 31, 2015. The construction, land development and other land loan portfolio remains a small percentage of the Company’s entire loan portfolio. As of December 31, 2015, the construction portfolio was 7% of total loans with a composition of 78% for construction and 22% for land development. This compares to the construction loan portfolio at December 31, 2014 which was 4% of total loans, with a composition of 65% for construction and 34% for land development.

Our other real estate loans consist primarily of loans made based on the borrower’s cash flow, secured by deeds of trust on commercial and residential property to provide an additional source of repayment in the event of default. Maturities on these loans are generally up to ten years (on an amortization ranging from fifteen to twenty-five years with a balloon payment due at maturity). The interest rates on these commercial real estate loans are either fixed or floating, with many of the loans that have maturities greater than five years having re-pricing provisions that adjust the interest rate to market rates at stated times prior to maturity. At December 31, 2015, owner-occupied nonresidential properties and other nonresidential properties are composed of 17% office buildings, 53% commercial buildings, 14% retail centers and 16% hotel/resorts/other, and at December 31, 2014, 17% office buildings, 53% commercial buildings, 13% retail centers and 17% hotel/resorts/other.

Our commercial and industrial loans are made for the purpose of providing working capital, financing for the purchase of equipment or for other business purposes. Such loans include loans with maturities ranging from sixty days to one year and “term loans” which are loans with maturities normally ranging from one to five years.

 

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Small Business Administration “SBA” loans are loans originated under the guidelines of the U. S. Small Business Administration lending programs. SBA-guaranteed loans may not be made to a small business if the borrower has access to other financing on reasonable terms. These loans are made to finance a small business and its need for working capital, accounts receivable financing, the purchase of equipment and inventory, or for the purchase of owner-occupied commercial real estate. The Company has a preferred lender status from the SBA to originate SBA loans. The Company acquired its SBA operations with the PC Bancorp acquisition in 2012.

For SBA guaranteed loans, a secondary market exists to purchase the guaranteed portion of these loans with the Company continuing to service the entire loan. The secondary market for guaranteed loans is comprised of investors seeking long term assets with yields that adapt to the prevailing interest rates. These investors are typically financial institutions, insurance companies, pension funds, and other investors that purchase this product. When a decision to sell the guaranteed portion of an SBA loan is made by the Company, bids are solicited from secondary market investors and the loan is normally sold to the highest bidder.

Other loans include personal loans that are generally made for the purpose of financing investments, various types of consumer goods and other personal purposes. Also included are loans to non-depository financial institutions.

Outstanding unused loan commitments consist primarily of commercial, construction and home equity lines of credit which have not been fully disbursed, as well as some standby letters of credit which generally support lease or other direct obligations. Based upon our experience, the outstanding unused loan commitments are expected to decrease in line with increases in loan demand, subject to economic conditions. During 2015, the Company’s percentage of commercial unused loan commitments to total commercial loan commitments has increased slightly. The Company had $722 million in outstanding unused loan commitments, and $84 million in outstanding standby letters of credit, with total off-balance sheet commitments totaling $806 million at December 31, 2015. Comparatively, the Company had $662 million in outstanding unused loan commitments, and $58 million in outstanding standby and performance letters of credit, with total off-balance sheet commitments totaling $720 million at December 31, 2014. The year over year increase is consistent with the continuous growth of the Company’s loan portfolio and customer relationships combined with the successful execution of the 1st Enterprise merger.

We do not have any concentrations in our loan portfolio by industry or group of industries, except for the level of loans that are secured by real estate as presented in the table above. In addition, we have not made any loans to finance leveraged buyouts or for highly leveraged transactions.

The following table sets forth the maturity distribution of the Company’s outstanding loans at December 31, 2015. In addition, the table shows the distribution of loans with fixed or predetermined interest rates and those with variable or floating interest rates. The Company currently utilizes the Wall Street Journal Prime Rate, the 5 year U.S. Treasury Rate, the 5 year FHLB Seattle Rate, the 5 year LIBOR Swap Rate, the 3 Year LIBOR Swap Rate and the One-Month LIBOR to price its variable rate loans. As of December 31, 2015, we had 89 loans with a recorded investment balance of $50 million with remaining maturities greater than twenty years. As of

 

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December 31, 2014, we had 27 loans with a recorded investment balance of $17 million with remaining maturities greater than twenty years.

 

(Dollars in thousands)    Maturing  
     Within One Year      One to Five Years      After Five Years      Total  
As of December 31, 2015            

Commercial and Industrial

   $ 317,790       $ 165,640       $ 53,938       $ 537,368   

Owner-Occupied Nonresidential Properties

     21,865         81,066         305,047         407,979   

Other Nonresidential Properties

     40,953         113,773         378,442         533,168   

Construction, Land Development and Other Land

     93,670         26,420         5,742         125,832   

1-4 Family Residential Properties

     13,169         34,191         67,165         114,525   

Multifamily Residential Properties

     9,437         29,869         31,873         71,179   

Other

     32,288         5,771         5,053         43,112   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 529,172       $ 456,731       $ 847,260       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

 

Loans with fixed or pre-determined interest rates

   $ 68,370       $ 227,450       $ 173,040       $ 468,860   

Loans with floating or adjustable interest rates (1)

     460,802         229,281         674,220         1,364,303   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans

   $ 529,172       $ 456,731       $ 847,260       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes approximately $471 million of variable rate loans that are either at or below their floor.

Impaired Loans, Non-Accrual Loans. At December 31, 2015, the Company had 15 loans on non-accrual totaling $2.1 million, or 0.11% of total loans. At December 31, 2014, the Company had 20 loans on non-accrual totaling $3.9 million, or 0.24% of total loans. Approximately 50% of the non-accrual loans balance is made up of 11 commercial and industrial loans totaling $1.0 million at December 31, 2015, compared to 67% consisting of 15 commercial and industrial loans totaling $2.6 million at December 31, 2014. The reduction in the non-accrual loans balance from 2014 is due to payoffs and charge-offs. At December 31, 2015 and 2014, all loans classified as impaired are on non-accrual status and all troubled debt restructured loans are impaired and on non-accrual status. Of the non-accrual loans, none individually exceeds $400 thousand. There were no non-performing assets or loans greater than 90 days past due and accruing interest as of December 31, 2015 and 2014.

 

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The following is a summary of our asset quality data and key ratios at the dates indicated (dollars in thousands):

 

     December 31,
2015
    December 31,
2014
 

Loans originated by the Bank on non-accrual

   $ 89      $ 2,131   

Loans acquired through acquisition that are on non-accrual

     1,962        1,778   
  

 

 

   

 

 

 

Total non-accrual loans

     2,051        3,909   

Other Real Estate Owned

     325        850   
  

 

 

   

 

 

 

Total non-performing assets

   $ 2,376      $ 4,759   
  

 

 

   

 

 

 

Net charge-offs year to date

   $ 2,009      $ 232   

Non-accrual loans to total loans

     0.11     0.24

Total non-performing assets to total assets

     0.09     0.21

Allowance for loan losses to total loans

     0.86     0.78

Allowance for loan losses to total loans accounted at historical cost, which excludes loans acquired by acquisition

     1.25     1.39

Net year to date (charge-offs) to average year to date loans

     (0.12 )%      (0.02 )% 

Allowance for loan losses to non-accrual loans accounted at historical cost, which excludes non-accrual loans acquired by acquisition and related allowance

     17583     592

Allowance for loan losses to total non-accrual loans

     764     323

The risk that borrowers will fail, or will be unable to repay their loans, is an inherent part of the banking business. The Company has established guidelines and practices to specifically identify loans that may become past due in the future, either as to interest or principal, for more than 90 days. Such loans are given special attention by our credit officers and additional efforts are made to get the borrowers to bring their loans current or to provide additional collateral to reduce the risk of potential losses on these loans. In addition, the Company may in the future renegotiate the payment terms of loans to permit the borrower to defer interest or principal payments in those instances where it appears that the borrower may be encountering temporary or short-term financial difficulties and we believe that the future deferral would reduce the likelihood of an eventual loss on the loan. When we have reason to believe that continued payment of interest and principal on any loan is unlikely, the loan is placed on a non-accrual status (that is, accrual of interest on the loan is discontinued and any previously accrued but unpaid interest on the loan is reversed and, therefore, the loan ceases to be an earning asset for the Company). The Company has established practices and guidelines to increase its efforts to recover all amounts due us that become delinquent in the future, which may include the initiation of foreclosure proceedings against the collateral securing the loan.

The Company will consider any loan to be impaired when, based upon current information and events, it is probable that interest and principal will not be collected according to the contractual terms of the original loan agreement. In determining impairment, we evaluate, both performing and non-performing loans, which exhibit, among other characteristics, high loan-to-value ratios, low debt-coverage ratios, delinquent loan payments or other indications that the borrowers are experiencing increased financial difficulties. In general, payment delays of less than 90 days or payment shortfalls of less than 1% are deemed insignificant and, for that reason, would not necessarily result in the classification of such loans as impaired. The Company generally considers all non-accrual and troubled debt restructured loans to be impaired. At December 31, 2015 and 2014, all classified loans within the loan portfolio were evaluated for possible impairment, of which 7 loans for a total of $1.2 million were considered to be impaired at December 31, 2015 and 7 loans for a total of $2.7 million were considered to be impaired at December 31, 2014.

 

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All loans that become identified as impaired are generally placed on a non-accrual status and are evaluated at that time and regularly thereafter to determine whether the carrying value of the loan should be written off or reserved for or partially written-down to its recoverable value (net realizable value), or whether the terms of the loan, including the collateral required to secure the loan, should be renegotiated with the borrower. Impaired loans will be charged-off or partially charged-off when the possibility of collecting the full balance of the loan becomes remote. Information regarding the Company’s allowance for loan loss is set forth below in this section of this report under the caption, “Allowance for Loan Loss.”

In addition, the Company has loans classified as substandard of $40 million and $30 million at December 31, 2015 and 2014, respectively. This balance includes impaired loans of $1.2 million and purchased credit impaired loans of $847 thousand at December 31, 2015, compared to impaired loans of $2.4 million and purchased credit impaired loans of $1.3 million at December 31, 2014. These potential problem loans are loans that have a well-defined weakness based on objective evidence. For these potential problem loans, there is a possibility that the Company could incur some loss if the weakness is not properly corrected. At December 31, 2015 and 2014, management expects full repayment of principal and interest on all loans that are on accrual status.

Allowance for Loan Loss

The Company maintains an allowance for loan loss (“Allowance”) to provide for probable charge-offs in the loan portfolio. Additions to the Allowance are made by charges to operating expense in the form of a provision for loan losses. Loan charge-offs are charged against the Allowance when management believes the collectability of the loan principal becomes unlikely. Subsequent recoveries, if any, are credited to the Allowance.

The Allowance is an amount that management believes is adequate to absorb estimated charge-offs related to specifically identified loans, as well as probable loan charge-offs inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior charge-off experience.

The Allowance consists of specific and general components. The specific component relates to loans that are identified as impaired. The general component covers non-impaired loans and is based on the historical charge-off experience in various loan segments adjusted for qualitative factors.

A loan is identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the original loan agreement. Generally these loans are rated substandard or worse. Most impaired loans are classified as nonaccrual. However, there are some loans that are termed impaired due to doubt regarding collectability according to contractual terms, but are both fully secured by collateral and are current in their interest and principal payments. Impaired loans are measured for reserve requirements based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. The amount of an impairment reserve, if any and any subsequent increase in impairment is charged against the Allowance. Factors that contribute to a performing loan being classified as impaired include payment status, collateral value, probability of collecting scheduled payments, delinquent taxes and debts to other lenders that cannot be serviced out of existing cash flow.

A loan is classified as a troubled debt restructuring when a borrower is experiencing financial difficulties that leads to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider for new debt of similar risk. The loan terms which have been modified or restructured due to a borrower’s financial difficulty may include a reduction in the stated interest rate, an extension of the maturity at an interest rate below current market interest rates, a reduction in the face amount of the debt (principal forgiveness), a reduction in the accrued interest or payment amount, or re-aging, extensions, deferrals, renewals, rewrites and other actions intended to minimize potential losses.

 

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The restructured loans may be categorized as “special mention” or “substandard” depending on the severity of the modification. Regardless, all modified loans that are classified as troubled debt restructurings are evaluated for impairment at modification. Loans that were paid current at the time of modification may be upgraded in their classification after a sustained period of repayment performance, usually six months or longer.

Loans that are past due at the time of modification are categorized as “substandard” and placed on non-accrual status. Once there is a sustained period of repayment performance (usually six months or longer) and there is a reasonable assurance that the repayment of principal and interest will continue based on a current credit evaluation, those loans may be upgraded in their classification and placed on accrual status.

The Company has instituted loan policies designed to adequately evaluate and analyze the risk factors associated with our loan portfolio and to enable us to analyze such risk factors prior to granting new loans and to assess the sufficiency of the Allowance. We conduct a critical evaluation of the loan portfolio quarterly and have an external review of the loan portfolio conducted once to twice a year. The Allowance is based on the historical loan loss experience of the portfolio loan segments for the past 20 quarters, however the Bank utilizes Uniform Bank Peer Group (“UBPR”) historical loss data to evaluate potential loss exposure for those loan segments where the Company had no meaningful historical loss experience. The Allowance also includes an assessment of the following qualitative factors: the results of any internal and external loan reviews and any regulatory examination, loan charge-off experience, estimated potential charge-off exposure on each classified loan, credit concentrations, changes in the value of collateral for collateral dependent loans, and any known impairment in the borrower’s ability to repay. The Company also evaluates environmental and other factors such as underwriting standards, staff experience, the nature and volume of loans and loan terms, business conditions, political and regulatory conditions, local and national economic trends. The quantitative portion of the Allowance is adjusted for qualitative factors to account for model imprecision and to incorporate the range of probable outcomes inherent in the estimates used for the Allowance.

Each quarter the Company reviews the Allowance and makes additional provisions to the Allowance as needed based on a review of the factors discussed above. At December 31, 2015, the allowance for loan loss was $15.7 million, or 0.86% of total loans. This compares with the Allowance of $12.6 million, or 0.78% of outstanding loans at December 31, 2014, and $10.6 million or 1.14% of outstanding loans at December 31, 2013.

The Allowance increased $3.1 million, to $16 million at December 31, 2015 from $13 million at December 31, 2014 due to a provision for loan losses of $5.1 million and net charge-offs of $2.0 million. The allowance for loan loss as a percentage of total loans was 0.86% at December 31, 2015 and 0.78% at December 31, 2014. The Allowance as a percentage of loans (excluding loan balances and the related Allowance on loans acquired through acquisition) was 1.25% and 1.39% at December 31, 2015 and 2014, respectively. The decrease in the allowance ratio related to organic loans was directly attributable to gradual improvements in the economic conditions within the Company’s markets, as well as a continued low level of non-performing assets at December 31, 2015.

The Company’s management considered the following factors in evaluating the Allowance at December 31, 2015 and 2014:

 

   

As of December 31, 2015 there were net loan charge-offs of $2.0 million

 

   

There were $2.5 million in gross loan charge-offs as of December 31, 2015 primarily due to two large loan relationships

 

   

There were fifteen non-accrual loans totaling $2.1 million

 

   

The overall growth and composition of the loan portfolio

 

   

Changes to the overall economic conditions within the markets in which the Company makes loans

 

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Concentrations within the loan portfolio, as well as risk conditions within its commercial and industrial loan portfolio

 

   

The remaining fair value adjustments on loans acquired through acquisition with special attention to the fair value adjustments associated with the purchased credit impaired loans

The Allowance and the reserve for unfunded loan commitments are significant estimates that can and do change based on management’s process in analyzing the loan portfolio and on management’s assumptions about specific borrowers and applicable economic and environmental conditions, among other factors. In considering all of the above factors, management believes that the Allowance at December 31, 2015 is adequate. Although the Company maintains its Allowance at a level which it considers adequate to provide for probable charge-offs, there can be no assurance that such charge-offs will not exceed the estimated amounts, thereby adversely affecting future results of operations.

Loans acquired through acquisition are recorded at fair value at acquisition date without a carryover of the related Allowance. Loans acquired with deteriorated credit quality are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect principal and interest payments according to contractual terms. These loans are accounted for under ASC Subtopic 310-30 Receivables — Loans and Debt Securities Acquired with Deteriorated Credit Quality. Evidence of credit quality deterioration as of the acquisition date may include factors such as past due and non-accrual status. The difference between undiscounted contractually required payments at acquisition and the undiscounted cash flows expected to be collected at acquisition is referred to as the credit loss or non-accretable yield. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Subsequent decreases to the expected cash flows will result in a provision for loan losses.

The following is a summary of activity in the allowance for loan loss and certain pertinent ratios for the periods indicated (dollars in thousands):

 

     December 31,  
     2015     2014     2013     2012     2011  

Allowance for loan loss at beginning of year

   $ 12,610      $ 10,603      $ 8,803      $ 7,495      $ 5,860   

Provision for loan losses

     5,080        2,239        2,852        1,768        1,442   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries:

          

Loans charged-off:

          

Commercial and Industrial

     (2,218     (619     (1,704     (444     (482

Construction, Land Development and Other Land

     —          —          —          —          (100

Commercial and Other Real Estate

     (292     (73     (200     (233     —     

Consumer and Other

     —          —          (8     (10     (11
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

     (2,510     (692     (1,912     (687     (593
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Commercial and Industrial

     497        354        70        76        786   

Construction, Land Development and Other Land

     —          —          763        —          —     

Commercial and Other Real Estate

     5        106        12        139        —     

Other

     —          —          15        12        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     502        460        860        227        786   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     (2,008     (232     (1,052     (460     193   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan loss at end of year

   $ 15,682      $ 12,610      $ 10,603      $ 8,803      $ 7,495   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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As is set forth in the following table, the Allowance is allocated among the different loan segments because there are differing levels of risk associated with each loan segment. However, the allowance for loan loss allocated to specific loan segments are not the total amounts available for future charge-offs that might occur within such segments because the total allowance for loan loss is applicable to the entire portfolio.

 

(Dollars in thousands)   December 31,  
    2015     2014     2013     2012     2011  
    Allowance
for Loan
Loss
    % of
Loans to
Total
Loans
    Allowance
for Loan
Loss
    % of
Loans to
Total
Loans
    Allowance
for Loan
Loss
    % of
Loans to
Total
Loans
    Allowance
for Loan
Loss
    % of
Loans to
Total
Loans
    Allowance
for Loan
Loss
    % of
Loans to
Total
Loans
 

Commercial and Industrial

  $ 5,924        29   $ 5,864        33   $ 5,534        32   $ 4,572        31   $ 3,541        38

Construction, Land Development and Other Land

    2,076        7        1,684        4        1,120        5        2,035        6        752        7   

Commercial and Other Real Estate

    6,821        62        4,802        61        3,886        61        2,084        61        2,911        51   

Consumer and Other

    861        2        260        2        63        2        112        2        291        4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 15,682        100   $ 12,610        100   $ 10,603        100   $ 8,803        100   $ 7,495        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Deposits

Total deposits increased $339 million to $2.3 billion at December 31, 2015, primarily due to a $255 million increase in non-interest bearing demand deposits, a $55 million increase in interest bearing transaction accounts and a $35 million increase in money market and savings deposits, offset by a decrease of $6 million in certificates of deposit. The increases in these deposits are primarily related to strong organic deposit growth in 2015 which demonstrates the Company’s focus on its relationship-based, business-banking franchise model. Non-interest bearing deposits represented 56% and 53% of total deposits at December 31, 2015 and 2014 respectively.

The following table summarizes the distribution of total deposits by branch as of December 31, 2015 (dollars in thousands):

 

     December 31,
2015
 

Irvine

   $ 543,204   

Los Angeles

     339,613   

West Los Angeles

     327,799   

Encino

     293,409   

Conejo Valley

     248,137   

Anaheim

     223,836   

South Bay

     113,850   

Inland Empire

     109,306   

Santa Clarita

     87,637   
  

 

 

 

Total

   $ 2,286,791   
  

 

 

 

The Company experienced growth in all deposit categories except for certificates of deposit during 2015. Non-interest bearing demand deposits increased by $255 million or 25% to $1.3 billion and represented 56% of total deposits at December 31, 2015, up from 53% at December 31, 2014. Average non-interest bearing demand deposits as a percentage of the Company’s average outstanding deposits were 53% and 54% for the years ended December 31, 2015, 2014, respectively.

 

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The Company’s interest bearing transaction accounts increased by $55 million, or 26% to $261 million as of December 31, 2015 compared to the prior year-end. The overall rate paid by the Company on its interest bearing transaction accounts averaged 0.16% in 2015 and 0.18% in 2014.

The Company’s money market and savings deposits increased by $35 million or 6%, to $679 million as of December 31, 2015 compared to the prior year-end. The overall rate paid by the Company on its money market and savings deposits averaged 0.24% in 2015 compared to 0.25% in 2014.

The Company’s certificates of deposit decreased by $6.3 million, or 10% to $59 million as of December 31, 2015 compared to the prior year-end. At December 31, 2015, $58 million of total time deposits mature within one year. The overall rate paid by the Company on its certificates of deposit averaged 0.31% in 2015 compared to 0.35% in 2014. Over the past several years, the Company has effectively lowered the rate paid on its maturing certificate of deposits. The Company’s growth in core deposits during the last several years provided the liquidity to absorb the runoff of higher cost certificates of deposit.

The Company’s business is not seasonal in nature and is not dependent upon funds from sources outside the United States. It is the Company’s strategy to rely on deposits from its customers rather than utilizing brokered deposits. Certain types of customers (such as fiduciaries and trustees) may require FDIC insurance coverage greater than what can be offered by one bank under applicable law. In these cases, the Company offers two programs, CDARS® (Certificate of Deposit Account Registry Service) that places certificates of deposit with participating institutions on a reciprocal basis, which means that the Company receives deposits in amounts and at rates equivalent to those its customers place with CDARS® participating banks. The second program Insured Cash Sweep® “ICS®” deposit program provides for the placement of reciprocal non-interest bearing demand deposits with participating institutions. These reciprocal deposits under both programs, while classified on reports to federal regulatory agencies as “brokered deposits” differ substantially from traditional brokered deposits because they are equivalent to deposits placed by the Company’s customers. These “reciprocal” transactions are facilitated by Promontory Interfinancial Network, LLC. CDARS® and ICS® reciprocal deposits are not considered brokered deposits for calculation of FDIC insurance premiums. At December 31, 2015 and 2014, these CDARS® and ICS® reciprocal deposits were the only brokered funds held by the Company. The Company has continued to use these programs for customers that must have full FDIC coverage on their deposit balances. CDARS® certificates of deposit balances remained at $29 million at December 31, 2014 and 2015. The Company began offering the ICS® program during 2013, and has a balance of $9.3 million at December 31, 2015. The Company does not engage in any advertising of its certificates of deposit products.

The following table summarizes the distribution of the average deposit balances and the average rates paid on deposits during the years ended December 31, 2015, 2014 and 2013 (dollars in thousands):

 

     Analysis of Average Deposits  
     Years Ended December 31,  
     2015     2014     2013  
     Amount     %
Rate
    Amount     %
Rate
    Amount      %
Rate
 

Non-interest bearing demand deposits

   $ 1,151,075        —     $ 704,437        —     $ 587,637         —  

Interest-bearing transaction deposits

     258,444        0.16     153,327        0.18     130,247         0.18

Money market and savings deposits

     690,065        0.24     390,185        0.25     361,486         0.28

Time deposits

     61,275        0.31     61,048        0.35     65,943         0.39
  

 

 

     

 

 

     

 

 

    

Total Deposits

   $ 2,160,859        0.10   $ 1,308,997        0.11   $ 1,145,313         0.13
  

 

 

     

 

 

     

 

 

    

Securities Sold Under Agreements to Repurchase

The Company has developed an overnight sweep program in order to accommodate several of our sophisticated business customers, many of whom act as fiduciaries, and thus require additional security in excess

 

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of FDIC insurance limits. Under this overnight sweep program, excess funds over a specified amount in the customers demand deposit account are automatically swept into securities sold under agreements to repurchase, (“repos”). For these business customers, the Company enters into certain transactions, the legal forms of which are sales of securities under agreements to repurchase at a later date at a set price. Repos are classified as secured borrowings and generally mature the next business day (“overnight repos”) but may extend the maturity up to 180 days (“term repos”) from the issue date. The Company’s repos at December 31, 2015 and 2014 have been concentrated in the overnight repo program. Under the overnight repo program, the Company’s business deposit customers have their excess deposit balances over an established limit automatically swept into this product on an overnight basis. The following business day, the repos mature and the matured fund balances are re-deposited back into the customer’s demand deposit account. At December 31, 2015, the Company had $14 million in the overnight repo program (repos maturing on January 4, 2016). The repo balances increased by $5 million, or 53%, to $14 million at December 31, 2015, from the $9.4 million at December 31, 2014. The Company pledges certain investment securities as collateral for the Repo program. Securities with a fair market value of $47 million and $32 million were pledged to secure the repos at December 31, 2015 and 2014, respectively. The Company considers the funds maintained under the overnight repo program to be a stable and reliable source of funding for the Company. The Company does not advertise this product and generally limits it to businesses and other sophisticated customers.

Details regarding the Company’s repos are reflected in the table below (dollars in thousands):

 

    2015     2014     2013  
    Balances
at Year-
end
    Average
Balance
    Weighted
Average
Rate
    Balances
at Year-
end
    Average
Balance
    Weighted
Average
Rate
    Balances
at Year-
end
    Average
Balance
    Weighted
Average
Rate
 

Securities sold under agreements to repurchase

  $ 14,360      $ 13,966        0.22   $ 9,411      $ 13,579        0.19   $ 11,141      $ 24,376        0.30

The maximum amount of outstanding repos at any month-end was $17 million, $16 million and $30 million in 2015, 2014 and 2013, respectively.

Capital Resources

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital requirements that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company currently includes in Tier 1 capital an amount of subordinated debentures equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity less goodwill, core deposit intangibles and a portion of the SBA servicing assets. On July 2, 2013, the Board of Governors of the Federal Reserve System (“Federal Reserve”) approved a final rule (the “Final Rule”) that revises the current capital rules for U.S. banking organizations including the capital rules for the Company. The FDIC adopted the rule as an “interim final rule” on July 9, 2013. The Final Rule implements the regulatory capital reforms recommended by the Basel Committee. The Final Rule permanently grandfathers non-qualifying capital instruments (such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the Tier 1 Risk-Based Capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009, such as the Company. As a result the Company’s trust preferred securities will continue to be included in Tier 1 risk-based capital. The Company also currently

 

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includes in its Tier 1 capital an amount of Non-Cumulative Perpetual Preferred Stock, Series A issued under the SBLF program. The U.S. Department of the Treasury is the sole holder of all outstanding shares of CU Bancorp Preferred Stock. Under the Final Rule, the CU Bancorp Preferred Stock will continue to be included in Tier 1 Risk-based capital.

As of December 31, 2015, the Company and the Bank are categorized as well-capitalized under the regulatory framework for Prompt Corrective Action. To be categorized as well-capitalized, the Company and Bank must maintain minimum Total risk-based capital, Tier 1 risk-based capital, Common equity tier 1 and Tier 1 leverage ratios, as set forth in the following table.

The following tables present the Total risk-based capital ratio, Tier 1 risk-based capital ratio, Common equity tier 1 ratio and the Tier 1 leverage ratio of the consolidated Company in addition to the Bank as of December 31, 2015, and December 31, 2014, and compare the actual ratios to the capital requirements imposed by government regulations. All amounts reflected in the table below are stated in thousands, except percentages:

CU Bancorp

 

     December 31,
2015
    December 31,
2014
    Adequately
Capitalized
    Well
Capitalized
 
     Amount     Amount     (greater than or equal to)  

Regulatory Capital Ratios:

        

Tier 1 leverage ratio

     9.67     12.92     4.0     5.00

Common Equity Tier 1 ratio

     9.61     —          4.5     6.5

Total Tier 1 risk-based capital ratio

     10.85     10.95     6.0     8.0

Total risk-based capital ratio

     11.54     11.61     8.0     10.0

Regulatory Capital Data:

        

Common Equity Tier 1

   $ 223,977        —         

Total Tier 1 capital

     252,681      $ 218,147       

Total risk-based capital

     268,971        231,228       

Average total assets

     2,611,774        1,689,096       

Risk-weighted assets

     2,329,770        1,992,043       

California United Bank:

 

     December 31,
2015
    December 31,
2014
    Adequately
Capitalized
    Well
Capitalized
 
     Amount     Amount     (greater than or equal to)  

Regulatory Capital Ratios:

        

Tier 1 leverage ratio

     9.34     12.44     4.0     5.0

Common Equity Tier 1 ratio

     10.47     —          4.5     6.5

Total Tier 1 risk-based capital ratio

     10.47     10.55     6.0     8.0

Total risk-based capital ratio

     11.17     11.20     8.0     10.0

Regulatory Capital Data:

        

Common Equity Tier 1

   $ 243,989        —         

Tier 1 capital

     243,989      $ 210,031       

Total risk-based capital

     260,279        223,112       

Average total assets *

     2,612,206        1,688,308       

Risk-weighted assets

     2,329,798        1,991,253       

 

* Represents the average total assets for the leverage ratio

 

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Liquidity

The following table provides a summary of the Company’s primary and secondary liquidity levels at the dates indicated (dollars in thousands):

 

     December 31,
2015
    December 31,
2014
 
     Amount     Amount  

Primary Liquidity- On Balance Sheet:

    

Cash and due from banks

   $ 50,960      $ 33,996   

Interest-earning deposits in other financial institutions

     171,103        98,590   

Investment securities available-for-sale

     315,785        226,962   

Less: pledged cash and due from banks

            (1,500

Less: pledged investment securities

     (197,251     (148,805
  

 

 

   

 

 

 

Total primary liquidity

   $ 340,597      $ 209,243   
  

 

 

   

 

 

 

Ratio of primary liquidity to total deposits

     14.9     10.7

Additional Liquidity Not Included In Primary Liquidity:

    

Certificates of deposit in other financial institutions

   $ 56,860      $ 76,433   

Less: Certificate of deposits pledged

     (2,731     (2,731
  

 

 

   

 

 

 

Total additional liquidity

   $ 54,129      $ 73,702   
  

 

 

   

 

 

 

Secondary Liquidity — Off-Balance Sheet:

    

Available Borrowing Capacity:

    

Total secured borrowing capacity with FHLB

   $ 544,132      $ 484,669   

Fed Funds borrowing lines

     72,000        71,000   

Secured credit line with the FRBSF

     18,708        17,528   
  

 

 

   

 

 

 

Total secondary liquidity

   $ 634,840      $ 573,197   
  

 

 

   

 

 

 

As of December 31, 2015, the Company’s primary overnight source of liquidity consisted of the balances reflected in the table above. The Company’s primary liquidity consisted of cash and due from banks and interest-earning deposits in other financial institutions. The amount of funds maintained directly with the Federal Reserve included in interest-earning deposits in other financial institutions was $102 million and $60 million, at December 31, 2015 and December 31, 2014, respectively. The next source of liquidity is the Company’s collateralized borrowings and unsecured borrowing facilities. In addition, the Company has $57 million of certificates of deposits in other financial institutions where the weighted average maturity is approximately 6.9 months that could be utilized over time to supplement the liquidity needs of the Company.

The Company’s primary long term source of funding has come from the liability side of the balance sheet and has historically been through the growth in non-interest bearing and interest bearing core deposits from its customers. Additional sources of funds from the Company’s asset side of the balance sheet have included Federal Funds sold, interest-earning deposits with other financial institutions, balances maintained with the Federal Reserve Bank, certificates of deposit in other financial institutions and payments of principal and interest on loans and investment securities. While maturities and scheduled principal amortization on loans are a reasonably predictable source of funds, deposit flows and loan prepayments are greatly influenced by the level of interest rates, economic conditions and competition.

As an additional source of liquidity, the Company maintains credit facilities, “Fed Funds Borrowing Lines,” of $72 million and $71 million at December 31, 2015 and December 31, 2014, respectively, with its primary correspondent banks for the purchase of overnight Federal funds. The lines are subject to availability of funds and have restrictions as to the number of days and length used during a month. At December 31, 2015 and December 31, 2014, $5 million of these credit facilities required the pledging of investment securities collateral.

 

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The Company has established a secured credit facility with the FHLB of San Francisco which allows the Bank to borrow up to 25% of the Bank’s total assets, which equates to a credit line of approximately $651 million at December 31, 2015. The Company currently has no outstanding borrowings with the FHLB. As of December 31, 2015, the Company had $821 million of loan collateral pledged with the FHLB. This level of loan collateral would provide the Company with $544 million in borrowing capacity. Any amount of borrowings in excess of the $544 million would require the Company to pledge additional collateral. In addition, the Company must maintain a certain investment level in the common stock of the FHLB. The Company’s investment in the common stock of the FHLB is $8 million at December 31, 2015. This level of capital would allow the Company to borrow up to $297 million. Any advances from the FHLB in excess of the $297 million would require additional purchases of FHLB common stock. The Company had $20 million pledged with the FHLB at December 31, 2015.

The Company maintains a secured credit facility with the Federal Reserve Bank of San Francisco (“FRBSF”) which is collateralized by investment securities pledged with the FRB. At December 31, 2015, the Company’s available borrowing capacity was $19 million.

The Company maintains investments in certificates of deposit with other financial institutions, with various balances maturing monthly. The Company had balances of $57 million and $76 million at December 31, 2015 and December 31, 2014, respectively. At both December 31, 2015 and 2014, $2.7 million of the Company’s certificates of deposit with other financial institutions were pledged as collateral as credit support for the interest rate swap contracts and are not available as a source of liquidity.

At December 31, 2015 and December 31, 2014, $0 and $1.5 million of the Company’s due from bank balances was pledged as collateral as credit support for the interest rate swap contracts and is not available as a source of liquidity.

The Company’s commitments to extend credit (off-balance sheet liquidity risk) are agreements to lend funds to customers as long as there are no violations as established in the loan agreement. Many of the commitments are expected to expire without being drawn upon, and as such, the total commitment amounts do not necessarily represent future cash requirements. Financial instruments with off-balance sheet risk for the Company include both undisbursed loan commitments, as well as undisbursed letters of credit. The Company’s exposure to extend credit was $806 million and $720 million at December 31, 2015 and December 31, 2014, respectively.

Holding Company Liquidity

The primary sources of liquidity for CU Bancorp (“the holding company”), on a stand-alone basis, include the ability to raise capital through the issuance of capital stock, issue subordinated debt, secure outside borrowings and receive dividend payments from the Bank. The payment of dividends from the Bank to the holding company is the primary source of liquidity. The ability of the holding company to obtain funds for the payment of dividends to our stockholders and for the payment of holding company expenses is largely dependent upon the Bank’s earnings and retained earnings. The Bank is subject to restrictions under certain federal and state laws and regulations which limit its ability to transfer funds to the holding company through cash dividends, intercompany loans and or advances.

Dividends paid by state banks, such as California United Bank, are regulated by the California Department of Business Oversight “DBO” under its general supervisory authority, as it relates to a bank’s capital requirements. A state bank may declare a dividend without the approval of the DBO as long as the total dividends declared in a calendar year do not exceed either the retained earnings or the total of net profits for three previous fiscal years less any dividends paid during such period. The Bank has never paid a dividend to the holding company.

 

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CU Bancorp’s liquidity on a stand-alone basis was $6.8 million and $4.6 million, in cash on deposit at the Bank, at December 31, 2015 and December 31, 2014, respectively. Management believes this amount of cash is currently sufficient to fund the holding company’s cash flow needs over at least the next twelve to twenty-four months.

Aggregate Contractual Obligations

The following table summarizes the aggregate contractual obligations as of December 31, 2015 (amounts in thousands):

 

     Maturity/Obligation by Period  
     Total      Less than
One Year
     One
Year to
Three
Years
     Four
Years to
Five
Years
     After
Five
Years
 

Deposits

   $ 2,286,791       $ 2,286,255       $ 536       $ —         $ —     

Securities sold under agreements to repurchase

     14,360         14,360         —           —           —     

Subordinated debentures

     12,372         —           —           —           12,372   

Operating leases

     17,866         3,387         5,811         4,550         4,118   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,331,389       $ 2,304,002       $ 6,347       $ 4,550       $ 16,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For deposits, securities sold under agreements to repurchase and subordinated debentures, the dollar balances reflected in the table above are categorized by the maturity date of the obligation.

Deposits represent both non-interest bearing and interest bearing deposits. Non-interest bearing demand deposits include demand deposit accounts which represent 56% of the total deposit balances at December 31, 2015. Interest bearing deposits include interest bearing transaction accounts, money market and savings deposits and certificates of deposit.

Securities sold under agreements to repurchase “Repos” represent sales of securities under agreements to repurchase at a later date at a set price. While Repos have fixed maturity dates, the majority of the Company’s repos mature on an overnight “next business day” basis.

Subordinated debentures represent notes issued to capital trusts which were formed solely for the purpose of issuing trust preferred securities. These subordinated debentures were acquired as a part of the merger with PC Bancorp. The aggregate amount indicated above represents the full amount of the contractual obligation and does not include a purchase accounting fair value discount of $2.7 million. All of these securities are variable rate instruments. Each series has a maturity of 30 years from their approximate date of issue. All of these securities are currently callable at par with no prepayment penalties.

For operating leases, the dollar balances reflected in the table above are categorized by the due date of the lease payments. Operating leases represent the total minimum lease payments under non-cancelable operating leases.

ITEM 7A — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk arises primarily from credit risk, operational risk and interest rate risk inherent in our lending, investments, borrowings, and deposit taking activities. Risk management is an important part of the Company’s operations and a key element of its overall financial results. The FDIC, in recent years, has emphasized appropriate risk management, prompting banks to have adequate systems to identify, monitor and manage risks. The Company’s Board of Directors and committees meet on a regular basis to oversee operations. The Company’s business activities are monitored and various strategies to manage risk exposure are applied. The

 

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Board of Directors has adopted various policies and has empowered the committees with oversight responsibility concerning different aspects of our operations. The Company’s Audit and Risk Committee is responsible for overseeing internal auditing functions and for interfacing with independent outside auditors as well as compliance and related risk. The Company’s Loan Committee reviews large loans made by management, concentrations, portfolio and trend reports, minutes of management’s problem loan and special assets committee meetings and reviews with Audit and Risk Committee the external loan review reports on behalf of the Board of Directors. The Company’s Management Asset/Liability Risk Committee establishes the Investment Policy, Liquidity Policy and the Asset/Liability Policy, reviews investments purchases, and monitors the investment portfolio, interest rate risk, and liquidity management. All committees regularly report to the Board of Directors.

Credit risk

Credit risk is defined as the risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract or otherwise fail to perform as agreed. Credit risk is found in all activities where success depends on a counter party, issuer or borrower performance. Credit risk arises through the extension of loans, deposits in other financial institutions, certain investment securities, derivative instruments, other assets and off balance sheet commitments.

Credit risk in the investment portfolio and correspondent bank accounts is addressed through defined limits in the Company’s policies. Policy limitations on industry concentrations and house lending limits on aggregate customer borrowings, as well as underwriting standards to ensure loan quality are designed to reduce loan credit risk. Senior Management, Directors’ Loan Committees and the Board of Directors are provided with information to appropriately identify, measure, control and monitor the credit risk of the Company.

Credit risk in the investment securities area is addressed by the Company through a review of the Company’s securities by management on a quarterly basis. Credit risk within the securities portfolio is the risk that the Company will not be able to recover all of the principal value on its investment securities. This credit review process starts with the Company evaluating the securities portfolio to determine if there has been an other-than-temporary impairment on each of the individual securities in the investment securities portfolio. To determine if an other-than-temporary impairment exists on a debt security, the Company first determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Company will recognize an other-than-temporary impairment in earnings equal to the difference between the security’s fair value and its adjusted cost basis. If neither of the conditions is met, the Company determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss is the portion of the other-than-temporary impairments that is recognized in earnings and is a reduction to the cost basis of the security. The portion of total impairment related to all other factors is included in accumulated other comprehensive income (loss). Significant judgment of management is required in this analysis that includes, but is not limited to assumptions regarding the collectability of principal and interest, future default rates, future prepayment speeds, the amount of current delinquencies that will result in defaults and the amount of eventual recoveries expected on these defaulted loans through the foreclosure process.

Implicit in lending activities is the risk that losses will occur and that the amount of such losses will vary over time. Consequently, we maintain an allowance for loan loss (“Allowance”) by charging a provision for loan losses to earnings. Loans determined to be losses are charged against the Allowance. Our Allowance is maintained at a level considered by us to be adequate to provide for estimated probable losses inherent in the existing portfolio.

The Allowance is based upon estimates of probable losses inherent in the loan portfolio. The nature of the process by which we determine the appropriate Allowance requires the exercise of considerable judgment. The amount of losses (actual charge-offs) realized with respect to the Company’s loan portfolio can vary significantly

 

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from the estimated amounts. We employ a systematic methodology that is intended to reduce the differences between estimated and actual losses.

The Company’s methodology for assessing the appropriateness of the Allowance is conducted on a quarterly basis and considers all loans. The systematic methodology consists of two major elements.

The first major element includes a detailed analysis of the loan portfolio in two phases. Individual loans are reviewed to identify loans for impairment. A loan is impaired when principal and interest are deemed uncollectible in accordance with the original contractual terms of the loan. Impairment is measured as either the expected future cash flows discounted at each loan’s effective interest rate, the fair value of the loan’s collateral if the loan is collateral dependent or an observable market price of the loan (if one exists). Upon measuring the impairment, we will ensure an appropriate level of Allowance is present or established.

Central to the first phase of our credit risk management is our loan risk rating system. The originating relationship officer assigns borrowers an initial risk rating, which is reviewed and confirmed or possibly changed by Credit Management, which is based primarily on a thorough analysis of each borrower’s financial capacity and the loan underwriting structure, in conjunction with industry and economic trends. Approvals are granted based upon the amount of acceptable inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in payment performance or in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.

The Company augments its credit review function by engaging an outside party to review our loans twice a year. In 2015, the Company had two loan reviews conducted during the year by an outside third party. The first loan review was based on loan data as of March 31, 2015 and conducted May 18 through May 28, 2015, and the second review was based on loan data as of September 30, 2015 and conducted October 12 through October 23, 2015. The final loan review report was issued on July 1, 2015 for the first review, and on December 3, 2015 for the second review. The purpose of this review is to assess internal loan risk ratings, the adequacy and accuracy of impairment amount on impaired loans, the adequacy and accuracy of cash flow analysis, compliance with the accrual of interest rules, compliance with applicable laws and regulations, compliance with board-approved policies and procedures, identify any weak underwriting practices and to determine if there is any overall deterioration in the credit quality of the portfolio and to assess the adequacy of the Allowance.

The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar risk characteristics. In this second phase, groups of loans are reviewed to evaluate the historical loss experience, adjusted for qualitative factors in each category of loans, and then aggregated to determine a portfolio Allowance. Uniform Bank Peer Group loss experience is considered for those loan segments where the Company had no historical loss experience. The quantitative portion of the Allowance is adjusted for qualitative factors to account for model imprecision and to incorporate the range of probable outcomes inherent in the estimates used for the Allowance.

In the second major element of the analysis, all known relevant internal and external factors that may affect a loan’s collectability are considered. We also perform an evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowance. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the second element of the analysis of the Allowance include, but are not limited to the following conditions that existed as of the balance sheet date:

 

   

then-existing general economic and business conditions affecting the key lending areas of the Company

 

   

then-existing economic and business conditions of areas outside the lending areas, if any

 

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credit quality trends (including trends in non-performing loans expected to result from existing conditions)

 

   

collateral values

 

   

loan volumes and concentrations

 

   

seasoning of the loan portfolio

 

   

specific industry conditions within portfolio segments

 

   

recent loss experience in particular segments of the portfolio

 

   

duration of the current business cycle

 

   

bank regulatory examination results and

 

   

findings of the Company’s external credit review examiners

To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, our estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, our evaluation of the inherent loss related to such condition is reflected in the second major element of the Allowance. The relationship of the two major elements of the Allowance to the total Allowance may fluctuate from period to period. Although we have allocated a portion of the Allowance to specific loan categories, the adequacy of the Allowance must be considered in its entirety. See Lending and Allowance for Loan Losses section of Item 7, Management’s Discussion and Analysis on Financial Condition and Results of Operations for further discussion.

Interest Rate Risk

Interest rate risk is the exposure of a Company’s financial condition, both earnings and the market value of assets and liabilities, to adverse movements in interest rates. Interest rate risk results from differences in the maturity or timing of interest earning assets and interest bearing liabilities, changes in the slope of the yield curve over time, imperfect correlation in the adjustment of rates earned and paid on different instruments with otherwise similar characteristics (e.g. three-month Treasury bill versus three-month LIBOR) and from interest-rate-related options embedded in bank products (e.g. loan prepayments, floors and caps, callable investment securities, customers redeploying non-interest bearing to interest bearing deposits, etc.).

The potential impact of interest rate risk is significant because of the liquidity and capital adequacy consequences that reduced earnings or net operating losses caused by a reduction in net interest income could imply. We recognize and accept that interest rate risk is a routine part of bank operations and will from time to time impact our profits and capital position. The objective of interest rate risk management is to control exposure of net interest income to risks associated with interest rate movements in the market, to achieve consistent growth in net interest income and to profit from favorable market opportunities.

The careful planning of asset and liability maturities and the matching of interest rates to correspond with this maturity matching is an integral part of the active management of an institution’s net yield. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, net yields may be affected. Even when interest earning assets are perfectly matched to interest-bearing liabilities from a repricing standpoint, risks remain in the form of prepayment of assets, and the possibility of timing lags between when the assets reprices and the liabilities reprice (the repricing between the assets and liabilities may not happen at exactly the same time), and the possibility that the assets may not reprice to the same extent that the liabilities reprice due to different pricing indices that the products are tied to. In our overall attempt to match assets and liabilities, we take into account rates and maturities to be offered in connection with our certificates of deposit and our fixed rate as well as variable rate loans. Because of our ratio of rate sensitive assets to rate sensitive liabilities, the Company will be positively affected by an increasing interest rate market.

 

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Variable rate loans make up 74% of the loan portfolio; however, the Company has floors on some of its loans. At December 31, 2015, 34% of variable rate loans are at the floor and thus an increase in the underlying index may not necessarily result in an increase in the coupon until the loans index plus margin exceeds that floor. At December 31, 2015, 55% of the variable rate loans are tied to Prime index with $631 million subject to repricing within 30 days of a 25 basis point increase in Prime rate.

The Company had 19 pay-fixed, receive-variable interest rate contracts that were designed to convert fixed rate loans into variable rate loans, with remaining maturities extending out for up to eight years These swaps were acquired as a result of the PC Bancorp acquisition. The majority (seventeen of the nineteen interest rate swap contracts) are designated as accounting hedges and hedge accounting is applied at December 31, 2015. The total notional amount of the outstanding swaps contracts as of December 31, 2015 is $26 million. Additionally, at December 31, 2015, the Company had twelve interest rate swap agreements with customers and twelve offsetting interest-rate swaps with a counterparty bank that were acquired as a result of the merger with 1st Enterprise on November 30, 2014. The swap agreements are not designated as hedging instruments and hedge accounting is not applied. The purpose of entering into offsetting derivatives not designated as a hedging instrument is to provide the Company a variable-rate loan receivable and provide the customer the financial effects of a fixed-rate loan without creating significant volatility in the Company’s earnings. At December 31, 2015, the total notional amount of the Company’s swaps acquired from 1st Enterprise was $28 million.

Since interest rate changes do not affect all categories of assets and liabilities equally or simultaneously, a cumulative gap analysis alone cannot be used to evaluate our interest rate sensitivity position. To supplement traditional gap analysis, we perform simulation modeling to estimate the potential effects of changing interest rates. The process allows us to explore the complex relationships within the gap over time and various interest rate environments.

The following table is a summary of the Company’s one-year GAP as of the dates indicated (dollars in thousands):

 

     December 31,  
     2015      2014      Increase
(Decrease)
 

Total interest-sensitive assets maturing or repricing within one year (“one-year assets”)

   $ 1,335,781       $ 1,256,339       $ 79,442   

Total interest-sensitive liabilities maturing or repricing within one year (“one-year liabilities”)

     1,026,565         932,143         94,422   
  

 

 

    

 

 

    

 

 

 

One-year GAP

   $ 309,216       $ 324,196       $ (14,980
  

 

 

    

 

 

    

 

 

 

 

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The following tables present the Company’s GAP information as of the date indicated (dollars in thousands):

 

    Maturity or Repricing Data  
December 31, 2015   Three
Months or
Less
    Over Three
Through
Twelve
Months
    Over One
Year Through
Three Years
    Over Three
Years
    Non-Interest
Bearing
    Total  

Interest-Sensitive Assets:

           

Cash and due from banks

  $ —        $ —        $ —        $ —        $ 50,960      $ 50,960   

Interest earning deposits in other financial institutions

    171,103        —          —          —          —          171,103   

average yield

    0.41     —          —          —          —          0.41

Certificates of deposit in other financial institutions

    11,551        45,309        —          —          —          56,860   

average yield

    0.64     0.85       —          —          0.81

Investment securities

    12,703        126,351        86,373        133,803        —          359,230   

average yield

    1.84     1.26     1.19     2.03     —          1.55

Loans, gross (1)

    816,430        152,335        292,253        593,673        —          1,854,691   

average yield (2)

    4.03     4.88     4.49     4.41     —          4.29
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-sensitive assets

  $ 1,011,787      $ 323,995      $ 378,626      $ 727,476      $ 50,960      $ 2,492,844   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-Sensitive Liabilities:

           

Non-interest bearing demand deposits

  $ —        $ —        $ —        $ —        $ 1,288,085      $ 1,288,085   

Interest-bearing transaction accounts

    261,123        —          —          —          —          261,123   

average rate

    0.15     —          —          —          —          0.15

Money market and Savings deposits

    679,081        —          —          —          —          679,081   

average rate

    0.25     —          —          —          —          0.25

Certificates of deposit

    9,158        48,808        536        —          —          58,502   

average rate (3)

    0.21     0.22     0.25     —          —          0.22

Securities sold under agreements to repurchase

    14,360        —          —          —          —          14,360   

average rate

    0.23     —          —          —          —          0.23

Subordinated debentures

    12,372        —          —          —          —          12,372   

average rate (4)

    2.44     —          —          —          —          2.44

Swaps

    1,664        —          —          —          —          1,664   

average rate

    47.85     —          —          —          —          47.85

Total interest-sensitive liabilities

  $ 977,758      $ 48,808      $ 536      $ —        $ 1,288,085      $ 2,315,187   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GAP

  $ 34,029      $ 275,187      $ 378,090      $ 727,476      $ (1,237,125   $ 177,657   
           

 

 

 

Cumulative GAP

  $ 34,029      $ 309,216      $ 687,306      $ 1,414,782      $ 177,657     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

(1) Variable rate loans at or below their floor are categorized based on their maturity date.
(2) Excludes amortization of the net deferred loan fees and loan discount accretion.
(3) Excludes amortization of the fair value adjustments on the PC Bancorp certificates of deposit.
(4) Includes amortization of the fair value adjustments on these subordinated debentures.

 

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We also utilize the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The simulation model estimates the impact of changing interest rates on the interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company’s consolidated balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 100 and 400 basis point upward and 200 basis point downward shift in interest rates.

The following depicts the Company’s net interest income sensitivity analysis as of December 31, 2015:

 

Simulated Rate Changes

   Estimated Net Interest Income Sensitivity
(dollars in thousands)
 

+ 400 basis points

     31.4   $ 26,245   

+ 100 basis points

     7.7   $ 6,417   

- 200 basis points (1)

     (7.6 )%    $ (6,321

 

(1) The simulated rate change under the -200 basis points reflected above actually reflects only a maximum negative 46 basis points or less decline in actual rates based on the targeted Fed Funds target rate by the government of 0.25% to 0.50%. The -200 simulation model reflects repricing of the Company’s earning assets of between 0% to 0.46% with little to no repricing of the liabilities at the current levels.

The Company is currently asset sensitive. The estimated sensitivity does not necessarily represent our forecast and the results may not be indicative of actual changes to our net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, pricing strategies on loans and deposits and replacement of asset and liability cash flows. The duration of the Company’s investment securities portfolio at December 31, 2015 is approximately 2.1 years. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.

Because of our ratio of rate sensitive assets to rate sensitive liabilities, we tend to benefit from an increasing interest rate market and, conversely, suffer in a decreasing interest rate market. As such, the management of interest rates and inflation through national economic policy may have an impact on our earnings. Increases in interest rates may have a corresponding impact on the ability of borrowers to repay loans with us.

Inflation

The impact of inflation on a financial institution can differ significantly from that exerted on other companies. Banks, as financial intermediaries, have many assets and liabilities that may move in concert with inflation both as to interest rates and value. However, financial institutions are affected by inflation’s impact on non-interest expenses, such as salaries and occupancy expenses.

 

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ITEM 8 — FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CU BANCORP

INDEX TO FINANCIAL STATEMENTS

AND FINANCIAL STATEMENT SCHEDULES

 

     Page  

Report of Independent Registered Public Accounting Firm

     97   

Consolidated Financial Statements

  

Consolidated Balance Sheets

     98   

Consolidated Statements of Income

     99   

Consolidated Statements of Comprehensive Income

     100   

Consolidated Statements of Shareholders’ Equity

     101   

Consolidated Statements of Cash Flows

     102   

Notes to Consolidated Financial Statements

     104   

ITEM 9 — CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A — CONTROLS AND PROCEDURES

a)  Evaluation of disclosure controls and procedures

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 (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of our fiscal year. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure.

b)  Changes in internal controls over financial reporting

There have been no changes in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) identified during the fiscal quarter that ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f). Our internal control system was designed to provide reasonable assurance to management and the board of directors regarding the effectiveness of our internal control processes over the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

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We have assessed the effectiveness of our internal controls over financial reporting as of December 31, 2015 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued in 2013. Based on our assessment, we believe that, as of December 31, 2015, our internal control over financial reporting is effective based on those criteria.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

ITEM 9B — OTHER INFORMATION

None

PART III

 

ITEM 10 — DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding executive officers is included in Part I of this Form 10-K as permitted by General Instruction G(3).

The additional information required by this item will appear in the Company’s definitive proxy statement for the 2016 Annual Meeting of Stockholders (the “2016 Proxy Statement”), and such information either shall be (i) deemed to be incorporated herein by reference from that portion of the 2016 Proxy Statement, if filed with the SEC pursuant to Regulation 14A not later than 120 days after the end of the Company’s most recently completed fiscal year, or (ii) included in an amendment to this report filed with the SEC on Form 10-K/A not later than the end of such 120 day period.

ITEM 11 — EXECUTIVE COMPENSATION

The information required by this item will appear in the 2016 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the 2016 Proxy Statement, if filed with the SEC pursuant to Regulation 14A not later than 120 days after the end of the Company’s most recently completed fiscal year, or (ii) included in an amendment to this report filed with the SEC on Form 10-K/A not later than the end of such 120 day period.

ITEM 12 — SECURITY OWNSERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT RELATED STOCK HOLDERS MATTERS

See Item 14. below.

ITEM 13 — CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

See Item 14. below

ITEM 14 — PRINCIPAL ACCOUNTANT FEES AND SERVICES

Pursuant to General Instruction G(3), the information required to be furnished by ITEMS 12, 13 and 14 of Part III will appear in the 2016 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the 2016 Proxy Statement, if filed with the SEC pursuant to Regulation 14A not later than

 

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120 days after the end of the Company’s most recently completed fiscal year, or (ii) included in an amendment to this report filed with the SEC on Form 10-K/A not later than the end of such 120 day period.

Employee Code of Conduct

CU Bancorp has adopted a Code of Conduct (the CU Bancorp Principles of Business Conduct and Ethics) that applies to all employees, directors and officers, including the Company’s principal executive officer, principal financial and accounting officer. The Code of Conduct is also applicable to the Board of Directors and can also be located on the Company’s website by visiting www.cunb.com under Investor Relations. A copy of the Code of Conduct is available, without charge, upon written request to CU Bancorp, Human Resources, 15821 Ventura Blvd., Suite 100, Encino, CA 91436.

PART IV

 

ITEM 15 — EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) Documents Filed as Part of this Report

Financial Statements

Reference is made to the Index to Financial Statements for a list of financial statements filed as part of this Report.

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

CU Bancorp

We have audited the accompanying consolidated balance sheets of CU Bancorp and its subsidiaries (the Company) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.

/s/RSM US LLP

Los Angeles, California

March 14, 2016

 

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CU BANCORP

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

     December 31,  
     2015     2014  

ASSETS

    

Cash and due from banks

   $ 50,960      $ 33,996   

Interest earning deposits in other financial institutions

     171,103        98,590   
  

 

 

   

 

 

 

Total cash and cash equivalents

     222,063        132,586   

Certificates of deposit in other financial institutions

     56,860        76,433   

Investment securities available-for-sale, at fair value

     315,785        226,962   

Investment securities held-to-maturity, at amortized cost

     42,036        47,147   
  

 

 

   

 

 

 

Total investment securities

     357,821        274,109   

Loans

     1,833,163        1,624,723   

Allowance for loan loss

     (15,682     (12,610
  

 

 

   

 

 

 

Net loans

     1,817,481        1,612,113   

Premises and equipment, net

     5,139        5,377   

Deferred tax assets, net

     17,033        16,504   

Other real estate owned, net

     325        850   

Goodwill

     64,603        63,950   

Core deposit and leasehold right intangibles

     7,671        9,547   

Bank owned life insurance

     49,912        38,732   

Accrued interest receivable and other assets

     35,734        34,916   
  

 

 

   

 

 

 

Total Assets

   $ 2,634,642      $ 2,265,117   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

LIABILITIES

    

Non-interest bearing demand deposits

   $ 1,288,085      $ 1,032,634   

Interest bearing transaction accounts

     261,123        206,544   

Money market and savings deposits

     679,081        643,675   

Certificates of deposit

     58,502        64,840   
  

 

 

   

 

 

 

Total deposits

     2,286,791        1,947,693   

Securities sold under agreements to repurchase

     14,360        9,411   

Subordinated debentures, net

     9,697        9,538   

Accrued interest payable and other liabilities

     16,987        19,283   
  

 

 

   

 

 

 

Total Liabilities

     2,327,835        1,985,925   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 7 and Note 21)

    

SHAREHOLDERS’ EQUITY

    

Serial Preferred Stock – authorized, 50,000,000 shares:
Series A, non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 16,400 shares authorized, 16,400 issued and outstanding at December 31, 2015 and 2014

     16,995        16,004   

Common stock – authorized, 75,000,000 shares no par value, 17,175,389 and 16,683,856 shares issued and outstanding at December 31, 2015 and 2014, respectively

     230,688        226,389   

Additional paid-in capital

     23,017        19,748   

Retained earnings

     36,923        16,861   

Accumulated other comprehensive income (loss)

     (816     190   
  

 

 

   

 

 

 

Total Shareholders’ Equity

     306,807        279,192   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 2,634,642      $ 2,265,117   
  

 

 

   

 

 

 

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

 

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CU BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

 

     Years Ended
December 31,
 
     2015      2014     2013  

Interest Income

       

Interest and fees on loans

   $ 84,537       $ 51,882      $ 48,201   

Interest on investment securities

     4,518         2,369        1,913   

Interest on interest bearing deposits in other financial institutions

     1,087         926        732   
  

 

 

    

 

 

   

 

 

 

Total Interest Income

     90,142         55,177        50,846   
  

 

 

    

 

 

   

 

 

 

Interest Expense

       

Interest on interest bearing transaction accounts

     413         278        238   

Interest on money market and savings deposits

     1,652         963        1,027   

Interest on certificates of deposit

     190         216        255   

Interest on securities sold under agreements to repurchase

     30         34        74   

Interest on subordinated debentures

     438         431        485   
  

 

 

    

 

 

   

 

 

 

Total Interest Expense

     2,723         1,922        2,079   
  

 

 

    

 

 

   

 

 

 

Net Interest Income

     87,419         53,255        48,767   

Provision for loan losses

     5,080         2,239        2,852   
  

 

 

    

 

 

   

 

 

 

Net Interest Income after Provision for Loan Losses

     82,339         51,016        45,915   
  

 

 

    

 

 

   

 

 

 

Non-Interest Income

       

Gain (loss) on sale of securities, net

     112         (47     47   

Gain on sale of SBA loans, net

     1,797         1,221        1,087   

Deposit account service charge income

     4,644         2,744        2,377   

Other non-interest income

     5,177         3,791        3,007   
  

 

 

    

 

 

   

 

 

 

Total Non-Interest Income

     11,730         7,709        6,518   
  

 

 

    

 

 

   

 

 

 

Non-Interest Expense

       

Salaries and employee benefits (includes stock based compensation expense of $2,966, $1,699 and $1,088 for the years ended December 31, 2015, 2014 and 2013, respectively)

     37,955         26,519        22,870   

Occupancy

     5,792         4,112        4,194   

Data processing

     2,495         1,968        1,868   

Legal and professional

     2,411         2,006        2,166   

FDIC deposit assessment

     1,466         844        880   

Merger expenses

     498         2,302        43   

OREO valuation write-downs and expenses

     245         15        95   

Office services expenses

     1,526         1,026        1,034   

Other operating expenses

     7,577         4,593        4,490   
  

 

 

    

 

 

   

 

 

 

Total Non-Interest Expense

     59,965         43,385        37,640   
  

 

 

    

 

 

   

 

 

 

Net Income before Provision for Income Tax Expense

     34,104         15,340        14,793   

Provision for income tax expense

     12,868         6,432        5,008   
  

 

 

    

 

 

   

 

 

 

Net Income

     21,236         8,908        9,785   

Preferred stock dividends and discount accretion

     1,174         124        —     
  

 

 

    

 

 

   

 

 

 

Net Income available to Common Shareholders

   $ 20,062       $ 8,784      $ 9,785   
  

 

 

    

 

 

   

 

 

 

Earnings Per Share

       

Basic earnings per share

   $ 1.21       $ 0.77      $ 0.93   

Diluted earnings per share

   $ 1.18       $ 0.75      $ 0.90   

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

 

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

 

     Years Ended
December 31,
 
     2015     2014      2013  

Net Income

   $ 21,236      $ 8,908       $ 9,785   

Other Comprehensive Income (Loss), net of tax:

       

Non-credit portion of other-than-temporary impairments arising during the period

     —          —           (22

Net change in unrealized gain (loss) on available-for-sale investment securities

     (1,006     395         (1,577
  

 

 

   

 

 

    

 

 

 

Other Comprehensive Income (Loss)

     (1,006     395         (1,599
  

 

 

   

 

 

    

 

 

 

Comprehensive Income

   $ 20,230      $ 9,303       $ 8,186   
  

 

 

   

 

 

    

 

 

 

 

 

 

 

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

 

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CU BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Three Years Ended December 31, 2015

(Dollars in thousands)

 

    Preferred Stock     Common Stock                          
    Issued and
Outstanding
Shares
    Amount     Issued and
Outstanding
Shares
    Amount     Additional
Paid-in
Capital
    Retained
Earnings

(Deficit)
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 

Balance at December 31, 2012

    —        $ —          10,758,674      $ 118,885      $ 7,052      $ (1,708   $ 1,394      $ 125,623   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net issuance of restricted stock

    —          —          69,450        —          —          —          —          —     

Exercise of stock options

    —          —          282,031        2,790        —          —          —          2,790   

Stock based compensation expense related to employee stock options and restricted stock

    —          —          —          —          1,088        —          —          1,088   

Restricted stock repurchase

    —          —          (28,791     —          (422     —          —          (422

Excess tax benefit – stock based compensation

    —          —          —          —          659        —          —          659   

Net income

    —          —          —          —          —          9,785        —          9,785   

Other comprehensive loss

    —          —          —          —          —          —          (1,599     (1,599
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2013

    —          —          11,081,364        121,675        8,377        8,077        (205     137,924   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net issuance of restricted stock

      —          167,384        —          —          —          —          —     

Exercise of stock options

    —          —          221,016        2,029        —          —          —          2,029   

Issuance of preferred stock for 1st Enterprise merger, net of fair value discount

    16,400        15,921        —          —          —          —          —          15,921   

Issuance of common stock for 1st Enterprise merger, net of $27 of issuance costs

    —          —          5,240,409        102,685        —          —          —          102,685   

Issuance of replacement stock options for 1st Enterprise merger

    —          —          —          —          9,561        —          —          9,561   

Stock based compensation expense related to employee stock options and restricted stock

    —          —          —          —          1,699        —          —          1,699   

Restricted stock repurchase

    —          —          (26,317     —          (471     —          —          (471

Excess tax benefit – stock based compensation

    —          —          —          —          582        —          —          582   

Preferred stock dividends and discount accretion

    —          83        —          —          —          (124     —          (41

Net income

    —          —          —          —          —          8,908        —          8,908   

Other comprehensive income

    —          —          —          —          —          —          395        395   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2014

    16,400        16,004        16,683,856        226,389        19,748        16,861        190        279,192   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net issuance of restricted stock

    —          —          81,825        —          —          —          —          —     

Exercise of stock options

    —          —          454,019        4,299        —          —          —          4,299   

Stock based compensation expense related to employee stock options and restricted stock

    —          —          —          —          2,966        —          —          2,966   

Restricted stock repurchase

    —          —          (44,311     —          (971     —          —          (971

Excess tax benefit – stock based compensation

    —          —          —          —          1,274        —          —          1,274   

Preferred stock dividends and discount accretion

    —          991        —          —          —          (1,174     —          (183

Net income

    —          —          —          —          —          21,236        —          21,236   

Other comprehensive loss

    —          —          —          —          —          —          (1,006     (1,006
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

    16,400      $ 16,995        17,175,389      $ 230,688      $ 23,017      $ 36,923      $ (816   $ 306,807   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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CU BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

     Years Ended December 31,  
     2015     2014     2013  

Cash flows from operating activities:

      

Net income:

   $ 21,236      $ 8,908      $ 9,785   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Provision for loan losses

     5,080        2,239        2,852   

Provision for unfunded loan commitments

     137        142        73   

Stock based compensation expense

     2,966        1,699        1,088   

Depreciation

     1,424        1,019        1,082   

Net accretion of discounts/premiums for loans acquired and deferred loan fees/costs

     (9,365     (5,360     (6,158

Net amortization from investment securities

     3,305        1,677        1,642   

Increase in bank owned life insurance

     (1,180     (661     (617

Amortization of core deposit intangibles

     1,680        391        309   

Amortization of time deposit premium

     (15     (42     (141

Net amortization of leasehold right intangible asset and liabilities

     (21     142        (313

Accretion of subordinated debenture discount

     159        159        210   

Loss on disposal of fixed assets

     92        7        15   

Valuation write-downs on OREO

     133        —          —     

Gain on sale of OREO

     —          —          (23

Loss (gain) on sale of securities, net

     (112     47        (47

Gain on sale of SBA loans, net

     (1,797     (1,221     (1,087

Decrease in deferred tax assets

     675        732        3,101   

Decrease (increase) in accrued interest receivable and other assets

     456        2,428        (7,558

Increase (decrease) in accrued interest payable and other liabilities

     (1,964     2,041        6,459   

Net excess in tax benefit on stock compensation

     (1,274     (582     —     

Decrease in fair value of derivative swap liability

     (251     (1,147     (2,095
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     21,364        12,618        8,577   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Cash and cash equivalents acquired in acquisition, net of cash paid

     —          8,650        —     

Purchases of investment securities

     (134,688     (52,042     (36,318

Proceeds from sales of investment securities

     5,737        25,156        6,968   

Proceeds from repayment and maturities from investment securities

     40,310        23,080        36,703   

Loans originated, net of principal payments

     (200,739     (132,846     (72,116

Purchases of premises and equipment

     (1,278     (1,042     (1,206

Proceeds from sale of OREO

     717        —          3,135   

Net decrease (increase) in certificates of deposit in other financial institutions

     19,573        (4,572     (33,301

Purchase of bank owned life insurance

     (10,000     —          —     

Net redemption of FHLB and other bank stock

     —          —          150   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (280,368     (133,616     (95,985
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Net increase in Non-interest bearing demand deposits

     255,451        67,591        88,665   

Net increase in Interest bearing transaction accounts

     54,579        8,033        42,988   

Net increase (decrease) in Money market and savings deposits

     35,406        (55,236     40,449   

Net decrease in certificates of deposit

     (6,323     (8,433     (17,614

Net increase (decrease) in securities sold under agreements to repurchase

     4,949        (1,730     (11,716

Net proceeds from stock options exercised

     4,299        2,029        2,790   

Issuance costs of common stock for 1st Enterprise merger

     —          (27     —     

Restricted stock repurchase

     (971     (471     (422

Dividends paid on preferred stock

     (183     (41     —     

Net excess in tax benefit on stock compensation

     1,274        582        659   
  

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     348,481        12,297        145,799   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     89,477        (108,701     58,391   

Cash and cash equivalents, beginning of year

     132,586        241,287        182,896   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of year

   $ 222,063      $ 132,586      $ 241,287   
  

 

 

   

 

 

   

 

 

 

 

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CU BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

 

     Years Ended December 31,  
     2015     2014      2013  

Supplemental disclosures of cash flow information:

       

Cash paid during the year for interest

   $ 2,877      $ 1,801       $ 2,029   

Net cash paid (refunds received) during the year for taxes

   $ 11,567      $ 3,725       $ (270

Supplemental disclosures of non-cash investing activities:

       

Net change in unrealized gains (losses) on investment securities, net of tax

   $ (1,006   $ 395       $ (1,577

Loans transferred to other real estate owned

   $ 325      $ 850       $ —     

Supplemental disclosures related to acquisitions:

       

Assets acquired

   $ —        $ 833,497       $ —     

Liabilities assumed

   $ —        $ 705,214       $ —     

Issuance of 16,400 shares of preferred stock

   $ —        $ 15,921       $ —     

Cash paid for fractional and dissenter shares and stock options

   $ —        $ 89       $ —     

 

 

 

 

The accompanying notes are an integral part of these financial statements

 

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CU BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015

Note 1 – Summary of Significant Accounting Policies

CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. CU Bancorp was established to facilitate the reorganization and merger of Premier Commercial Bank, N.A. into California United Bank, which took place after the close of business on July 31, 2012. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company,” as used throughout this document, refers to the consolidated financial statements of CU Bancorp and California United Bank.

California United Bank (the “Bank”) is a full-service commercial business bank offering a broad range of banking products and services including: deposit services, lending and cash management to small and medium-sized businesses, to non-profit organizations, to business principals and entrepreneurs, to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors. The Bank opened for business in 2005, with its headquarters office located in Los Angeles, California. As a state chartered non-member bank, the Bank is subject to regulation by the California Department of Business Oversight (“DBO”) and the Federal Deposit Insurance Corporation (“FDIC”). The deposits of the Bank are insured by the FDIC to the maximum amount allowed by law.

Basis of Financial Statement Presentation

The consolidated financial statements include the accounts of the Company and the Bank. Significant intercompany items have been eliminated in consolidation. The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission.

CU Bancorp is the common shareholder of Premier Commercial Statutory Trust I, Premier Commercial Statutory Trust II, and Premier Commercial Statutory Trust III, entities which were acquired in the merger with Premier Commercial Bancorp (“PC Bancorp”). These trusts were established for the sole purpose of issuing trust preferred securities and do not meet the criteria for consolidation. For more detail, see Note 13 – Borrowings and Subordinated Debentures.

Use of Estimates in the Preparation of Consolidated 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 the amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, these accounting principles require the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements.

Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan loss and various assets and liabilities measured at fair value. While management uses the most current available information to recognize losses on loans, future additions to the allowance for loan loss may be necessary based on, among other factors, changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan loss. Regulatory agencies may require the Company to recognize additions to the allowance for loan loss based on their judgment about information available to them at the time of their examination.

 

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Business Combinations

The Company has a number of fair value adjustments recorded within the consolidated financial statements at December 31, 2015 that relate to the business combinations with California Oaks State Bank “COSB”, Premier Commercial Bancorp “PC Bancorp” and 1st Enterprise Bank “1st Enterprise” on December 31, 2010, July 31, 2012 and November 30, 2014, respectively. These fair value adjustments includes goodwill, fair value adjustments on loans, core deposit intangible assets, other intangible assets, fair value adjustments to acquired lease obligations, fair value adjustments to certificates of deposit and fair value adjustments on derivatives. The assets and liabilities acquired through acquisitions have been accounted for at fair value as of the date of the acquisition. The goodwill that was recorded on the transactions represented the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized and is reviewed for impairment on October 1st of each year. If an event occurs or circumstances change that result in the Company’s fair value declining below its book value, the Company would perform an impairment analysis at that time.

Based on the Company’s 2015 goodwill impairment analysis, no impairment to goodwill has occurred. The Company is a sole reporting unit for evaluation of goodwill.

The core deposit intangibles on non-maturing deposits, which represent the intangible value of depositor relationships resulting from deposit liabilities assumed through acquisitions, are being amortized over the projected useful lives of the deposits. The weighted average remaining life of the core deposit intangible is estimated at approximately 7.9 years at December 31, 2015. Core deposit intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Loans acquired through acquisition are recorded at fair value at acquisition date without a carryover of the related Allowance. Purchased Credit Impaired (“PCI”) loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable, at the acquisition date, that the Company will not be able to collect all contractually required amounts. When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans. The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans. For non-PCI loans, loan fair value adjustments consist of an interest rate premium or discount on each individual loan and are amortized to loan interest income based on the effective yield method over the remaining life of the loans. Subsequent decreases to the expected cash flows for both PCI and non-PCI loans will result in a provision for loan losses.

Business Segments

The Company is organized and operates as a single reporting segment, principally engaged in commercial business banking. The Company conducts its lending and deposit operations through nine full service branch offices located in Los Angeles, Orange, Ventura and San Bernardino counties.

Cash and Cash Equivalents

Within the Consolidated Statements of Cash Flows, cash and cash equivalents include cash, due from banks and interest earning deposits in other financial institutions. Cash flows from loans, deposits, securities sold under agreements to repurchase and certificates of deposit in other financial institutions are reported on a net basis.

Restricted Cash

Banking regulations require that all banks maintain a percentage of their deposits as reserves in cash or on deposit with the Federal Reserve Bank. Reserve balances of $14 million and $12 million were required by the

 

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Federal Reserve Bank of San Francisco as of December 31, 2015 and 2014, respectively. As of December 31, 2015, the Bank was in compliance with all known U.S. Federal Reserve Bank (“Federal Reserve”) reporting and reserve requirements.

Interest Earning Deposits in Other Financial Institutions

Interest earning deposits in other financial institutions represent short term interest earning deposits, which include money market deposit accounts with other financial institutions, and interest earning deposits with the Federal Reserve. These deposits and investments can generally provide the Company with immediate liquidity and generally can be liquidated the same day as is the case with the Federal Reserve and up to seven days on money market deposit accounts with other financial institutions.

Certificates of Deposit in Other Financial Institutions

The Company’s investments in certificates of deposit issued by other financial institutions are generally fully insured by the FDIC up to the applicable limit of $250 thousand and have an original maturity of between 30 days and 12 months. The current remaining maturities of the Company’s certificates of deposit in other financial institutions at December 31, 2015 range from 4 days to 12 months with a weighted average maturity of 6.9 months and a weighted average yield of 0.81%. At December 31, 2015 and 2014, respectively, the Company had $2.7 million and $4.1 million of certificates of deposits pledged as collateral for its interest rate swap agreements with two counterparty banks.

Concentrations and Credit Risk in Other Financial Institutions

The Company maintains certain deposits in other financial institutions in amounts that exceed federal deposit insurance coverage. At December 31, 2015, the amount of deposits in other financial institutions that the Company did not maintain with either the Federal Reserve Bank or the Federal Home Loan Bank and were not covered by FDIC insurance was $47 million in non-interest bearing accounts, $60 million in interest bearing accounts, and $2.5 million in certificates of deposit in other financial institutions. Based on management’s evaluation of the credit risk of maintaining balances and transactions with these correspondent financial institutions, management does not believe that the Company is exposed to any significant credit risk on these balances.

Investment Securities

The Company currently classifies its investment securities under the available-for-sale and held-to-maturity classifications. Under the available-for-sale classification, securities can be sold in response to certain conditions, such as changes in interest rates, changes in the credit quality of the securities, when the credit quality of a security does not conform with current investment policy guidelines, fluctuations in deposit levels or loan demand or a need to restructure the portfolio to better match the maturity or interest rate characteristics of liabilities with assets. Securities classified as available-for-sale are accounted for at their current fair value rather than amortized cost. Unrealized gains or losses are excluded from net income and reported as a separate component of accumulated other comprehensive income (loss) included in shareholders’ equity. If the Company has the intent and the ability at the time of purchase to hold certain securities until maturity, they are classified as held-to-maturity and are stated at amortized cost.

As of each reporting date, the Company evaluates the securities portfolio to determine if there has been an other-than-temporary impairment (“OTTI”) on each of the individual securities in the investment securities portfolio. If it is probable that the Company will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an OTTI shall be considered to have occurred. Once an OTTI is considered to have occurred, the credit portion of the loss is required to be recognized in current earnings, while the non-credit portion of the loss is recorded as a separate component of shareholders’ equity.

 

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In estimating whether an other-than-temporary impairment loss has occurred, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) the current liquidity and volatility of the market for each of the individual security categories, (iv) the current slope and shape of the Treasury yield curve, along with where the economy is in the current interest rate cycle, (v) the spread differential between the current spread and the long-term average spread for that security category, (vi) the projected cash flows from the specific security type, (vii) any financial guarantee and financial condition of the guarantor and (viii) the intent and ability of the Company to retain its investment in the issue for a period of time sufficient to allow for any anticipated recovery in fair value.

If it’s determined that an OTTI exists on a debt security, the Company then determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Company will recognize the amount of the OTTI in earnings equal to the difference between the security’s fair value and its adjusted cost basis. If neither of the conditions is met, the Company determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss is the portion of the other-than-temporary impairment that is recognized in earnings and is a reduction to the cost basis of the security. The portion of total impairment related to all other factors is included in other comprehensive income. Significant judgment is required in this analysis that includes, but is not limited to assumptions regarding the collectability of principal and interest, future default rates, future prepayment speeds, the amount of current delinquencies that will result in defaults and the amount of eventual recoveries expected on the underlying collateral.

Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the interest method over the expected maturity term of the securities. For mortgage-backed securities, the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. The amount of prepayments varies from time to time based on the interest rate environment and the rate of turnover of mortgages. The Company’s investment in the common stock of the FHLB, Pacific Coast Bankers Bank (“PCBB”) and The Independent Banker’s Bank (“TIB”) is carried at cost and is included in other assets on the accompanying consolidated balance sheets.

Federal Home Loan Bank Stock

As a member of the Federal Home Loan Bank of San Francisco (“FHLB”), the Bank is required to maintain an investment in capital stock of the FHLB. The stock does not have a readily determinable fair value and as such is carried at cost and evaluated for impairment. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the changes in (increases or declines) in the net assets of the FHLB as compared to the capital stock amount and the length of time these changes (situation) has persisted, (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and (d) the liquidity position of the FHLB.

The Company’s investment in FHLB stock is included in other assets on the accompanying consolidated balance sheets.

Loans and Interest and Fees on Loans

The Company extends commercial, Small Business Administration, commercial real estate, construction and personal loans to business principals and entrepreneurs, to small and medium-sized businesses, to non-profit

 

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organizations, to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers, and to investors. Loans that the Company has the ability and intent to hold until maturity are stated at their outstanding unpaid principal balances net of charge offs, net of deferred loan fees and costs on originated loans, net of unearned discounts and unamortized premiums on acquired loans, and further reduced by the valuation allowance for loan losses. Nonrefundable loan fees and direct costs associated with the origination of loans are deferred and recognized in interest income over the loan term using the level yield method. Further, discounts or premiums on acquired loans are accreted or amortized to interest income using the level yield method.

Interest on loans is accrued daily and credited to income based on the principal amount outstanding. Interest is calculated using the terms of the loan according to the contractual note agreements. A small number of commercial real estate loans have been identified and designated as hedged items by the Company. For a detailed discussion of the accounting related to the loans designated as hedged items, see Note 1 – Summary of Significant Accounting Policies under “Derivative Financial Instruments and Hedging Activity” and Note 14 – Derivative Financial Instruments.

Nonaccrual loans: For all loan types, when a borrower discontinues making payments as contractually required by the note, the Company must determine whether it is appropriate to continue to accrue interest. Generally, the Company places loans in a nonaccrual status and the accrual of interest on loans is discontinued when the loan has become delinquent by more than 90 days or when management determines that the full repayment of principal and collection of interest is unlikely. The Company may decide to continue to accrue interest on certain loans more than 90 days delinquent, if the loan is well secured by collateral and in the process of collection.

When a loan is placed on nonaccrual status or has been charged-off, all interest income that has been accrued but not yet collected is reversed against interest income. Subsequent payments received from the customer are applied to principal and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required.

Impaired loans: A loan is identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the original loan agreement. Generally, these loans are rated substandard or worse. Most impaired loans are classified as nonaccrual. However, there are some loans that are designated impaired due to doubt regarding collectability according to contractual terms, but are both fully secured by collateral and are current in their interest and principal payments. These impaired loans that are not classified as nonaccrual continue to pay as agreed. Impaired loans are measured for allowance requirements based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of an impairment allowance, if any, and any subsequent changes are charged against the allowance for loan loss. Factors that contribute to a performing loan being classified as impaired include payment status, collateral value, probability of collecting scheduled payments, delinquent taxes, and debts to other lenders that cannot be serviced out of existing cash flow.

Troubled debt restructurings: A loan is classified as a troubled debt restructuring when a borrower experiences financial difficulties that lead to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. The loan terms which have been modified or restructured due to a borrower’s financial difficulty may include a reduction in the stated interest rate, an extension of the maturity at an interest rate below current market interest rates, a reduction in the face amount of the debt (principal forgiveness), a reduction in the accrued interest, or re-aging, extensions, deferrals, renewals, rewrites and other actions intended to minimize potential losses.

Troubled debt restructurings are considered impaired loans and are evaluated for the amount of impairment, with the appropriate allowance for loan loss.

 

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In determining whether a debtor is experiencing financial difficulties, the Company considers if the debtor is in payment default or would be in payment default in the foreseeable future without the modification, the debtor declared or is in the process of declaring bankruptcy, there is substantial doubt that the debtor will continue as a going concern, the debtor’s entity-specific projected cash flows will not be sufficient to service its debt, or the debtor cannot obtain funds from sources other than the existing creditors at a market rate for debt with similar risk characteristics.

In determining whether the Company would grant a concession, the Company assesses, if it does not expect to collect all amounts due, whether the current value of the collateral will satisfy the amounts owed, whether additional collateral or guarantees from the debtor will serve as adequate compensation for other terms of the restructuring, and whether the debtor otherwise has access to funds at a market rate for debt with similar risk characteristics. Typical concessions include reductions to the stated interest rate, payment extensions, principal forgiveness and other actions.

A loan that is modified at a market rate of interest will not be classified as a troubled debt restructuring in the calendar year subsequent to the restructuring if it is in compliance with the modified terms and the expectation exists for continued performance going forward. Payment performance prior and subsequent to the restructuring is taken into account in assessing whether it is likely that the borrower can meet the new terms. This may result in the loan being returned to accrual at the time of restructuring. The Company generally requires a period of sustained repayment for at least six months for return to accrual status.

Loans Held for Sale and Servicing Assets

Loans held for sale are loans originated by the Company and include the principal amount outstanding net of unearned income and the loans are carried at the lower of cost or fair value on an aggregate basis. A decline in the aggregate fair value of the loans below their aggregate carrying amount is recognized through a charge to earnings in the period of such decline. Unearned income on these loans is taken into earnings when they are sold. At December 31, 2015 and 2014, the Company had no loans classified as held for sale.

Gains or losses resulting from sales of loans are recognized at the date of settlement and are based on the difference between the cash received and the carrying value of the related loans less transaction costs. A transfer of financial assets in which control is surrendered is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in the exchange. Assets, liabilities, derivative financial instruments, or other retained interests issued or obtained through the sale of financial assets are measured at estimated fair value, if practicable.

The most common retained interest related to loan sales is a servicing asset. Servicing assets are amortized in proportion to and over the period of the estimated future net servicing income. The amortization of the servicing asset and the servicing income are included in non-interest income. The fair value of the servicing assets is estimated by discounting the future cash flows using market-based discount rates and prepayment speeds. The Company’s servicing asset is evaluated regularly for impairment. The servicing asset is stratified based on the original term to maturity and the year of origination of the underlying loans for purposes of measuring impairment. If the fair value of the servicing asset is less than the amortized carrying value, the asset is considered to be impaired and an impairment charge will be taken against earnings. The servicing asset is included in other assets on the consolidated balance sheets.

Allowance for Loan Loss

The allowance for loan loss (“Allowance”) is established by a provision for loan losses that is charged against income, increased by charges to expense and decreased by charge-offs (net of recoveries). Loan charge-offs are charged against the Allowance when management believes the collectability of loan principal becomes unlikely. Subsequent recoveries, if any, are credited to the Allowance.

 

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The Allowance is an amount that management believes will be adequate to absorb estimated charge-offs related to specifically identified loans, as well as probable loan charge-offs inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. Management carefully monitors changing economic conditions, the concentrations of loan categories and collateral, the financial condition of the borrowers, the history of the loan portfolio, as well as historical peer group loan loss data to determine the adequacy of the Allowance. The Allowance is based upon estimates, and actual charge-offs may vary from the estimates. No assurance can be given that adverse future economic conditions will not lead to delinquent loans, increases in the provision for loan losses and/or charge-offs. These evaluations are inherently subjective, as they require estimates that are susceptible to significant revisions as conditions change. In addition, regulatory agencies, as an integral part of their examination process, may require additions to the Allowance based on their judgment about information available at the time of their examinations. Management believes that the Allowance as of December 31, 2015 is adequate to absorb known and probable losses in the loan portfolio.

The Allowance consists of specific and general components. The specific component relates to loans that are categorized as impaired. For loans that are categorized as impaired, a specific allowance is established when the realizable value of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on the type of loan and historical charge-off experience adjusted for qualitative factors.

While the general allowance covers all non-impaired loans and is based on historical loss experience adjusted for the various qualitative factors as discussed in Note 6 – Loans, the change in the Allowance from one reporting period to the next may not directly correlate to the rate of change of nonperforming loans for the following reasons:

 

   

A loan moving from the impaired performing status to an impaired non-performing status does not mandate an automatic increase in allowance. The individual loan is evaluated for a specific allowance requirement when the loan moves to the impaired status, not when the loan moves to non-performing status. In addition, the impaired loan is reevaluated at each subsequent reporting period. Impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

   

Not all impaired loans require a specific allowance. The payment performance of the borrower may require an impaired classification, but the collateral evaluation may support adequate collateral coverage. For a number of impaired loans in which borrower performance is in question, the collateral coverage may be sufficient. In those instances, neither a general allowance nor a specific allowance is assessed.

Premises and Equipment

Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives, which range from three to seven years for furniture and fixtures. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the improvements or the remaining lease term, whichever is shorter. Expenditures for improvements or major repairs are capitalized and those for ordinary repairs and maintenance are charged to operations as incurred.

Other Real Estate Owned (“OREO”)

Real estate properties that are acquired through, or in lieu of, loan foreclosure are initially recorded at fair value, less estimated costs to sell, at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of the cost basis or fair value less estimated costs to sell. Gains and losses on the sale of OREOs and operating expenses of such assets are included in non-interest expense, and operating revenue of such assets is included in non-interest income.

 

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Goodwill and Other Intangible Assets

Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination determined to have an indefinite useful life are not amortized, but tested for impairment at least annually, or more frequently if events and circumstances exist that indicate that an impairment test should be performed. The Company has selected October 1st as the date to perform its annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives. Goodwill is the only intangible asset with an indefinite life on the Company’s consolidated balance sheets. There was no impairment as of December 31, 2015 or 2014. The increase in goodwill in 2014 and 2015 was the result of the merger with 1st Enterprise Bank on November 30, 2014. For more discussion, see Note 2 – Business Combinations.

Core deposit intangible assets arising from business combinations are amortized using an accelerated method over their estimated useful lives and are classified under core deposit and leasehold right intangibles on the Company’s consolidated balance sheets.

Leasehold right intangible is the present value of the excess of market rate lease payments over the contractual lease payments of an acquired lease. The leasehold intangible asset is amortized to expense over the life of the lease and is classified under core deposit and leasehold right intangibles on the Company’s consolidated balance sheets.

Qualified Affordable Housing Project Investments

The Company has made investments in qualified affordable housing projects that are defined within the industry and here as investments in Low Income Housing Tax Credits (“LIHTC”). The investment in LIHTC provides the Company with tax credits and tax benefits which are designed to encourage investments in the construction and rehabilitation of low-income housing. The Company’s investments are made to limited partnerships that manage or invest in qualified affordable housing projects primarily to receive both tax credits and benefits in addition to CRA credits. In December 2013, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2014-01, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force). ASU 2014-1 modifies the conditions that a reporting entity must meet to be eligible to use a method other than the equity or cost method to account for qualified affordable housing project investments. If the modified conditions are met, the amendments permit an entity to amortize the initial cost of the investment in proportion to the amount of the tax credits and tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). The four conditions that must be met to utilize the proportional amortization method are: (a) it is probable that the tax credits allocable to the investor will be available, (b) the investor does not have the ability to exercise significant influence over the operating and financial policies of the limited partnership, and substantially all of the projected benefits are from tax credits and tax benefits, (c) the investor’s projected yield based solely on the cash flows from the tax credits and tax benefits is positive and (d) the investor is a limited partnership investor in the limited liability entity for both legal and tax purposes, and the investor is limited to its capital investment. The Company believes that all the above conditions are met to qualify the Company to account for its investments in LIHTC under ASU 2014-1. In addition, the Company is required to evaluate its investments in LIHTC for impairment, when there are events or changes in circumstances indicating it is more likely than not that the carrying amount of the Company’s investment would not be realized either through the receipt of tax credits and tax benefits or through a sale. Management does not believe there is any impairment of its LIHTC investments at December 31, 2015. See Note 11 – Investments in Qualified Affordable Housing Projects for details on the Company’s investments in LIHTC’s.

 

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Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Derivative Financial Instruments and Hedging Activities

All derivative instruments (interest rate swap contracts) were recognized on the consolidated balance sheet at their current fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and hedged item related to the hedged risk are recognized in earnings. Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging, establishes the accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. ASC Topic 815 requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

On the date a derivative contract is entered into by the Company, the Company will designate the derivative contract as either a fair value hedge (i.e. a hedge of the fair value of a recognized asset or liability), a cash flow hedge (i.e. a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability), or a stand-alone derivative (i.e. and instrument with no hedging designation). For a derivative designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as other non-interest income. At inception and on an ongoing basis, the derivatives that are used in hedging transactions are assessed for effectiveness as to how effective they are in offsetting changes in fair values or cash flows of hedged items.

The Company will discontinue hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting change in the fair value of the hedged item, the derivative expires or is sold, is terminated, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company will continue to carry the derivative on the balance sheet at its fair value (if applicable), but will no longer adjust the hedged asset or liability for changes in fair value. The adjustments of the carrying amount of the hedged asset or liability will be accounted for in the same manner as other components of the carrying amount of that asset or liability, and the adjustments are amortized to interest income over the remaining life of the hedged item upon the termination of hedge accounting.

Income Taxes and Other Taxes

The Company provides for current federal and state income taxes payable and for deferred taxes that result from differences between financial accounting rules and tax laws governing the timing of recognition of various income and expense items. The Company recognizes deferred income tax assets and liabilities for the future tax effects of such temporary differences based on the difference between the financial statement and tax bases of the existing assets and liabilities using the statutory rate expected in the years in which the differences are expected to reverse. The effect on deferred taxes of any enacted change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established to the extent necessary to reduce the

 

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deferred tax asset to the level at which it is “more likely than not” that the tax assets or benefits will be realized. Realization of tax benefits for deductible temporary differences and loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryback and carryforward period and that current tax law will allow for the realization of those tax benefits.

The Company is required to account for uncertainty associated with the tax positions it has taken or expects to be taken on past, current and future tax returns. Where there may be a degree of uncertainty as to the tax realization of an item, the Company may only record the tax effects (expense or benefits) from an uncertain tax position in the consolidated financial statements if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. The Company does not believe that it has any material uncertain tax positions taken to date that are not more likely than not to be realized. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

Comprehensive Income

The Company has adopted accounting guidance issued by the Financial Accounting Standards Board (“FASB”) that requires all items recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company also classifies items of other comprehensive income by their nature in the Consolidated Statements of Comprehensive Income.

Earnings per Share (“EPS”)

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS includes the dilutive effect of potential common stock using the treasury stock method only if the effect on earnings per share is dilutive. See Note 4 – Computation of Earnings per Common Share.

Recent Accounting Pronouncements

In November 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity. This ASU will require an entity to determine the nature of the host contract by considering the economic characteristics and risks of the entire hybrid financial instrument issued in the form of a share, including the embedded derivative feature that is being evaluated for separate accounting from the host contract when evaluating whether the host contract is more akin to debt or equity. In evaluating the stated and implied substantive terms and features, the existence or omission of any single term or feature does not necessarily determine the economic characteristics and risks of the host contract. Although an individual term or feature may weigh more heavily in the evaluation on the basis of facts and circumstances, an entity should use judgment based on an evaluation of all the relevant terms and features. ASU 2014-16 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. For all other entities, the ASU is effective for fiscal years ending after December 15, 2015, and interim periods within fiscal years thereafter. The effects of initially adopting the amendments should be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of a share as of the beginning of the fiscal year for which the amendment is effective. Retrospective application is permitted to all relevant prior periods. Early adoption, including adoption in an interim period, is permitted. If an entity early adopts the amendments in an interim period, any adjustments shall be reflected as of the beginning of the fiscal year that includes that interim period. The Company does not expect the adoption of this ASU to have an impact on the Company’s financial position or results of operations.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis to improve targeted areas of the consolidation guidance and reduce the number of

 

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consolidation models. The Company may either apply the amendments retrospectively or use a modified retrospective approach. ASU 2015-02 is effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

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 related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts. ASU 2015-03 is effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted if the guidance is applied as of the beginning of the annual period of adoption. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which replaced existing revenue recognition guidance for contracts to provide goods or services to customers and amended existing guidance related to recognition of gains and losses on the sale of certain nonfinancial assets such as real estate. ASU 2014-09 established a principles-based approach to recognizing revenue that applies to all contracts other than those covered by other authoritative GAAP guidance. Quantitative and qualitative disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows were also required. ASU 2014-09 was to be effective for interim and annual periods beginning after December 15, 2016 and was to be applied on either a modified retrospective or full retrospective basis. In response to stakeholders’ requests to defer the effective date required by ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), in August 2015, the FASB issued ASU 2015-14 which defers the original effective date for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2015-14 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

In August 2015, the FASB issued ASU 2015-15, Interest – Imputation of Interest (Subtopic 835-30), Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-15 is effective for interim and annual periods beginning after December 15, 2015. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805), Simplifying the Accounting for Measurement Period Adjustments. GAAP requires that during the measurement period, the acquirer retrospectively adjust the provisional amounts recognized at the acquisition date with a corresponding adjustment to goodwill. Those adjustments are required when new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts initially recognized or would have resulted in the recognition of additional assets or liabilities. The acquirer also must revise comparative information for prior periods presented in the financial statements as needed, including revising depreciation, amortization, or other income effects as a result of changes made to provisional amounts. To simplify the accounting for adjustments made to provisional amounts recognized in a business combination, the amendments in ASU 2015-16 eliminate the requirement to retrospectively account for those adjustments. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments in this ASU should be applied prospectively to adjustments to provisional amounts that occur after the effective date of

 

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this ASU with earlier application permitted for financial statements that have not been issued. For all other entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The amendments in this ASU should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this ASU with earlier application permitted for financial statements that have not yet been made available for issuance. The Company has elected to early adopt ASU 2015-16 for the year ended December 31, 2015. See Note 8 – Goodwill, Core Deposits and Leasehold Right Intangibles for the Company’s disclosures on the effect of adoption.

On January 5, 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). Changes to the current GAAP model primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged. The classification and measurement guidance will be effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. All entities can early adopt the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. Early adoption of these provisions can be elected for all financial statements of fiscal years and interim periods that have not yet been issued (for public business entities) or that have not yet been made available for issuance. The classification and measurement guidance is the first ASU issued under the FASB’s financial instruments project. The ASU for the new impairment guidance is expected in the first quarter of 2016. An exposure draft of the new hedging guidance is expected in the first half of 2016. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

On February 25, 2016, the FASB issued ASU 2016-02, Leases. While both lessees and lessors are affected by the new guidance, the effects on the lessees are much more significant. The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases. By definition, a short-term lease is one in which: (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect an accounting policy by class of underlying asset under which right-of-use assets and lease liabilities are not recognized and lease payments are generally recognized as expense over the lease term on a straight-line basis. This change will result in lessees recognizing right-of-use assets and lease liabilities for most leases currently accounted for as operating leases under the legacy lease accounting guidance. For many entities, this could significantly affect the financial ratios they use for external reporting and other purposes, such as debt covenant compliance. Examples of changes in the new guidance affecting both lessees and lessors include: (a) defining initial direct costs to only include those incremental costs that would not have been incurred if the lease had not been entered into, (b) requiring related party leases to be accounted for based on their legally enforceable terms and conditions, (c) eliminating the additional requirements that must be applied today to leases involving real estate and (d) revising the circumstances under which the transfer contract in a sale-leaseback transaction should be accounted for as the sale of an asset by the seller-lessee and the purchase of an asset by the buyer-lessor. In addition, both lessees and lessors are subject to new disclosure requirements. ASU 2016-02 is effective for public entities for interim and annual periods beginning after December 15, 2018. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

Note 2 – Business Combinations

On November 30, 2014, the Company completed the merger with 1st Enterprise pursuant to the terms of the Agreement and Plan of Merger dated June 2, 2014, as amended (“Merger Agreement”). 1st Enterprise was merged with and into the Bank, with the Bank continuing as the surviving entity in the merger. Pursuant to the

 

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terms and conditions set forth in the Merger Agreement, each outstanding share of 1st Enterprise common stock (other than shares as to which the holder exercised dissenters’ rights) was converted into the right to receive 1.3450 of a share of CU Bancorp common stock, resulting in 5.2 million shares of CU Bancorp common stock issued. The fair value of the 5.2 million common stock issued as part of the consideration paid ($103 million) was determined based on the closing market price ($19.60) of CU Bancorp common stock on November 30, 2014. The 16,400 shares of 1st Enterprise Non-Cumulative Perpetual Preferred Stock, Series D were converted into the right to receive 16,400 shares of CU Bancorp’s Non-Cumulative Perpetual Preferred Stock, Series A (“CU Bancorp Preferred Stock”). The U.S. Department of the Treasury is the sole holder of all outstanding shares of CU Bancorp Preferred Stock. As part of the Merger Agreement, CU Bancorp adopted the 1st Enterprise 2006 Stock Incentive Plan, as amended, as its own equity plan and all stock options granted by 1st Enterprise thereunder are exercisable for CU Bancorp common stock on substantially the same terms but adjusted to reflect the exchange ratio set forth in the Merger Agreement. See Note 16 – Stock Options and Restricted Stock for more details. The merger was accounted for by the Company using the acquisition method of accounting. Accordingly, the assets and liabilities of 1st Enterprise were recorded at their respective fair values at acquisition date and represents management’s estimates based on available information as of the acquisition date.

In connection with the merger, the consideration paid, the assets acquired, and the liabilities assumed were recorded at fair value on the date of acquisition, as summarized in the following table (dollars in thousands):

 

     November 30,
2014
 

Assets acquired:

  

Cash and due from banks

   $ 8,739   

Interest earning deposits in other financial institutions

     11,554   

Investment securities available-for-sale

     117,407   

Investment securities held-to-maturity

     47,457   

Loans

     553,183   

Premises and equipment, net

     1,830   

Deferred tax asset

     5,682   

Goodwill

     51,658   

Core deposit and leasehold right intangibles

     7,533   

Bank owned life insurance

     16,871   

Accrued interest receivable and other assets

     11,583   
  

 

 

 

Total assets acquired

   $ 833,497   
  

 

 

 

Liabilities assumed:

  

Deposits

   $ 703,358   

Accrued interest payable and other liabilities

     1,856   
  

 

 

 

Total liabilities assumed

   $ 705,214   
  

 

 

 

Total consideration paid:

  

CU Bancorp common stock issued

   $ 102,712   

CU Bancorp preferred stock issued

     15,921   

Fair value of 1st Enterprise stock options

     9,561   

Cash paid to a dissenter shareholder

     87   

Cash in lieu of fractional shares paid to 1st Enterprise shareholders

     2   
  

 

 

 

Total Consideration

   $ 128,283   
  

 

 

 

1st Enterprise operated as a full-service independent commercial banking institution in the Southern California market with three branches located in downtown Los Angeles, Orange County and the Inland Empire and a loan production office in the San Fernando Valley. 1st Enterprise and the Bank had complementary business models and both had developed strong commercial banking platforms and production capabilities, low-cost deposit bases and robust credit cultures.

 

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For the years ended December 31, 2015 and 2014, the Company expensed $498 thousand and $2.3 million of merger expenses, respectively. Additionally, for the same periods, the Company expensed $1.2 million and $423 thousand of severance and retention expenses, respectively.

The other intangible assets are primarily related to core deposits and are being amortized on an accelerated basis over a period of approximately ten years in proportion to the related estimated benefits. The assets and liabilities of 1st Enterprise were accounted for at fair value and required either a third party analysis or an internal valuation analysis of fair value. An analysis was performed on loans, investment securities, contractual lease obligations, deferred compensation, deposits, premises and equipment, other assets, other liabilities and preferred stock as of the merger date. Balances that were considered to be at fair value at the date of acquisition were cash and cash equivalents, bank owned life insurance, derivatives, other assets (interest receivable), and certain other liabilities (interest payable). The Company made significant estimates and exercised significant judgment in estimating fair values and accounting for such acquired assets and liabilities. Such fair values are subject to adjustment as more information about facts and circumstances that existed as of the acquisition date become available. This period is called the “measurement period” and it cannot exceed one year from the date of acquisition. See Note 8 – Goodwill, Core Deposits and Leasehold Right Intangibles for further details on a subsequent adjustment made to the 1st Enterprise goodwill during the one year measurement period. The Company also adopted the presentation and disclosure requirements of ASU 2015-16. For tax purposes, acquisition accounting adjustments, including goodwill are not taxable or deductible.

The following table summarizes the fair value of the total consideration transferred as part of the merger with 1st Enterprise as well as the fair value adjustments to 1st Enterprise’s balance sheet as of the acquisition date and the resulting goodwill (dollars in thousands):

 

           November 30,
2014
 

Consideration paid:

    

CU Bancorp common stock issued

     $ 102,712   

CU Bancorp preferred stock issued

       15,921   

Fair value of 1st Enterprise stock options

       9,561   

Cash paid to a dissenter shareholder

       87   

Cash in lieu of fractional shares paid to 1st Enterprise shareholders

       2   
    

 

 

 

Total consideration

       128,283   

Net assets of 1st Enterprise at November 30, 2014

       75,205   

Fair value adjustments:

    

Investment securities

   $ 1,779     

Loans, net

     (12,362  

Premises and equipment

     (377  

Deferred taxes

     3,019     

Core deposits and leasehold intangibles

     7,424     

Other assets

     (52  

Other liabilities

     1,989     
  

 

 

   

 

 

 

Total fair value adjustments

       1,420   
    

 

 

 

Fair value of net assets acquired

     $ 76,625   
    

 

 

 

Excess of consideration paid over fair value of net assets acquired (goodwill)

     $ 51,658   
    

 

 

 

The Company estimated the fair value for most loans acquired from 1st Enterprise by utilizing a methodology wherein loans with comparable characteristics were aggregated by type of collateral, whether loans are fixed, adjustable, interest only or have balloon structures. Other considerations included risk ratings, delinquency history, performance status (accrual or non-accrual) and other relevant factors. The discounted cash

 

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flow approach (“DCF”) was used to arrive at the fair value of the loans acquired. Projected cash flows were determined by estimating future credit losses and prepayment rates, which were then discounted to present value at a risk-adjusted discount rate for similar loans.

There was no carryover of 1st Enterprise’s allowance for loan losses associated with the loans acquired as the loans were initially recorded at fair value.

Purchased Credit Impaired (“PCI”) loans are accounted for under ASC 310-30 and non-PCI loans are accounted for under ASC 310-20. PCI loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable at the acquisition date, that the Company will not be able to collect all contractually required amounts. When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans. The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date, which can fluctuate due to changes in expected cash flows during the life of the PCI loans.

The following table presents the fair value of loans pursuant to accounting standards for PCI and non-PCI loans as of the 1st Enterprise acquisition date (dollars in thousands):

 

     November 30,
2014
 
     PCI
loans
     Non-PCI
loans
     Total  

Contractually required payments

   $ 577       $ 569,276       $ 569,853   

Less: non-accretable difference

     (108      —           (108
  

 

 

    

 

 

    

 

 

 

Cash flows expected to be collected (undiscounted)

     469         569,276         569,745   

Accretable yield

     —           (16,562      (16,562
  

 

 

    

 

 

    

 

 

 

Fair value of acquired loans

   $ 469       $ 552,714       $ 553,183   
  

 

 

    

 

 

    

 

 

 

Pro Forma Financial Information (Unaudited)

The following table presents (unaudited) financial information regarding 1st Enterprise operations included in our consolidated statement of income from the date of acquisition, November 30, 2014, through December 31, 2014. The following table also presents (unaudited) pro forma information for the periods indicated as though the 1st Enterprise merger had been completed as of January 1, 2013. The 2014 pro forma net income excludes historical non-recurring merger expenses net of taxes, totaling approximately $3.2 million for the Company and 1st Enterprise (dollars in thousands, except per share data).

 

     1st Enterprise  actual
results from
acquisition date
through
     Proforma
Year ended
December 31,
     Proforma
Year ended
December 31,
 
     December 31, 2014      2014      2013  

Net interest income after provision for loan losses

   $ 2,023       $ 77,140       $ 68,771   

Net income

   $ 766       $ 17,218       $ 15,299   
  

 

 

    

 

 

    

 

 

 

Preferred stock dividends and discount accretion

        (1,234      (889
     

 

 

    

 

 

 

Net income available to common shareholders

      $ 15,984       $ 14,410   
     

 

 

    

 

 

 

Diluted earnings per share

      $ 0.94       $ 0.87   

 

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The above proforma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the merged companies that would have been achieved had the acquisition occurred at January 1, 2013 for 1st Enterprise nor are they intended to represent or be indicative of future results of operations. The proforma results do not include expected operating cost savings as a result of the acquisition. These proforma results require significant estimates and judgments particularly as it relates to valuation and accretion of income associated with acquired loans.

Note 3 – Computation of Book Value and Tangible Book Value per Common Share

Book value per common share was calculated by dividing total shareholders’ equity less preferred stock, by the number of common shares issued and outstanding. Tangible book value per common share was calculated by dividing tangible common equity, by the number of common shares issued and outstanding. The tables below present the computation of book value and tangible book value per common share as of the dates indicated (dollars in thousands, except share and per share data):

 

     December 31,  
     2015      2014  

Total Shareholders’ Equity

   $ 306,807       $ 279,192   

Less: Preferred stock

     16,995         16,004   

Less: Goodwill

     64,603         63,950   

Less: Core deposit and leasehold right intangibles

     7,671         9,547   
  

 

 

    

 

 

 

Tangible Shareholders’ Equity

     217,538       $ 189,691   
  

 

 

    

 

 

 

Common shares issued and outstanding

     17,175,389         16,683,856   

Book value per common share

   $ 16.87       $ 15.78   
  

 

 

    

 

 

 

Tangible book value per common share

   $ 12.67       $ 11.37   
  

 

 

    

 

 

 

Note 4 – Computation of Earnings per Common Share

Basic and diluted earnings per common share were determined by dividing the net income available to common shareholders by the applicable basic and diluted weighted average common shares outstanding. The following table shows weighted average basic common shares outstanding, potential dilutive shares related to stock options, unvested restricted stock, and weighted average diluted shares for the periods indicated (dollars in thousands, except share and per share data):

 

     Years Ended
December 31,
 
     2015      2014      2013  

Net Income

   $ 21,236       $ 8,908       $ 9,785   

Less: Preferred stock dividends and discount accretion

     1,174         124         —     
  

 

 

    

 

 

    

 

 

 

Net Income available to common shareholders

   $ 20,062       $ 8,784       $ 9,785   
  

 

 

    

 

 

    

 

 

 

Weighted average basic common shares outstanding

     16,543,787         11,393,445         10,567,436   

Dilutive effect of potential common share issuances from stock options and restricted stock

     439,434         274,288         269,425   
  

 

 

    

 

 

    

 

 

 

Weighted average diluted common shares outstanding

     16,983,221         11,667,733         10,836,861   
  

 

 

    

 

 

    

 

 

 

Income per common share

        

Basic

   $ 1.21       $ 0.77       $ 0.93   

Diluted

   $ 1.18       $ 0.75       $ 0.90   
  

 

 

    

 

 

    

 

 

 

Anti-dilutive shares not included in the calculation of diluted earnings per share

     32,811         79,000         81,000   
  

 

 

    

 

 

    

 

 

 

 

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Note 5 – Investment Securities

The investment securities portfolio has been classified into two categories: available-for-sale (“AFS”) and held-to-maturity (“HTM”).

The following tables present the amortized cost, gross unrealized gains and losses, and fair values of investment securities by major category as of the dates indicated (dollars in thousands):

 

            Gross Unrealized         

December 31, 2015

   Amortized
Cost
     Gains      Losses      Fair Value  

Available-for-sale:

           

U.S. Govt Agency and Sponsored Agency – Note Securities

   $ 1,014       $ —         $ —         $ 1,014   

U.S. Govt Agency – SBA Securities

     93,674         399         583         93,490   

U.S. Govt Agency – GNMA Mortgage-Backed Securities

     30,916         202         418         30,700   

U.S. Govt Sponsored Agency – CMO & Mortgage-Backed Securities

     97,693         250         789         97,154   

Corporate Securities

     4,016         7         —           4,023   

Municipal Securities

     1,010         1         —           1,011   

Asset Backed Securities

     7,890         —           243         7,647   

U.S. Treasury Notes

     80,981         —           235         80,746   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

     317,194         859       $ 2,268         315,785   

Held-to-maturity:

           

Municipal Securities

     42,036         335         32         42,339   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     42,036         335       $ 32         42,339   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 359,230       $ 1,194       $ 2,300       $ 358,124   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

            Gross Unrealized         

December 31, 2014

   Amortized
Cost
     Gains      Losses      Fair Value  

Available-for-sale:

           

U.S. Govt Agency and Sponsored Agency – Note Securities

   $ 2,036       $ 2       $ —         $ 2,038   

U.S. Govt Agency – SBA Securities

     54,062         770         345         54,487   

U.S. Govt Agency – GNMA Mortgage-Backed Securities

     29,364         255         277         29,342   

U.S. Govt Sponsored Agency – CMO & Mortgage-Backed Securities

     107,348         457         577         107,228   

Corporate Securities

     4,043         77         —           4,120   

Municipal Securities

     1,039         11         —           1,050   

Asset Backed Securities

     8,711         1         40         8,672   

U.S. Treasury Notes

     20,031         —           6         20,025   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

     226,634         1,573       $ 1,245         226,962   

Held-to-maturity:

           

Municipal Securities

     47,147         169         157         47,159   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     47,147         169       $ 157         47,159   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 273,781       $ 1,742       $ 1,402       $ 274,121   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s investment securities portfolio at December 31, 2015, consists of U.S. Treasury Notes, U.S. Agency and U.S. Sponsored Agency issued AAA and AA rated investment-grade securities, asset backed securities, investment grade corporate bond securities, and municipal securities. At December 31, 2015 and December 31, 2014, securities with a market value of $197 million and $149 million, respectively, were pledged

 

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as collateral for securities sold under agreements to repurchase, public deposits, outstanding standby letters of credit, bankruptcy deposits, and other purposes as required by various statutes and agreements. See Note 9 – Borrowings and Subordinated Debentures.

The following tables present the gross unrealized losses and fair values of AFS and HTM investment securities that were in unrealized loss positions, summarized and classified according to the duration of the loss period as of the dates indicated (dollars in thousands).

 

    < 12 Continuous
Months
    > 12 Continuous
Months
    Total  
December 31, 2015   Fair
Value
    Gross
Unrealized
Loss
    Fair
Value
    Gross
Unrealized
Loss
    Fair
Value
    Gross
Unrealized
Loss
 

Available-for-sale investment securities:

           

U.S. Govt. Agency – SBA Securities

  $ 53,852      $ 428      $ 7,935      $ 154      $ 61,787      $ 582   

U.S. Govt. Agency – GNMA Mortgage-Backed Securities

    5,417        47        14,296        371        19,713        418   

U.S. Govt. Sponsored Agency CMO & Mortgage-Backed Securities

    67,475        564        10,024        225        77,499        789   

Asset Backed Securities

    2,928        54        4,719        190        7,647        244   

U.S. Treasury Notes

    80,745        235        —          —          80,745        235   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale investment securities

  $ 210,417      $ 1,328      $ 36,974      $ 940      $ 247,391      $ 2,268   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held-to-maturity investment securities:

           

Municipal Securities

  $ 5,669      $ 16      $ 2,392      $ 16      $ 8,061      $ 32   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held-to-maturity investment securities

  $ 5,669      $ 16      $ 2,392      $ 16      $ 8,061      $ 32   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    < 12 Continuous
Months
    > 12 Continuous
Months
    Total  
December 31, 2014   Fair
Value
    Gross
Unrealized
Loss
    Fair
Value
    Gross
Unrealized
Loss
    Fair
Value
    Gross
Unrealized
Loss
 

Available-for-sale investment securities:

           

U.S. Govt. Agency – SBA Securities

  $ 10,688      $ 87      $ 10,095      $ 258      $ 20,783      $ 345   

U.S. Govt. Agency – GNMA Mortgage-Backed Securities

    12,784        65        8,784        212        21,568        277   

U.S. Govt. Sponsored Agency CMO & Mortgage-Backed Securities

    64,360        413        6,584        164        70,944        577   

Asset Backed Securities

    4,849        40        —          —          4,849        40   

U.S. Treasury Notes

    20,025        6        —          —          20,025        6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale investment securities

  $ 112,706      $ 611      $ 25,463      $ 634      $ 138,169      $ 1,245   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held-to-maturity investment securities:

           

Municipal Securities

  $ 23,966      $ 157      $ —        $ —        $ 23,966      $ 157   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held-to-maturity investment securities

  $ 23,966      $ 157      $ —        $ —        $ 23,966      $ 157   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The unrealized losses in each of the above categories are associated with the general fluctuation of market interest rates and are not an indication of any deterioration in the credit quality of the security issuers. Further, the Company does not intend to sell these securities and is not more-likely-than-not to be required to sell the securities before the recovery of its amortized cost basis. Accordingly, the Company had no securities that were classified as other-than-temporary impaired at December 31, 2015 or 2014, and did not recognize any impairment charges in the consolidated statements of income.

The amortized cost, fair value and the weighted average yield of debt securities at December 31, 2015, are reflected in the table below (dollars in thousands). Maturity categories are determined as follows:

 

   

U.S. Govt. Agency, U.S. Treasury Notes and U.S. Govt. Sponsored Agency bonds and notes – maturity date

 

   

U.S. Govt. Sponsored Agency CMO or Mortgage-Backed Securities, U.S. Govt. Agency GNMA Mortgage-Backed Securities, Asset Backed Securities and U.S. Gov. Agency SBA Securities – estimated cash flow taking into account estimated pre-payment speeds

 

   

Investment grade Corporate Bonds and Municipal Securities – the earlier of the maturity date or the expected call date.

Although, U.S. Government Agency and U.S. Government Sponsored Agency Mortgage-Backed and CMO securities have contractual maturities through 2048, the expected maturity will differ from the contractual maturities because borrowers or issuers may have the right to prepay such obligations without penalties.

 

     December 31, 2015  

Maturities Schedule of Securities (Dollars in thousands)

   Amortized
Cost
     Fair Value      Weighted
Average
Yield
 

Available-for-sale:

        

Due through one year

   $ 66,330       $ 66,185         1.07

Due after one year through five years

     147,915         147,115         1.27

Due after five years through ten years

     82,063         81,624         1.88

Due after ten years

     20,886         20,861         2.84
  

 

 

    

 

 

    

 

 

 

Total available-for-sale

     317,194         315,785         1.49

Held-to-maturity:

        

Due through one year

     2,237         2,243         1.77

Due after one year through five years

     34,307         34,506         1.58

Due after five years through ten years

     5,492         5,590         1.96
  

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     42,036         42,339         1.64
  

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 359,230       $ 358,124         1.50
  

 

 

    

 

 

    

 

 

 

The weighted average yields in the above table are based on effective rates of book balances at the end of the year. Yields are derived by dividing interest income, adjusted for amortization of premiums and accretion of discounts, by total amortized cost.

During the years ended December 31, 2015, 2014 and 2013 the Company recognized net gains and (losses) on sales of available-for-sale securities and held-to-maturity securities in the amount of $112 thousand, $(47) thousand and $47 thousand, respectively. The Company had net proceeds from the sale of available-for-sale securities and held-to-maturity securities of $5.7 million, $25 million and $7.0 million during the years ended December 31, 2015, 2014 and 2013, respectively.

 

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Investments in FHLB Common Stock

The Company’s investment in the common stock of the FHLB is carried at cost and was $8.0 million as of December 31, 2015 and 2014, respectively. See Note 13 – Borrowings and Subordinated Debentures for a detailed discussion regarding the Company’s borrowings and the requirements to purchase FHLB common stock.

The FHLB has declared and paid cash dividends in 2013, 2014, and 2015. The Company has received cash dividends from the FHLB of $1.1 million, $320 thousand, and $199 thousand for the years ending December 31, 2015, 2014, and 2013, respectively. The Company acquired $3.8 million of FHLB common stock in 2014 as part of the acquisition of 1st Enterprise.

The FHLB has been classified as one of the Company’s primary correspondent banks and is evaluated on a quarterly basis as part of the Company’s evaluation of its correspondent banking relationships under Federal Reserve Board Regulation F.

The investment in FHLB stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through December 31, 2015 and based on the current financial condition of the FHLB, no impairment losses appear necessary or warranted.

Interest Income on Investment Securities

The following table presents the composition of interest income on investment securities for the periods indicated (dollars in thousands):

 

     Years ended December 31,  
     2015      2014      2013  

Taxable interest

   $ 3,773       $ 2,331       $ 1,913   

Non-taxable interest

     745         38         —     

Total interest income on investment securities

   $ 4,518       $ 2,369       $ 1,913   

Note 6 – Loans

The following table presents the composition of the loan portfolio as of the dates indicated (dollars in thousands):

 

     December 31,  
     2015      2014  

Commercial and Industrial Loans:

   $ 537,368       $ 528,517   

Loans Secured by Real Estate:

     

Owner-Occupied Nonresidential Properties

     407,979         339,309   

Other Nonresidential Properties

     533,168         481,517   

Construction, Land Development and Other Land

     125,832         72,223   

1-4 Family Residential Properties

     114,525         121,985   

Multifamily Residential Properties

     71,179         52,813   
  

 

 

    

 

 

 

Total Loans Secured by Real Estate

     1,252,683         1,067,847   
  

 

 

    

 

 

 

Other Loans:

     43,112         28,359   
  

 

 

    

 

 

 

Total Loans

   $ 1,833,163       $ 1,624,723   
  

 

 

    

 

 

 

Loan balances in the table above include net deferred fees and net discount for a total of $22 million and $26 million as of December 31, 2015 and 2014, respectively.

 

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Loans are made to commercial, non-profit organizations and consumers. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in Southern California where a majority of the Company’s loan customers are located.

The Company’s extensions of credit are governed by its credit policies which are established to control the quality, structure and adherence to applicable laws. These policies are reviewed and approved by the Board of Directors on a regular basis.

Commercial and Industrial Loans: Commercial credit is extended primarily to small/middle market businesses, professional enterprises and their owners for business purposes. Typical loan types are working capital loans, loans for financing capital expenditures, asset acquisition loans and other business loans. Loans to closely held businesses will generally be guaranteed in full or in a meaningful amount by the businesses’ major owners. Commercial loans are made based primarily on the historical and projected cash flow of the borrower and secondarily on the underlying non-real estate collateral provided by the borrower. The cash flows of borrowers, however, may not behave as forecasted and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum standards and underwriting guidelines have been established for all commercial loan types.

Commercial Real Estate Loans: The Company’s goal is to create and maintain a high quality portfolio of commercial real estate loans with customers who meet the quality and relationship profitability objectives of the Company. These loans include owner-occupied nonresidential properties and other nonresidential properties. Owner-occupied nonresidential property loans are subject to underwriting standards and processes similar to commercial and industrial loans. These loans are viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the business. Other nonresidential property loans are also subject to strict underwriting standards and processes. For these loans the Company looks at the underlying cash flows from these properties, which include: the debt service coverage, the cash flow from the existing tenants in the property, the historical vacancy of the property, the financial strength of the tenants, and the type and duration of signed leases. Loan performance of commercial real estate loans may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

Construction and Land Development Loans: The Company defines construction loans as loans where the loan proceeds are controlled by the Company and used for the improvement of real estate in which the Company holds a deed of trust. Land development loans are loans on vacant land that may be developed by the owner of the property sometime in the future. Due to the inherent risk in this type of loan, they are subject to other specific underwriting policy guidelines outlined in the Company’s credit policies and are monitored closely.

Residential Loans: The Company originates residential real estate loans as either home equity lines of credit or multifamily “apartment loans.” Home equity lines of credit (“HELOCs”) are made to individuals and to business principals with whom the Company maintains, in most cases, either a business lending or deposit relationship. The underwriting standards are typical of home equity products with loan to value and debt service considerations. Multifamily loans are underwritten based on the projected cash flows of the property with consideration of market conditions and values where the property is located.

Other Loans: The Company originates loans to individuals for personal expenditures and investments that the Company maintains in most cases either a deposit or business relationship with. Also included in this category are loans to non-depository financial institutions, non-profit organizations and consumers.

Purchased loans: Loans acquired in acquisitions are recorded at estimated fair value on their purchase date without a carryover of the related allowance for loan loss. Loans acquired with deteriorated credit quality are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that

 

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the Company will not collect principal and interest payments according to the contractual terms of the original loan agreement. Evidence of credit quality deterioration as of the purchase date may include factors such as past due and non-accrual status. The difference between undiscounted contractually required payments at acquisition and the undiscounted cash flows expected to be collected at acquisition is referred to as the non-accretable yield. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses.

Restructured loans: Loans may be restructured in an effort to maximize collections. The Company may use various restructuring techniques, including, but not limited to, deferral of past due interest or principal, redeeming past due taxes, reduction of interest rates, extending maturities and modification of amortization schedules. The Company does not typically forgive principal balances or past due interest prior to pay-off or surrender of the property.

Concentrations

The Company makes commercial, construction, commercial real estate, and consumer home equity loans to customers primarily in Los Angeles, Riverside, Orange, San Bernardino and Ventura Counties. As an abundance of caution, the Company may require commercial real estate collateral on a loan classified as a commercial loan. At December 31, 2015, loans secured by real estate collateral accounted for approximately 69% of the loan portfolio. Of these loans, 96% are secured by first trust deed liens and 4% are secured by second trust deed liens. In addition, 32% are secured by owner-occupied non-residential properties. Loans secured by first trust deeds on commercial real estate generally have an initial loan to value ratio of not more than 75%, except for SBA guaranteed loans which may exceed this level. The Company’s policy for requiring collateral is to obtain collateral whenever it is available or desirable, depending upon the degree of risk in the proposed credit transaction. In addition, 24% of total loans have been secured by a UCC filing on the business property of the borrower. Approximately 6% of loans are unsecured. The Company’s loans are expected to be repaid from cash flows or from proceeds from the sale of selected assets of the borrowers.

A substantial portion of the Company’s customers’ ability to honor their contracts is dependent on the economy in the area. The Company’s goal is to continue to maintain a diversified loan portfolio, which requires the loans to be well collateralized and supported by sufficient cash flows.

 

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The following table is a breakout of the Company’s gross loans stratified by the industry concentration of the borrower by their respective NAICS code as of the dates indicated (dollars in thousands):

 

     December 31,  
     2015      2014  

Real Estate

   $ 857,021       $ 744,663   

Manufacturing

     174,773         161,233   

Construction

     161,618         113,763   

Wholesale

     134,093         124,336   

Hotel/Lodging

     105,741         88,269   

Finance

     87,734         96,074   

Professional Services

     60,952         64,215   

Healthcare

     47,293         43,917   

Other Services

     45,002         45,781   

Retail

     38,928         35,503   

Restaurant/Food Service

     26,226         24,525   

Administrative Management

     23,736         28,016   

Transportation

     22,237         18,158   

Information

     20,171         15,457   

Education

     9,244         10,253   

Management

     8,137         1,606   

Entertainment

     6,188         8,284   

Other

     4,069         670   
  

 

 

    

 

 

 

Total

   $ 1,833,163       $ 1,624,723   
  

 

 

    

 

 

 

Small Business Administration Loans

As part of the acquisition of PC Bancorp, the Company acquired loans that were originated under the guidelines of the Small Business Administration (“SBA”) program. The total portfolio of the SBA contractual loan balances being serviced by the Company at December 31, 2015 was $110 million, of which $77 million has been sold. Of the $33 million remaining on the Company’s books, $25 million is not guaranteed and $8 million is guaranteed by the SBA.

For SBA guaranteed loans, a secondary market exists to purchase the guaranteed portion of these loans with the Company continuing to “service” the entire loan. The secondary market for guaranteed loans is comprised of investors seeking long term assets with yields that adapt to the prevailing interest rates. These investors are typically financial institutions, insurance companies, pension funds, and other types of investors specializing in the acquisition of this product. When a decision to sell the guaranteed portion of an SBA loan is made by the Company, bids are solicited from secondary market investors and the loan is normally sold to the highest bidder.

At December 31, 2015, there were no loans classified as held for sale. At December 31, 2015, the balance of SBA 7a loans originated during the year is $2.0 million, of which $1.5 million is guaranteed by the SBA. The Company does not currently plan on selling these loans, but it may choose to do so in the future.

Allowance for Loan Loss

The allowance for loan loss is established through a provision for loan losses charged to expense, which represents managements’ best estimate of probable losses that exist within the loan portfolio. The Allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, Receivables and allowance allocations calculated in accordance with ASC Topic 450, Contingencies. Accordingly, the Allowance consists of specific and general components. The specific component relates to loans that are categorized as impaired. For loans that are categorized as impaired, a specific

 

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allowance is established when the realizable value of the impaired loan is lower than the carrying value of that loan. Impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. In addition, the impaired loan is reevaluated at each subsequent reporting period.

The general component covers non-impaired loans and is based on the historical loan loss experience of the portfolio loan segments for the past 20 quarters, however the Company utilizes Uniform Bank Peer Group (“UBPR”) historical loss data to evaluate potential loss exposure for those loan segments where the Company had no meaningful historical loss experience. The Allowance also includes an assessment of the following qualitative factors: the results of any internal and external loan reviews and any regulatory examination, loan charge-off experience, estimated potential charge-off exposure on each classified loan, credit concentrations, changes in the value of collateral for collateral dependent loans, and any known impairment in the borrower’s ability to repay. The Company also evaluates environmental and other factors such as underwriting standards, staff experience, the nature and volume of loans and loan terms, business conditions, political and regulatory conditions, local and national economic trends. The quantitative portion of the Allowance is adjusted for qualitative factors to account for model imprecision and to incorporate the range of probable outcomes inherent in the estimates used for the Allowance.

The Company conducts a critical evaluation of the credit quality of the loan portfolio and the adequacy of the Allowance on a quarterly basis. The level of the Allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the Allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the Allowance is dependent upon a variety of factors beyond the Company’s control, including among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. Portions of the Allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the Allowance is dependent upon a variety of factors beyond the Company’s control, including among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The following is a summary of activity for the allowance for loan loss for the dates and periods indicated (dollars in thousands):

 

     December 31,  
     2015     2014     2013  

Allowance for loan loss at beginning of year

   $ 12,610      $ 10,603      $ 8,803   

Provision for loan losses

     5,080        2,239        2,852   

Net (charge-offs) recoveries:

    

Charge-offs

     (2,510     (692     (1,912

Recoveries

     502        460        860   
  

 

 

   

 

 

   

 

 

 

Net (charge-offs)

     (2,008     (232     (1,052
  

 

 

   

 

 

   

 

 

 

Allowance for loan loss at end of year

   $ 15,682      $ 12,610      $ 10,603   
  

 

 

   

 

 

   

 

 

 

Net (charge-offs) to average loans

     (0.12 )%      (0.02 )%      (0.12 )% 

Allowance for loan loss to total loans

     0.86     0.78     1.14

Allowance for loan loss to total loans accounted for at historical cost, which excludes purchased loans acquired by acquisition

     1.25     1.39     1.50

 

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The following tables present, by portfolio segment, the changes in the allowance for loan loss and the recorded investment in loans as of the dates and for the periods indicated (dollars in thousands):

 

     Commercial
and
Industrial
    Construction,
Land
Development
and
Other Land
     Commercial
and

Other Real
Estate
    Other      Total  

Year ended – December 31 2015

         

Allowance for loan loss – Beginning balance

   $ 5,864      $ 1,684       $ 4,802      $ 260       $ 12,610   

Provision for loan losses

     1,781        392         2,306        601         5,080   

Net (charge-offs) recoveries:

         

Charge-offs

     (2,218     —           (292     —           (2,510

Recoveries

     497        —           5        —           502   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total net (charge-offs)

     (1,721     —           (287     —           (2,008
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance

   $ 5,924      $ 2,076       $ 6,821      $ 861       $ 15,682   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     Commercial
and
Industrial
    Construction,
Land
Development
and
Other Land
     Commercial
and

Other Real
Estate
    Other      Total  

Year ended – December 31 2014

         

Allowance for loan loss – Beginning balance

   $ 5,534      $ 1,120       $ 3,886      $ 63       $ 10,603   

Provision for loan losses

     595        564         883        197         2,239   

Net (charge-offs) recoveries:

         

Charge-offs

     (619     —           (73     —           (692

Recoveries

     354        —           106        —           460   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total net (charge-offs) recoveries

     (265     —           33        —           (232
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Ending balance

   $ 5,864      $ 1,684       $ 4,802      $ 260       $ 12,610   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The following tables present both the allowance for loan loss and the associated loan balance classified by loan portfolio segment and by credit evaluation methodology (dollars in thousands):

 

     Commercial
and
Industrial
     Construction,
Land
Development

and
Other Land
     Commercial
and

Other Real
Estate
     Other      Total  

December 31, 2015

           

Allowance for loan loss:

           

Individually evaluated for impairment

   $ —         $ —         $ —         $ —         $ —     

Collectively evaluated for impairment

     5,924         2,076         6,821         861         15,682   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Allowance for Loan Loss

   $ 5,924       $ 2,076       $ 6,821       $ 861       $ 15,682   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans receivable:

           

Individually evaluated for impairment

   $ 558       $ —         $ 649       $ —         $ 1,207   

Collectively evaluated for impairment

     536,333         125,832         1,124,667         43,112         1,829,944   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     477         —           1,535         —           2,012   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Receivable

   $ 537,368       $ 125,832       $ 1,126,851       $ 43,112       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     Commercial
and
Industrial
     Construction,
Land
Development

and
Other Land
     Commercial
and

Other Real
Estate
     Other      Total  

December 31, 2014

              

Allowance for loan loss:

              

Individually evaluated for impairment

   $ 222       $ —         $ —         $ —         $ 222   

Collectively evaluated for impairment

     5,642         1,684         4,802         260         12,388   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Allowance for Loan Loss

   $ 5,864       $ 1,684       $ 4,802       $ 260       $ 12,610   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans receivable:

              

Individually evaluated for impairment

   $ 1,914       $ —         $ 737       $ —         $ 2,651   

Collectively evaluated for impairment

     525,910         72,223         993,195         28,359         1,619,687   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     693         —           1,692         —           2,385   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Receivable

   $ 528,517       $ 72,223       $ 995,624       $ 28,359       $ 1,624,723   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Credit Quality of Loans

The Company utilizes an internal loan classification system as a means of reporting problem and potential problem loans. Under the Company’s loan risk rating system, loans are classified as “Pass,” with problem and potential problem loans as “Special Mention,” “Substandard” “Doubtful” and “Loss”. Individual loan risk ratings are updated continuously or at any time the situation warrants. In addition, management regularly reviews problem loans to determine whether any loan requires a classification change, in accordance with the Company’s policy and applicable regulations. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The internal loan classification risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

 

   

Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. There are several different levels of Pass rated credits, including “Watch” which is considered a transitory grade for pass rated loans that require greater monitoring. Loans not meeting the criteria of special mention, substandard, doubtful or loss that have been analyzed individually as part of the above described process are considered to be pass-rated loans.

 

   

Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. Special Mention loans do not currently expose the Company to sufficient risk to warrant classification as a Substandard, Doubtful or Loss classification, but possess weaknesses that deserve management’s close attention.

 

   

Substandard – loans that have a well-defined weakness based on objective evidence and can be characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

   

Doubtful – loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

   

Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

 

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The following tables present the risk category of loans by class of loans based on the most recent internal loan classification as of the dates indicated (dollars in thousands):

 

December 31, 2015    Commercial
and
Industrial
     Construction,
Land
Development
and Other
Land
     Commercial
and

Other Real
Estate
     Other      Total  

Pass

   $ 503,006       $ 125,832       $ 1,101,548       $ 40,132       $ 1,770,518   

Special Mention

     16,041         —           6,494         43         22,578   

Substandard

     18,321         —           18,809         2,937         40,067   

Doubtful

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 537,368       $ 125,832       $ 1,126,851       $ 43,112       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
December 31, 2014    Commercial
and
Industrial
     Construction,
Land
Development
and Other
Land
     Commercial
and

Other Real
Estate
     Other      Total  

Pass

   $ 502,624       $ 72,223       $ 977,525       $ 28,358       $ 1,580,730   

Special Mention

     8,738         —           4,878         —           13,616   

Substandard

     17,155         —           13,221         1         30,377   

Doubtful

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 528,517       $ 72,223       $ 995,624       $ 28,359       $ 1,624,723   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Age Analysis of Past Due and Non-Accrual Loans

The following tables present an aging analysis of the recorded investment in past due and non-accrual loans as of the dates indicated (dollars in thousands):

 

December 31, 2015    31-60
Days
Past Due
     61-90
Days
Past Due
     Greater
than

90 Days
Past Due
and
Accruing
     Total
Past Due
and
Accruing
     Total
Non-
Accrual
     Current      Total Loans  

Commercial and Industrial

   $ —         $ —         $ —         $ —         $ 1,032       $ 536,336       $ 537,368   

Construction, Land Development and Other Land

     —           —           —           —           —           125,832         125,832   

Commercial and Other Real Estate

     —           —           —           —           1,019         1,125,832         1,126,851   

Other

     —           —           —           —           —           43,112         43,112   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ —         $ —         $ 2,051       $ 1,831,112       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
December 31, 2014    31-60
Days
Past Due
     61-90
Days
Past Due
     Greater
than

90 Days
Past Due
and
Accruing
     Total
Past Due
and
Accruing
     Total
Non-
Accrual
     Current      Total Loans  

Commercial and Industrial

   $ 192       $ 233       $ —         $ 425       $ 2,604       $ 525,488       $ 528,517   

Construction, Land Development and Other Land

     —           —           —           —           —           72,223         72,223   

Commercial and Other Real Estate

     354         —           —           354         1,305         993,965         995,624   

Other

     —           —           —           —           —           28,359         28,359   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 546       $ 233       $ 0       $ 779       $ 3,909       $ 1,620,035       $ 1,624,723   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Included in the non-accrual column above are purchased credit impaired loans of $844 thousand and $1.3 million as of December 31, 2015 and 2014, respectively. Included in the current column are purchased credit impaired loans that have been returned to accrual status of $1.2 million and $1.1 million as of December 31, 2015 and 2014, respectively.

Impaired Loans

Impaired loans are evaluated by comparing the fair value of the collateral, if the loan is collateral dependent, or the present value of the expected future cash flows discounted at the loan’s effective interest rate, if the loan is not collateral dependent, with the recorded investment of a loan.

A valuation allowance is established for an impaired loan when the realizable value of the loan is less than the recorded investment. In certain cases, portions of impaired loans are charged-off to realizable value instead of establishing a valuation allowance and are included, when applicable, in the table below as impaired loans “with no specific allowance recorded.” The valuation allowance disclosed below is included in the allowance for loan loss reported in the consolidated balance sheets as of December 31, 2015 and December 31, 2014.

The following tables present, by loan portfolio segment, the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable for the dates and periods indicated. This table excludes purchased credit impaired loans (loans acquired in acquisitions with deteriorated credit quality) of $2.0 million and $2.4 million at December 31, 2015 and 2014, respectively.

Year ended December 31, 2015 (dollars in thousands)

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no specific allowance recorded:

        

Commercial and Industrial

   $ 558       $ 1,027       $ —         $ 672       $ —     

Commercial and Other Real Estate

     649         692         —           70         —     

With an allowance recorded:

        

Commercial and Industrial

     —           —           —           —           —     

Commercial and Other Real Estate

     —           —           —           —           —     

Total

        

Commercial and Industrial

     558         1,027         —           672         —     

Commercial and Other Real Estate

     649         692         —           70         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,207       $ 1,719       $ —         $ 742       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Year ended December 31, 2014 (dollars in thousands)

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no specific allowance recorded:

        

Commercial and Industrial

   $ 520       $ 609       $ —         $ 993       $ —     

Commercial and Other Real Estate

     737         739         —           2,491         —     

With an allowance recorded:

        

Commercial and Industrial

     1,394         1,546         222         1,507         —     

Total

        

Commercial and Industrial

     1,914         2,155         222         2,500         —     

Commercial and Other Real Estate

     737         739         —           2,491         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,651       $ 2,894       $ 222       $ 4,991       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following is a summary of additional information pertaining to impaired loans for the periods indicated (dollars in thousands):

 

     Year Ended December 31,  
     2015      2014      2013  

Average recorded investment in impaired loans

   $ 742       $ 4,991       $ 7,067   

Interest foregone on impaired loans

   $ 265       $ 421         710   

Cash collections applied to reduce principal balance

   $ 1,118       $ 3,014         5,057   

Interest income recognized on cash collections

   $ —         $ —         $ —     

Troubled Debt Restructuring

The Company’s loan portfolio contains certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers experiencing financial difficulties. Loans are restructured in an effort to maximize collections. Economic concessions can include: reductions to the stated interest rate, payment extensions, principal forgiveness or other actions.

The modification process includes evaluation of impairment based on the present value of expected future cash flows, discounted at the effective interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the loan collateral. In these cases, management uses the current fair value of the collateral, less selling costs, to evaluate the loan for impairment. If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and unamortized premium or discount) impairment is recognized through a specific allowance or a charge-off.

The following tables include the recorded investment and unpaid principal balances for troubled debt restructured loans at December 31, 2015, December 31, 2014 and December 31, 2013. These tables include TDR loans that were purchased credit impaired (“PCI”). TDR loans that are non-PCI loans are included in the Impaired Loans tables above. As of December 31, 2015, there were three PCI loans that are considered to be TDR loans with a recorded investment of $263 thousand and unpaid principal balances of $969 thousand.

 

Year ended December 31, 2015

(dollars in thousands)

   Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
 

Commercial and Industrial

   $ 627       $ 1,363       $         —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 627       $ 1,363       $ —     
  

 

 

    

 

 

    

 

 

 
Year ended December 31, 2014                     

Commercial and Industrial

   $ 530       $ 719       $ —     

Commercial and Other Real Estate

     114         115         —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 644       $ 834       $         —     
  

 

 

    

 

 

    

 

 

 
Year ended December 31, 2013                     

Commercial and Industrial

   $ 541       $ 843       $         —     

Commercial and Other Real Estate

     2,173         2,785         —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,714       $ 3,628       $ —     
  

 

 

    

 

 

    

 

 

 

 

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The following tables show the pre- and post-modification recorded investment in TDR loans by loan segment that have occurred during the periods indicated (dollars in thousands):

 

Year ended December 31, 2015    Number
of Loans
     Pre-Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
 

Extended Maturity Date and Deferred Principal and Interest Payments:

        

Commercial and Industrial

         3       $ 1,335       $ 208   
  

 

 

    

 

 

    

 

 

 

Total

     3       $ 1,335       $ 208   
  

 

 

    

 

 

    

 

 

 
Year ended December 31, 2014                     

Reduced Interest Rate and Lengthened Amortization:

        

Commercial and Industrial

     1       $ 224       $ 224   

Commercial and Other Real Estate

     1         114         114   
  

 

 

    

 

 

    

 

 

 

Total

     2       $ 338       $ 338   
  

 

 

    

 

 

    

 

 

 
Year ended December 31, 2013                     

Reduced Interest Rate and Lengthened Amortization:

        

Commercial and Industrial

     1       $ 310       $ 310   
  

 

 

    

 

 

    

 

 

 

Total

     1       $ 310       $ 310   
  

 

 

    

 

 

    

 

 

 

Loans are restructured in an effort to maximize collections. Impairment analyses are performed on the Company’s troubled debt restructured loans in conjunction with the normal allowance for loan loss process. The Company’s troubled debt restructured loans are analyzed to ensure adequate cash flow or collateral supports the outstanding loan balance.

There were no commitments to lend additional funds to borrowers whose terms have been modified in troubled debt restructurings at December 31, 2015 or 2014.

There have been no payment defaults in the year ended December 31, 2015 subsequent to modification on troubled debt restructured loans that have been modified within the last twelve months.

Loans Acquired Through Acquisition

The following table reflects the accretable net discount for loans acquired through acquisition, for the periods indicated (dollars in thousands):

 

     Year Ended December 31,  
         2015              2014      

Balance, beginning of year

   $ 21,402       $ 7,912   

Accretion, included in interest income

     (6,274      (3,023

Additions, due to acquisition

     —           16,562   

Reclassifications to non-accretable yield

     (518      (49
  

 

 

    

 

 

 

Balance, end of year

   $ 14,610       $ 21,402   
  

 

 

    

 

 

 

The above table reflects the fair value adjustment on the loans acquired from mergers that will be amortized to loan interest income based on the effective yield method over the remaining life of the loans. These amounts do not include the fair value adjustments on the purchased credit impaired loans acquired from mergers.

 

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Purchased Credit Impaired Loans

PCI loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable at the acquisition date, that the Company will not be able to collect all contractually required amounts.

When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans.

The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans.

The following table reflects the outstanding balance and related carrying value of PCI loans as of the dates indicated (dollars in thousands):

 

     December 31, 2015      December 31, 2014  
     Unpaid
Principal
Balance
     Carrying
Value
     Unpaid
Principal
Balance
     Carrying
Value
 

Commercial and Industrial

   $ 2,331       $ 477       $ 1,205       $ 693   

Commercial and Other Real Estate

     2,250         1,535         3,018         1,692   

Other

     61         —           62         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,642       $ 2,012       $ 4,285       $ 2,385   
  

 

 

    

 

 

    

 

 

    

 

 

 

There is no related allowance for credit losses with the PCI loans as of December 31, 2015 and 2014 included in the tables above.

The following table reflects the activities in the accretable net discount for PCI loans for the period indicated (dollars in thousands):

 

     Year Ended
December 31,
2015
     Year Ended
December 31,
2014
 

Balance, beginning of year

   $ 324       $ 395   

Accretion, included in interest income

     (78      (71

Reclassifications from non-accretable yield

     —           —     
  

 

 

    

 

 

 

Balance, end of year

   $ 246       $ 324   
  

 

 

    

 

 

 

Note 7 – Premises and Equipment and Lease Commitments

Premises and equipment are stated at cost less accumulated depreciation and amortization. The following major classifications of premises and equipment are summarized as follows as of the dates indicated (dollars in thousands):

 

     December 31,  
   2015      2014  

Furniture and equipment

   $ 8,345       $ 8,489   

Leasehold improvements

     7,260         7,009   
  

 

 

    

 

 

 

Total

     15,605         15,498   

Less: Accumulated depreciation and amortization

     (10,466      (10,121
  

 

 

    

 

 

 

Total

   $ 5,139       $ 5,377   
  

 

 

    

 

 

 

 

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Total depreciation expense for the years ended December 31, 2015, 2014, and 2013 was $1.4 million, $1.0 million, and $1.1 million, respectively.

The following is a schedule of future minimum lease payments for operating leases for office and branch space based upon obligations at December 31, 2015 (dollars in thousands):

 

Year

   Amount  

2016

   $ 3,387   

2017

     3,320   

2018

     2,491   

2019

     2,344   

2020

     2,206   

Thereafter

     4,118   
  

 

 

 

Total

   $ 17,866   
  

 

 

 

Total rental expense on facilities for the years ended December 31, 2015, 2014 and 2013 was $3.1 million, $2.2 million, and $2.2 million, respectively.

Note 8 – Goodwill, Core Deposit and Leasehold Right Intangibles

Goodwill

At December 31, 2015, the Company had goodwill of $65 million, of which $52 million was related to the 1st Enterprise merger. See Note 2 – Business Combinations for further details on the 1st Enterprise merger. The following table presents changes in the carrying value of goodwill for the periods indicated (dollars in thousands):

 

     Year Ended
December 31,
 
   2015      2014  

Balance, beginning of year

   $ 63,950       $ 12,292   

Measurement-period adjustment

     653         —     

Goodwill acquired during the year

     —           51,658   

Impairment losses

     —           —     
  

 

 

    

 

 

 

Balance, end of year

   $ 64,603       $ 63,950   
  

 

 

    

 

 

 

Accumulated impairment losses at end of year

   $ —         $ —     

As described in Note 1 Summary of Significant Accounting Policies, Recent Accounting Pronouncements, the Company early adopted ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustment, which eliminates the requirement to retrospectively adjust the financial statements for measurement-period adjustments that occur in periods after a business combination is consummated. Measurement-period adjustments are calculated as if they were known at the acquisition date, but are recognized in the reporting period in which they are determined. Prior period information is not revised. In November 2015, the Company recorded a measurement-period adjustment and increased goodwill by $653 thousand due to an additional write-down of $1.1 million taken when the Company finalized the fair value estimate of a loan relationship acquired in the 1st Enterprise merger. The 1st Enterprise merger closed on November 30, 2014. There would not be a significant impact on the consolidated statements of income for the years ended December 31, 2014 and 2015 had such measurement-period adjustment been recognized at the acquisition date, as such loan relationship had been on non-accrual status since early 2015.

The Company’s goodwill was evaluated for impairment during the fourth quarter of 2015, with no impairment loss recognition considered necessary.

 

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Core Deposit Intangibles (“CDI”)

The weighted average amortization period remaining for our core deposit intangibles is 7.94 years. The estimated aggregate amortization expense related to these intangible assets for each of the next five years is $1.3 million, $1.1 million, $936 thousand, $692 thousand, and $628 thousand. The Company’s core deposit intangibles were evaluated for impairment at December 31, 2015, taking into consideration the actual deposit runoff of acquired deposits to the level of deposit runoff expected at the date of merger. Based on the Company’s evaluation, no impairment has taken place on the core deposit intangibles. The following table presents the changes in the gross amounts of core deposit intangibles and the related accumulated amortization for the dates and periods indicated (dollars in thousands):

 

     Year Ended December 31,  
     2015      2014      2013  

Gross amount of CDI:

        

Balance, beginning of year

   $ 9,246       $ 2,103       $ 2,103   

Additions due to acquisitions

     —           7,143         —     
  

 

 

    

 

 

    

 

 

 

Balance, end of year

     9,246         9,246         2,103   
  

 

 

    

 

 

    

 

 

 

Accumulated Amortization:

        

Balance, beginning of year

     (1,056      (665      (356

Amortization

     (1,680      (391      (309
  

 

 

    

 

 

    

 

 

 

Balance, end of year

     (2,736      (1,056      (665
  

 

 

    

 

 

    

 

 

 

Net CDI, end of year

   $ 6,510       $ 8,190       $ 1,438   
  

 

 

    

 

 

    

 

 

 

Leasehold Right Intangibles

Leasehold right intangible is the present value of the excess of market rate lease payments over the contractual lease payments of an acquired lease. The Company recorded a leasehold right intangible of $390 thousand related to the Los Angeles headquarter lease as part of the 1st Enterprise merger. The recorded value of the Company’s leasehold right intangibles at December 31, 2015 and 2014 was $1.2 million and $1.4 million, respectively.

The amortization of the leasehold right intangibles is recorded within the consolidated income statement under occupancy expense. The net amortization of the leasehold right intangible assets and liabilities resulted in income of $62 thousand, income of $142 thousand, and expense of $313 thousand for the years ended December 31, 2015, 2014 and 2013, respectively. During 2015, the Company recorded a $41 thousand adjustment to the fair value of a lease that was acquired in the 1st Enterprise merger due to a change in the sublease rate assumption since the acquisition date. The adjustment was an expense to merger cost.

Note 9 – Bank Owned Life Insurance

At December 31, 2015 and 2014 the Company had $50 million and $39 million, respectively of Bank-Owned Life Insurance (“BOLI”). The Company recorded non-interest income associated with the BOLI policies of $1.3 million, $660 thousand and $617 thousand for the years ending December 31, 2015, 2014 and 2013, respectively. The increase in the Company’s balance in 2015 by $11 million to $50 million was from the $10 million in new BOLI policies purchased and a net increase of $1.2 million in the cash surrender value of the policies during 2015.

BOLI involves the purchase of life insurance by the Company on a selected group of employees where the Company is the owner and beneficiary of the policies. BOLI is recorded as an asset at its cash surrender value. Increases in the cash surrender value of these policies, as well as a portion of the insurance proceeds received, are recorded in noninterest income and are not subject to income tax, as long as they are held for the life of the

 

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covered parties. At December 31, 2015, the $50 million was allocated between eight individual insurance companies, with balances ranging from approximately 1% to 37% of the Company’s outstanding BOLI balances. On an annual basis, the Company reviews the financial stability and ratings of all the individual insurance companies to ensure they are adequately capitalized, and that there is minimal risk to the BOLI assets.

Note 10 – Investment in California Organized Investment Network (“COIN”)

During 2015, the Company made investments of $270 thousand in 60 month term, 0% interest rate deposits. The Company made a $220 thousand investment with Enterprise Community Investment, Inc. (“ECII”), that generated a $44 thousand tax credit, and a $50 thousand investment with Valley Economic Development Center (“VEDC”) that generated a $10 thousand tax credit. These investments qualified the Company for a $54 thousand Qualified Investment Tax Credit that was applied to the Company’s 2015 tax provision.

ECII and VEDC are certified Community Development Financial Institutions (“CDFI”) as defined and recognized by the United States Department of Treasury and by the California Organized Investment Network (“COIN”) within the California Department of Insurance.

Based on these investments being certified by the California Department of Insurance, the investments made in 2015 qualified for a 20% or $54 thousand State of California income tax credit in the year made. If the Company were to redeem this deposit prior to its contractual and stated maturity date, the Company would lose the benefit of the tax credit taken in prior years. The investment, to qualify for this specific tax credit, must be for a minimum term of sixty months. In addition, the tax credit is required to be applied during the year in which the investments were made. The deposits made in 2015 mature in 2020. These deposits are not insured by the FDIC, and are included in other assets on the consolidated balance sheet of the Company. The Company’s intentions are to hold these investments to their contractual maturity dates. These investments were also made to meet CRA investment goals.

Note 11 – Qualified Affordable Housing Project Investments

The Company’s investment in Qualified Affordable Housing Projects that generate Low Income Housing Tax Credits (“LIHTC”) was $3.7 million at December 31, 2015 and $4.1 million at December 31, 2014. The funding liability for the LIHTC was $1.1 million at December 31, 2015 compared to $3 million at December 31, 2014. The amount of tax credits and other tax benefits recognized was $543 thousand and $516 thousand as of December 31, 2015 and December 31, 2014, respectively. Further, the amount of amortization expense included in the provision for income taxes was $436 thousand and $370 thousand as of December 31, 2015 and 2014, respectively.

See Note 1 – Summary of Significant Accounting Policies, “Qualified Affordable Housing Project Investments” regarding how the Company accounts for its investments in LIHTC projects.

 

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The following table presents the Company’s original investment in the LIHTC projects, the current recorded investment balance, and the unfunded liability balance of each investment at December 31, 2015 and 2014. In addition, the table reflects the tax credits and tax benefits recorded by the Company during 2015 and 2014, the amortization of the investment and the net impact to the Company’s income tax provision for 2015 and 2014. Also see Note 19 – Income Tax, for the impact of these investments on the Company’s effective tax rate (dollars in thousands):

 

Qualified Affordable Housing Projects at
December 31, 2015
  Original
Investment
Value
    Current
Recorded
Investment
    Unfunded
Liability
Obligation
    Tax Credits
and Benefits (1)
    Amortization of
Investments (2)
    Net Income
Tax Benefit
 

Enterprise Green Communities West II LP

  $ 1,000      $ 604      $ 69      $ 136      $ 92      $ 44   

Enterprise Housing Partners Calgreen II Fund LP

    2,050        1,426        165        198        164        34   

Enterprise Housing Partners XXIV LP

    2,000        1,680        806        209        180        29   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total – Investments in Qualified Affordable Housing Projects

  $ 5,050      $ 3,710      $ 1,040      $ 543      $ 436      $ 107   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
Qualified Affordable Housing Projects at
December 31, 2014
  Original
Investment
Value
    Current
Recorded
Investment
    Unfunded
Liability
Obligation
    Tax Credits
and Benefits (1)
    Amortization of
Investments (2)
    Net Income
Tax Benefit
 

Enterprise Green Communities West II LP

  $ 1,000      $ 704      $ 162      $ 127      $ 84      $ 43   

Enterprise Housing Partners Calgreen II Fund LP

    2,050        1,588        635        229        174        55   

Enterprise Housing Partners XXIV LP

    2,000        1,849        1,685        160        112        48   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total – Investments in Qualified Affordable Housing Projects

  $ 5,050      $ 4,141      $ 2,482      $ 516      $ 370      $ 146   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
Qualified Affordable Housing Projects at
December 31, 2013
  Original
Investment
Value
    Current
Recorded
Investment
    Unfunded
Liability
Obligation
    Tax Credits
and Benefits (1)
    Amortization of
Investments (2)
    Net Income
Tax Benefit
 

Enterprise Green Communities West II LP

  $ 1,000      $ 787      $ 190      $ 236      $ 160      $ 76   

Enterprise Housing Partners Calgreen II Fund LP

    2,050        1,735        1,817        390        314        76   

Enterprise Housing Partners XXIV LP

    2,000        1,988        1,983        14        11        3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total – Investments in Qualified Affordable Housing Projects

  $ 5,050      $ 4,510      $ 3,990      $ 640      $ 485      $ 155   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The amounts reflected in this column represent both the tax credits, as well as the tax benefits generated by the Qualified Affordable Housing Projects operating loss for the year.
(2) This amount reduces the tax credits and benefits generated by the Qualified Affordable Housing Projects.

 

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The following table reflects the anticipated net income tax benefit that is expected to be recognized by the Company over the next several years (dollars in thousands):

 

Qualified Affordable Housing Projects    Enterprise
Green
Communities
West II LP
     Enterprise
Housing
Partners
Calgreen II
Fund LP
     Enterprise
Housing
Partners XXIV
LP
     Total
Net Income  Tax
Benefit
 

Anticipated net income tax benefit less amortization of investments:

           

2016

   $ 43       $ 42       $ 30       $ 115   

2017

     43         40         33         116   

2018 and thereafter

     199         266         290         755   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total – anticipated net income tax benefit in Qualified Affordable Housing Projects

   $ 285       $ 348       $ 353       $ 986   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 12 – Deposits

At December 31, 2015, 117 customers maintained balances (aggregating all related accounts, including multiple business entities and personal funds of business principals) in excess of $4.0 million. The aggregate amount of such deposits amounted to $1.3 billion or approximately 56% of the Company’s total customer deposit base. The depositors are not concentrated in any industry or business. At December 31, 2015 and 2014, the Company had “reciprocal” CDARS® and ICS® deposits that are classified as “brokered” deposits in regulatory reports. These “reciprocal” CDARS® and ICS® deposits are the only brokered deposits utilized by the Company, and the Company considers these deposits to be “core” in nature.

At December 31, 2015, $58 million out of total time deposits of $59 million mature within one year.

At December 31, 2015 and 2014, the Company had certificates of deposit with balances $100 thousand or more of $55 million and $61 million, respectively, and certificates of deposits with balances $250 thousand or more of $18 million and $20 million, respectively.

The following table shows the maturity of the Company’s time deposits of $100 thousand or more at December 31, 2015.

 

Maturity of Time Deposits of $100,000 or More*  

(Dollars in thousands)

 

Three months or less

   $ 8,005   

Over three through six months

     17,513   

Over six through twelve months

     28,714   

Over twelve months

     286   
  

 

 

 

Total

   $ 54,518   
  

 

 

 

 

*

includes CDARS® reciprocal time deposits of $100 thousand or more. Total CDARS® reciprocal time deposits included in the table above are $29 million.

ICS® Reciprocal Non-Interest Bearing Demand Deposits

During 2013 the Company began participating as a member of the Insured Cash Sweep® (“ICS®”) deposit program. Through ICS®, the Company may accept non-interest bearing deposits in excess of the FDIC insured maximum from a depositor and place the deposits through the ICS® network into other member banks in increments of less than the FDIC insured maximum in order to provide the depositor full FDIC insurance

 

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coverage. The Company receives an equal dollar amount of deposits from other ICS® member banks in exchange for the deposits the Company places into the ICS® network. These deposits are recorded on the Company’s balance sheet as ICS® reciprocal deposits. At December 31, 2015, the ICS® reciprocal deposits totaled $9.3 million.

CDARS® Reciprocal Time Deposits

The Company participates and is a member of the Certificate of Deposit Account Registry Service (CDARS®) deposit product program. Through CDARS®, the Company may accept deposits in excess of the FDIC insured maximum from a depositor and place the deposits through a network to other CDARS® member banks in increments of less than the FDIC insured maximum to provide the depositor full FDIC insurance coverage. Where the Company receives an equal dollar amount of deposits from other CDARS® member banks in exchange for the deposits the Company places into the network, the Company records these as CDARS® reciprocal deposits. At December 31, 2015 and 2014, CDARS® reciprocal deposits totaled $29 million and $30 million, respectively.

Note 13 – Borrowings and Subordinated Debentures

Securities Sold Under Agreements to Repurchase

The Company enters into certain transactions, the legal form of which are sales of securities under agreements to repurchase (“Repos”) at a later date at a set price. Securities sold under agreements to repurchase generally mature within 1 day to 180 days from the issue date and are routinely renewed.

As discussed in Note 5 – Investment Securities, the Company has pledged certain investments as collateral for these agreements. Securities with a fair value of $47 million and $32 million were pledged to secure the Repos at December 31, 2015 and December 31, 2014, respectively.

The tables below describe the terms and maturity of the Company’s securities sold under agreements to repurchase as of the dates indicated (dollars in thousands):

 

     December 31, 2015  

Date Issued

   Amount      Interest Rate      Original
Term
     Maturity Date  

December 31, 2015

   $ 14,360         0.08% – 0.25%         4 days        January 4, 2016   
  

 

 

          

Total

   $ 14,360         0.19%         
  

 

 

          

 

     December 31, 2014  

Date Issued

   Amount      Interest Rate      Original
Term
     Maturity Date  

December 31, 2014

   $ 9,411         0.13% – 0.25%         2 days         January 2, 2015   
  

 

 

          

Total

   $ 9,411         0.20%         
  

 

 

          

Federal Home Loan Bank Borrowings

The Company maintains a secured credit facility with the FHLB, allowing the Company to borrow on an overnight and term basis. The Company’s credit facility with the FHLB is $651 million, which represents approximately 25% of the Bank’s total assets, as reported by the Bank in its September 30, 2015 Federal Financial Institution Examination Council (FFIEC) Call Report.

As of December 31, 2015, the Company had $821 million of loan collateral pledged with the FHLB which provides $544 million in borrowing capacity. The Company has $20 million in investment securities pledged

 

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with the FHLB to support this credit facility. In addition, the Company must maintain an investment in the Capital Stock of the FHLB. Under the FHLB Act, the FHLB has a statutory lien on the FHLB capital stock that the Company owns and the FHLB capital stock serves as further collateral under the borrowing line.

The Company had no outstanding advances (borrowings) with the FHLB as of December 31, 2015 or 2014.

Interest on FHLB advances is generally paid monthly, quarterly or semi-annually depending on the terms of the advance, with principal and any accrued interest due at maturity. The Company had no FHLB borrowings during 2015 or 2014, except for the annual testing of the borrowing lines. The Company is required to purchase FHLB common stock to support its FHLB advances. At December 31, 2015 and 2014, the Company had $8.0 million and $8.0 million of FHLB common stock, respectively. The current value of the FHLB common stock of $8.0 million would support FHLB advances up to $297 million. Any advances from the FHLB in excess of $297 million would require additional purchases of FHLB common stock.

The FHLB has historically repurchased a portion to all of its excess capital from each bank where the level of capital is in excess of that bank’s current average borrowings above a certain minimum. The FHLB’s program whereby the FHLB analyzes each member bank’s capital requirement and returns each bank’s excess capital above a certain minimum not needed for current borrowings resulted in the repurchase of the Company’s FHLB common stock during 2013 by the FHLB. The FHLB did not repurchase any of the Company’s investment in FHLB capital stock during 2015 or 2014. The Company acquired FHLB capital stock of $3.8 million in 2014 from the acquisition of 1st Enterprise.

The FHLB has paid or declared dividends on its capital stock for all four quarters of the years ending December 31, 2015, 2014 and 2013.

Subordinated Debentures

The following table summarizes the terms of each issuance of subordinated debentures outstanding as of December 31, 2015:

 

Series

   Amount
(in  thousands)
     Issuance
Date
     Maturity
Date
     Rate Index     Current
Rate
    Next Reset
Date
 

Trust I

   $ 6,186         12/10/04         03/15/35         3 month LIBOR+2.05     2.56     03/15/16   

Trust II

     3,093         12/23/05         03/15/36         3 month LIBOR+1.75     2.26     03/15/16   

Trust III

     3,093         06/30/06         09/15/36         3 month LIBOR+1.85     2.36     03/15/16   
  

 

 

              

Subtotal

     12,372                

Unamortized fair value adjustment

     2,675                
  

 

 

              

Net

   $ 9,697                
  

 

 

              

The Company had an aggregate outstanding contractual balance of $12 million in subordinated debentures at December 31, 2015. These subordinated debentures were acquired as part of the PC Bancorp merger and were issued to trusts originally established by PC Bancorp, which in turn issued trust preferred securities. These subordinated debentures were issued in three separate series. Each issuance had a maturity of 30 years from their approximate date of issue. All three subordinated debentures are variable rate instruments that reprice quarterly based on the three month LIBOR plus a margin (see tables above). All three subordinated debentures had their interest rates reset in December 2015 at the current three month LIBOR plus their index, and will continue to reprice quarterly through their maturity date. All three subordinated debentures are currently callable at par with no prepayment penalties.

The original fair value adjustment related to the subordinated debentures was $3.3 million. The Company recorded $159 thousand, $120 thousand, and $210 thousand in amortization expense related to the fair value

 

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adjustment in 2015, 2014, and 2013, respectively. At December 31, 2015 the Company is estimating a remaining life of approximately 20 years on the subordinated debentures and is amortizing the fair value adjustment based on this estimated average remaining life. The Company is projecting annual amortization expense of approximately $159 thousand related to the fair value adjustment on the subordinated debentures.

Under Dodd Frank, trust preferred securities are excluded from Tier 1 capital, unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. CU Bancorp assumed approximately $12.4 million of junior subordinated debt securities issued to various business trust subsidiaries of Premier Commercial Bancorp and funded through the issuance of approximately $12.0 million of floating rate capital trust preferred securities. These junior subordinated debt securities were issued prior to May 19, 2010. Because CU Bancorp has less than $15 billion in assets, the trust preferred securities that CU Bancorp assumed from Premier Commercial Bancorp continue to be included in Tier 1 capital, subject to a limit of 25% of Tier 1 capital elements. See Note 22 – Regulatory Matters.

Interest payments made by the Company on subordinated debentures are considered dividend payments under FRB regulations. Notification to the FRB is required prior to the Company declaring and paying a dividend during any period in which the Company’s quarterly net earnings are insufficient to fund the dividend amount. This notification requirement is included in regulatory guidance regarding safety and soundness surrounding capital and includes other non-financial measures such as asset quality, financial condition, capital adequacy, liquidity, future earnings projections, capital planning and credit concentrations. Should the FRB object to the dividend payments, the Company would be precluded from paying interest on the subordinated debentures after giving notice within 15 days before the payment date. Payments would not commence until approval is received or the Company no longer needs to provide notice under applicable guidance. The Company has the right, assuming no default has occurred, to defer payments of interest on the subordinated debentures at any time for a period not to exceed 20 consecutive quarters. The Company has not deferred any interest payments.

Short-term Borrowings

Details regarding the Company’s short-term borrowings for the dates and periods indicated are reflected in the table below (dollars in thousands):

 

     Year Ended December 31,  
     2015     2014  
     Balance      Average
Balance
     Weighted
Average
Rate
    Balance      Average
Balance
     Weighted
Average
Rate
 

Securities sold under agreements to repurchase

   $ 14,360       $ 13,966         0.22   $ 9,411       $ 13,579         0.25

The maximum amount of short-term borrowings outstanding at any month-end was $17 million and $16 million in 2015 and 2014, respectively.

Note 14 – Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations and utilizes interest rate swap agreements (“swaps”) as part of its asset/liability management strategy to help manage its interest rate risk position. The Company has two counterparty banks.

Derivative Financial Instruments Acquired from 1st Enterprise

At December 31, 2015, the Company has twelve interest rate swap agreements with customers and twelve offsetting interest-rate swaps with a counterparty bank that were acquired as a result of the merger with 1st Enterprise on November 30, 2014. The swap agreements are not designated as hedging instruments. The purpose of entering into offsetting derivatives not designated as a hedging instrument is to provide the Company a variable-rate loan receivable and provide the customer the financial effects of a fixed-rate loan without creating significant interest rate risk in the Company’s earnings.

 

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The structure of the swaps is as follows: The Company enters into a swap with its customers to allow them to convert variable rate loans to fixed rate loans, and at the same time, the Company enters into a swap with the counterparty bank to allow the Company to pass on the interest-rate risk associated with fixed rate loans. The net effect of the transaction allows the Company to receive interest on the loan from the customer at a variable rate based on LIBOR plus a spread. The changes in the fair value of the swaps primarily offset each other and therefore should not have a significant impact on the Company’s results of operations. Our interest rate swap derivatives acquired from 1st Enterprise are subject to a master netting arrangement with one counterparty bank. None of our derivative assets and liabilities are offset in the balance sheet.

The Company believes the risk of loss associated with counterparty borrowers relating to interest rate swaps is mitigated as the loans with swaps are underwritten to take into account potential additional exposure, although there can be no assurances in this regard since the performance of the swaps is subject to market and counterparty risk. At December 31, 2015 and 2014, the total notional amount of the Company’s swaps acquired from 1st Enterprise was $28 million and $36 million, respectively.

The following tables present the fair values of the asset and liability of the Company’s derivative instruments acquired from 1st Enterprise as of the dates and periods indicated (dollars in thousands):

 

     Asset Derivatives  
     December 31,
2015
     December 31,
2014
 

Interest rate swap contracts fair value

   $ 881       $ 719   
  

 

 

    

 

 

 

Balance sheet location

    
 
 
Accrued Interest
Receivable and Other
Assets
 
 
  
    
 
 
Accrued Interest
Receivable and Other
Assets
 
 
  

 

     Liability Derivatives  
     December 31,
2015
     December 31,
2014
 

Interest rate swap contracts fair value

   $ 881       $ 719   
  

 

 

    

 

 

 

Balance sheet location

    
 
 
Accrued Interest
Payable and Other
Liabilities
 
 
  
    
 
 
Accrued Interest
Payable and Other
Liabilities
 
 
  

Derivative Financial Instruments Acquired from PC Bancorp

At December 31, 2015, the Company also has nineteen pay-fixed, receive-variable, interest rate contracts that are designed to convert fixed rate loans into variable rate loans. The Company acquired these interest rate swap contracts on July 31, 2012 as a result of the merger with PC Bancorp. All of the interest rate swap contracts acquired from PC Bancorp are with the same counterparty bank. The outstanding swaps have original maturities of up to 15 years.

 

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The following table presents the notional amount and the fair values of the asset and liability of the Company’s derivative instruments acquired from PC Bancorp as of the dates indicated (dollars in thousands):

 

     Liability Derivatives  
     December 31,
2015
     December 31,
2014
 

Fair Value Hedges

     

Total interest rate contracts notional amount

   $ 25,938       $ 29,289   
  

 

 

    

 

 

 

Derivatives not designated as hedging instruments:

     

Interest rate swap contracts fair value

   $ 313       $ 519   

Derivatives designated as hedging instruments:

     

Interest rate swap contracts fair value

     1,351         2,277   
  

 

 

    

 

 

 

Total interest rate contracts fair value

   $ 1,664       $ 2,796   
  

 

 

    

 

 

 

Balance sheet location

    
 
Accrued Interest Payable
and Other Liabilities
  
  
    
 
Accrued Interest Payable
and Other Liabilities
  
  

The Effect of Derivative Instruments on the Consolidated Statements of Income

The following table summarizes the effect of derivative financial instruments on the consolidated statements of income for the periods indicated (dollars in thousands):

 

     Year Ended
December 31,
 
     2015     2014     2013  

Derivatives not designated as hedging instruments:

      

Interest rate swap contracts – loans

      

Increase in fair value of interest rate swap contracts

   $ 206      $ 219      $ 306   

Payments on interest rate swap contracts on loans

     (263     (273     (289
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in other non-interest income

     (57     (54     17   
  

 

 

   

 

 

   

 

 

 

Interest rate swap contracts – subordinated debenture

      

Increase in fair value of interest rate swap contracts

     —          —          70   

Payments on interest rate swap contracts on subordinated debentures

     —          —          (70
  

 

 

   

 

 

   

 

 

 

Net increase in other non-interest income

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in other non-interest income

   $ (57   $ (54   $ 17   
  

 

 

   

 

 

   

 

 

 

Derivatives designated as hedging instruments:

      

Interest rate swap contracts – loans

      

Increase in fair value of interest rate swap contracts

   $ 926      $ 927        1,719   

Increase (decrease) in fair value of hedged loans

     133        315        (554

Payments on interest rate swap contracts on loans

     (1,089     (1,256     (1,294
  

 

 

   

 

 

   

 

 

 

Net decrease in interest income on loans

     (30     (14     (129
  

 

 

   

 

 

   

 

 

 

Under all of the Company’s interest rate swap contracts, the Company is required to pledge and maintain collateral for the credit support under these agreements. At December 31, 2015, the Company has pledged $2.0 million in investment securities, $2.7 million in certificates of deposit, for a total of $4.7 million, as collateral under the swap agreements.

 

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Note 15 – Balance Sheet Offsetting

Assets and liabilities relating to certain financial instruments, including derivatives, and securities sold under repurchase agreements (“Repos”), may be eligible for offset in the consolidated balance sheets as permitted under accounting guidance. The Company’s interest rate swap derivatives are subject to a master bilateral netting and offsetting arrangement under specific conditions as defined within a master agreement governing all interest rate swap contracts that the Company and the counterparty banks have entered into. In addition, the master agreement under which the interest rate contracts have been written require the pledging of assets by the Company based on certain risk thresholds. The Company has pledged a certificate of deposit and investment securities as collateral under the swap agreements. The pledged collateral under the swap agreements are reported in the Company’s consolidated balance sheets, unless the Company defaults under the master agreement. The Company currently does not net or offset the interest rate swap contracts in its consolidated balance sheets, as reflected within the table below.

The Company’s securities sold under repurchase agreements represent transactions the Company has entered into with several deposit customers. These transactions represent the sale of securities on an overnight or on a term basis to our deposit customers under an agreement to repurchase the securities from the customers the next business day or at maturity. There is an individual contract for each customer with only one transaction per customer. There is no master agreement that provides for the netting arrangement or the offsetting of these individual transactions or for the netting of collateral positions. The Company does not net or offset the Repos in its consolidated balance sheets as reflected within the table below.

 

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The table below presents the Company’s financial instruments that may be eligible for offsetting which include securities sold under agreements to repurchase that have no enforceable master netting arrangement and derivative securities that could be offset in the consolidated financial statements due to an enforceable master netting arrangement (dollars in thousands):

 

     Gross
Amounts
Recognized
in the
Consolidated
Balance
Sheets
     Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
     Net Amounts
of Assets
Presented

in the
Consolidated
Balance
Sheets
     Gross Amounts
Not Offset in the
Consolidated Balance Sheets
     Net Amount
(Collateral
over liability
balance
required to
be pledged)
 
            Financial
Instruments
     Collateral
Pledged
    

December 31, 2015

                 

Financial Assets:

                 

Interest rate swap contracts fair value (see Note 14 – Derivative Financial Instruments)

   $ 881       $ —         $ 881       $ 881       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 881       $ —         $ 881       $ 881       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities:

                 

Interest rate swap contracts fair value (see Note 14 – Derivative Financial Instruments)

   $ 2,545       $ —         $ 2,545       $ 2,545       $ 4,759       $ 2,214   

Securities sold under agreements to repurchase

     14,360         —           14,360         14,360         46,596         32,236   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 16,905       $ —         $ 16,905       $ 16,905       $ 51,355       $ 34,450   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2014

                 

Financial Assets:

                 

Interest rate swap contracts fair value (see Note 14 – Derivative Financial Instruments)

   $ 719       $ —         $ 719       $ 719       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 719       $ —         $ 719       $ 719       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities:

                 

Interest rate swap contracts fair value (see Note 14 – Derivative Financial Instruments)

   $ 3,515       $ —         $ 3,515       $ 3,515       $ 4,150       $ 635   

Securities sold under agreements to repurchase

     9,411         —           9,411         9,411         32,304         22,893   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 12,926       $ —         $ 12,926       $ 12,926       $ 36,454       $ 23,528   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Note 16 – Stock Options and Restricted Stock

Equity Compensation Plans

The Company’s 2007 Equity and Incentive Plan (“Equity Plan”) was adopted by the Company in 2007 and replaced two prior equity compensation plans. The Equity Plan provides for significant flexibility in determining the types and terms of awards that may be made to participants. The Equity Plan was revised and approved by the Company’s shareholders in 2011 and adopted by the Company as part of the Bank holding company reorganization. This plan is designed to promote the interest of the Company in aiding the Company to attract and retain employees, officers and non-employee directors who are expected to contribute to the future success of the organization. The Equity Plan is intended to provide participants with incentives to maximize their efforts on behalf of the Company through stock-based awards that provide an opportunity for stock ownership. This plan provides the Company with a flexible equity incentive compensation program, which allows the Company to grant stock options, restricted stock, restricted stock award units and performance units. Certain options and share awards provide for accelerated vesting, if there is a change in control, as defined in the Equity Plan.

Upon the adoption of the Equity Plan, the Company concurrently terminated both its earlier 2005 equity compensation plans. All the remaining unissued shares of common stock under both 2005 equity compensation plans were rolled into the 2007 Equity and Incentive Plan. No further shares were issued under these older plans. All option shares issued under the existing plans remain in force until the shares are either exercised, expire or are cancelled.

The Equity Plan was amended and restated in 2014 to (i) permit the grant of performance-based awards that are not subject to the deduction limitations of Section 162(m) of the Internal Revenue Code, including both equity compensation awards and cash bonus payments, (ii) prohibit the repricing of previously granted options; (iii) eliminate a provision of the Equity Plan that provides for an automatic annual increase in the shares of common stock available for awards under the Equity Plan; and (iv) extend the term of the plan to July 31, 2024.

Pursuant to the merger with 1st Enterprise as discussed in Note 2 above, CU Bancorp adopted the 1st Enterprise 2006 Stock Incentive Plan, as amended (“2006 Stock Incentive Plan”), as its own equity plan and all stock options granted by 1st Enterprise thereunder were fully vested and exercisable and were converted to CU Bancorp stock options on substantially the same terms but adjusted to reflect the exchange ratio set forth in the Merger Agreement and applicable Internal Revenue Code provisions and related regulations. No new equity awards will be granted under the 2006 Stock Incentive Plan. A total of 802,766 converted 1st Enterprise stock options were adopted into CU Bancorp stock options under the Equity Plan with a fair value of $9.6 million and an intrinsic value of $11 million at the merger date.

Under the Equity Plan, there are a total of 1,490,547 shares authorized. A total of 987,583 shares have been issued out of the plan, with 73,541 of these issued shares subsequently cancelled and returned back into the plan, leaving 576,505 available to be issued.

All non-qualified and incentive stock options granted under the current Equity Plan and the earlier 2005 equity compensation plans, have been issued with the exercise prices of the stock options equal to the fair market value of the underlying shares at the date of grant.

The Equity Plan and the original 2005 equity compensation plans provided for the issuance of non-qualified and incentive stock options. These plans provided that each option must have an exercise price not less than the fair market value of the stock at the date of grant and terms to expiration not to exceed ten years. All options granted under the plans require continuous service and have been issued with vesting increments of between 20% through 50% per year. All stock options issued under the original 2005 equity compensation plans that have not expired remain outstanding with no changes in their vesting, maturity date or rights.

During 2015, the Company had a combined federal and state excess tax benefit of $1.3 million, related to the vesting of restricted stock and the exercise of stock options during 2015, of which $384 thousand was related to restricted stock and $890 thousand was related to stock options. This excess tax benefit was recorded to additional paid in capital during the year ending December 31, 2015.

 

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During 2014, the Company had a combined federal and state excess tax benefit of $582 thousand, related to the vesting of restricted stock and the exercise of stock options during 2014, of which $233 thousand was related to restricted stock and $349 thousand was related to stock options. This excess tax benefit was recorded to additional paid in capital during the year ending December 31, 2014.

During 2013, the Company had a combined federal and state excess tax benefit of $659 thousand, related to the vesting of restricted stock and the exercise of stock options during 2013, of which $96 thousand was related to restricted stock and $563 thousand was related to stock options. This excess tax benefit was recorded to additional paid in capital during the year ending December 31, 2013.

At December 31, 2015, future compensation expense related to unvested restricted stock grants aggregated to the amounts reflected in the table below (dollars in thousands):

 

Future Stock Based Compensation Expense

   Restricted
Stock
 

2016

   $ 2,149   

2017

     789   

2018

     284   

2019

     35   

Thereafter

     —     
  

 

 

 

Total

   $ 3,257   
  

 

 

 

At December 31, 2015, the weighted-average period over which the total compensation cost related to unvested restricted stock grants not yet recognized is 1.8 years. There was no future compensation expense related to stock options as of December 31, 2015. All stock options outstanding at December 31, 2015 are vested.

The estimated fair value of both incentive stock options and non-qualified stock options granted in prior years, have been calculated using the Black-Scholes option pricing model. There have been no incentive stock options and no non-qualified stock options issued in 2013, 2014 or 2015. The following is the listing of the input variables and the assumptions utilized by the Company for each parameter used in the Black-Scholes option pricing model in prior years:

Risk-free Rate – The risk-free rate for periods within the contractual life of the option have been based on the U.S. Treasury rate that matures on the expected assigned life of the option at the date of the grant.

Expected Life of Options – The expected life of options have either been calculated using a formula from the Securities and Exchange Commission “SEC” for companies that do not have sufficient historical data to calculate the expected life, or from the estimated life of options granted by the Company. The formula from the SEC calculation of expected life is specifically based on the following: the expected life of the option is equal to the average of the contractual life and the vesting period of each option.

Expected Volatility – Beginning in 2009, the expected volatility has been based on the historical volatility for the Company’s shares.

Dividend Yield – The dividend yield has been based on historical experience and expected future changes on dividend payouts. The Company has not declared or paid dividends on its common stock in the past and does not expect to declare or pay dividends on its common stock within the foreseeable future.

Stock Options

There were no stock options granted by the Company in 2013, 2014 or 2015.

 

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The following table summarizes the stock option activity under the plans for the year ended December 31, 2015:

 

     Shares     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term

(in years)
     Aggregate
Intrinsic
Value

(in thousands)
 

Outstanding stock options at December 31, 2014

     1,016,490      $ 10.13         1.6       $ 15,479   

Granted

     —             

Exercised

     (454,019        

Forfeited

     (5,000        

Expired

     —             
  

 

 

         

Outstanding stock options at December 31, 2015

     557,471      $ 10.57         0.8       $ 8,248   
  

 

 

         

Exercisable options at December 31, 2015

     557,471      $ 10.57         0.8       $ 8,248   

Unvested options at December 31, 2015

     —             

The Company recorded stock option expense of $2 thousand, $10 thousand and $21 thousand, for the years ended December 31, 2015, 2014, and 2013, respectively.

The total intrinsic value of options exercised during the years ended December 31, 2015, 2014, and 2013 was $6.5 million, $2.1 million, and $2.3 million, respectively.

Restricted Stock

The weighted-average grant-date fair value per share in the table below is calculated by taking the total aggregate cost of the restricted shares issued divided by the number of shares of restricted stock issued. The aggregate cost of the restricted stock was calculated by multiplying the number of shares granted at each of the grant dates by the closing stock price of the Company’s common stock on the date of the grant. The following table summarizes the restricted stock activity under the Equity Plan for the year ended December 31, 2015:

 

     Number
of Shares
     Weighted-Average
Grant-Date Fair
Value per Share
 

Restricted Stock:

     

Unvested, at December 31, 2014

     309,506       $ 16.41   

Granted

     132,500         21.51   

Vested

     (119,873      14.52   

Cancelled and forfeited

     (10,675      16.92   
  

 

 

    

Unvested, at December 31, 2015

     311,458       $ 19.29   
  

 

 

    

 

 

 

Restricted stock compensation expense related to the restricted stock grants reflected in the table above was $2.7 million, $1.7 million, and $1.1 million for the period ended December 31, 2015, 2014, and 2013, respectively. Restricted stock awards reflected in the table above are valued at the closing stock price on the date of grant and are expensed to stock based compensation expense over the period for which the related service is performed. The weighted-average grant-date fair value per share for restricted stock granted for 2015, 2014, and 2013 was $21.51, $19.39, and $16.80, respectively. The total fair value of shares vested during the year for 2015, 2014, and 2013 is $2.7 million, $2.3 million, and $1.4 million, respectively. In 2015, the Company granted 40,000 shares of Restricted Stock Unit (“RSU”) under the Equity Plan to one of its executive officers. Such grant is reflected in the table above. The shares of common stock underlying the 40,000 shares of RSU will not be issued until the RSUs vest and are not included in the Company’s shares outstanding as of December 31, 2015.

 

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The RSUs are valued at the closing stock price on the date of grant and are expensed to stock based compensation expense over the period for which the related service is performed.

Note 17 – Supplemental Executive and Director Retirement Plans

Supplemental Executive Retirement Plan

The Company adopted a non-qualified supplemental executive retirement plan (“SERP”) for certain executives of the Company. In addition, the Company acquired several SERP plans from the 2012 PC Bancorp acquisition. These SERP plans provide the designated executives with retirement benefits. Pre-retirement survivor benefits are provided for designated beneficiaries of participants who do not survive until retirement in an amount equal to the lump sum actuarial equivalent of the participant’s accrued benefit under the SERP. The SERP is considered an unfunded plan for tax and ERISA purposes. All obligations arising under the SERP are payable from the general assets of the Company. At December 31, 2015 and 2014, the SERP plan had accrued liabilities of $3.3 million and $3.2 million, respectively.

As a result of its acquisition of 1st Enterprise in 2014, the Company acquired a deferred compensation plan with a liability balance of $596 thousand at December 31, 2014. This deferred compensation plan was established in which eligible employees can elect to defer a percentage of salary of bonuses to be paid after terminating employment with the Company. Payments can be made in lump sum or equal installments for as long as 10 years. A deferral account is established for each participant and the account will earn interest quarterly based on the Company’s established crediting rate. Participants are immediately 100% vested for the amount of their deferral account.

The Company acquired, as a result of its acquisition of PC Bancorp, a Supplemental Employee Salary Continuation Plan, a Deferred Director Fee Plan, and a Split Dollar Employee Insurance Plan for certain executive officers and one Director of PC Bancorp. At December 31, 2015, the accrued liability of the PC Bancorp Supplemental Employee Salary Plan was $1.1 million, and the accrued liability of the Deferred Director Fee Plan was $282 thousand.

The Company recorded a total of $947 thousand, $705 thousand, and $661 thousand in deferred salary compensation expense for the years ended December 31, 2015, 2014 and 2013, respectively, related to the deferred compensation plans.

Split Dollar Employee Insurance Plan

The Company’s accrued liability for the Split Dollar Employee Insurance Plan was $1.2 million and $1.2 million at December 31, 2015 and 2014, respectively. The Company recorded split dollar life insurance expense of $39 thousand, $38 thousand, and $36 thousand in 2015, 2014 and 2013 respectively, related to the split dollar policies.

Note 18 – Defined Contribution Plan 401(k)

The Company has a 401(k) defined contribution plan for the benefit of its employees. The California United Bank 401(k) Profit Sharing Plan (the “401(k) Plan”) allows eligible employees to contribute a portion of their income to a trust for investment on a pre-tax basis until retirement. Participants are 100% vested in their own deferrals.

Effective January 1, 2013, the Company’s 401(k) Plan was amended and the “safe harbor” or guaranteed employer contributions were discontinued. The Company adopted instead, an “employer match” type of contribution for the benefit of the employees covered under the plan. The employer matching contributions are not fully vested until the employee completes five years of service.

 

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In 2013, the Company matched $0.50 on the dollar for every dollar the employee contributed to the plan, up to a maximum of 4% of the employee’s eligible compensation subject to an IRS limitation.

In 2015 and 2014, the Company matched $0.50 on the dollar for every dollar the employee contributed to the plan, up to a maximum of 3% of the employee’s eligible compensation subject to an IRS limitation. The dollar amount an individual employee may contribute to this plan is subject to regulatory limits.

The Company’s expense relating to the contributions made to the 401(k) plan for the benefit of its employees was $642 thousand, $418 thousand and $431 thousand for the years ended December 31, 2015, 2014, and 2013, respectively.

Note 19 – Income Taxes

The Company provides for current federal and state income taxes payable and for deferred taxes that result from differences between financial accounting rules and tax laws governing the timing of recognition of various income and expense items. The Company recognizes deferred income tax assets and liabilities for the future tax effects of such temporary differences based on the difference between the financial statement and tax bases of the existing assets and liabilities using the statutory rate expected in the years in which the differences are expected to reverse. The effect on deferred taxes of any enacted change in tax rates is recognized in income in the period that includes the enactment date. The future realization of any of the Company’s deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. Based on historical and future expected taxable earnings and available tax strategies, the Company concluded that it is more likely than not that all the benefit of the deferred tax assets will be realized, with the exception of the deferred tax assets related to certain capital loss carryforward from separate reporting years that are subject to limitation.

The tax effects from an uncertain tax position are recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. The Company believes that there are no material uncertain tax positions at December 31, 2015, 2014, and 2013. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

Income tax expense consists of the following (dollars in thousands):

 

     Year Ended December 31,  
     2015      2014      2013  

Current provision

        

Federal

   $ 9,265       $ 4,517       $ 1,669   

State

     2,923         1,183         238   
  

 

 

    

 

 

    

 

 

 

Total current provision

     12,188         5,700         1,907   

Deferred provision

        

Federal

     291         382         2,674   

State

     389         350         427   
  

 

 

    

 

 

    

 

 

 

Total deferred provision

     680         732         3,101   
  

 

 

    

 

 

    

 

 

 

Total current and deferred provision

   $ 12,868       $ 6,432       $ 5,008   
  

 

 

    

 

 

    

 

 

 

 

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The following is a summary of the components of the net deferred tax asset recognized in the accompanying balance sheets as of the dates indicated (dollars in thousands):

 

     December 31,  
     2015     2014  

Deferred Tax Assets

    

Federal tax loss carryforward

   $ 64      $ 99   

State tax loss carryforward

     170        162   

Allowance for loan loss

     7,473        5,823   

Purchase accounting and loan fair value adjustments

     7,024        9,430   

Accruals and other liabilities

     958        1,457   

Stock compensation and deferred compensation costs

     5,732        6,703   

Net unrealized loss on securities available-for-sale

     593        —     

Start up, organizational and other costs

     332        612   
  

 

 

   

 

 

 

Total deferred tax assets

     22,346        24,286   
  

 

 

   

 

 

 

Deferred Tax Liabilities

    

Net unrealized gain on securities available-for-sale

     —          (138

State taxes

     (441     (1,041

Unamortized fair value on subordinated debentures

     (1,230     (1,310

Core deposit intangibles

     (2,984     (3,754

Prepaid expense and other

     (652     (1,524
  

 

 

   

 

 

 

Total deferred tax liabilities

     (5,307     (7,767
  

 

 

   

 

 

 

Valuation allowance

     (6     (15
  

 

 

   

 

 

 

Deferred tax assets, net

   $ 17,033      $ 16,504   
  

 

 

   

 

 

 

The Company’s deferred tax assets and deferred tax liabilities include balances associated with the acquisition of 1st Enterprise in 2014, PC Bancorp in 2012 and COSB in 2010, which are non-taxable business combinations. These balances represent temporary differences for which deferred tax assets and liabilities are recognized because the financial statement carrying amounts of the acquired assets and assumed liabilities generally are their respective fair values at the date of the acquisition, whereas the tax basis equals the acquiree’s former tax basis (carryover tax basis).

The Company has federal net operating loss carryforwards attributable to the COSB acquisition of $0 and $282 thousand and state net operating loss carryforwards of $0 and $165 thousand at December 31, 2015, and 2014, respectively. The decrease in both the federal and state net operating loss carryforwards was attributable to the Company being able to utilize all remaining carryforwards from the COSB acquisition in both federal and state net operating loss carryforwards in the 2015 tax provision. The federal and state net operating loss carryforwards from the COSB acquisition are subject to an annual limitation of $624 thousand due to the ownership change on December 31, 2010.

In addition, the Company has a state tax capital loss carryforward acquired from the PC Bancorp acquisition of $54 thousand at December 31, 2015 and at December 31, 2014. The capital loss carryforward will expire in 2016. The Company has recorded a full valuation allowance against the state tax capital loss carryforward as it is more likely than not that the credit will not be realized.

The Company has a $1.3 million state net operating loss carryforward at CU Bancorp that arose from CU Bancorp’s 2012 separately filed tax return. The ability to utilize this net operating loss is dependent upon allocation of sufficient consolidated income to CU Bancorp in the future based on a three-factor formula. In assessing the need for a valuation allowance against these losses, the Company carefully weighed both positive and negative evidence currently available. Based upon the evidence, the Company concluded it is more likely than not that these net operating losses will be realized before the expiration in 2032.

 

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The Company also has a $182 thousand capital loss carryforward that was generated in 2014. The Company concluded it is more likely than not that these capital loss carryforward will be realized before the expiration in 2019.

The Company’s investments in Qualified Affordable Housing Projects generated low income housing tax credits and benefits net of investment amortization of $107 thousand and $146 thousand in 2015 and 2014, respectively. See Note 11 – Investments in Qualified Affordable Housing Projects for a discussion on the investments.

The following table presents a reconciliation of the statutory income tax rate to the consolidated effective income tax rate for each of the periods indicated (dollars in thousands):

 

     For Years Ended December 31,  
     2015     2014     2013  
     Amount     Percent     Amount     Percent     Amount     Percent  

Federal income tax expense at statutory rate

   $ 11,937        35.00   $ 5,369        35.00   $ 5,178        35.00

State franchise taxes, net of federal benefit, excluding LIHTC investments

     2,236        6.55        1,209        7.88        524        3.54   

Effect of rate change on net deferred tax asset

     —          —          —          —          (326     (2.20

Release of state valuation allowance on use of net operating loss

     (29     (0.09     (68     (0.44     (68     (0.46

Meals and entertainment, dues and other non-deductible items

     132        0.39        75        0.49        54        0.37   

Cash surrender life insurance

     (453     (1.33     (231     (1.51     (210     (1.42

Stock compensation expense

     (100     (0.29     (53     (0.35     (126     (0.85

LIHTC investments

     (141     (0.41     (119     (0.77     (155     (1.05

Merger costs

     —          —          515        3.36        5        0.03   

Tax Exempt Income

     (314     (0.92     —          —          —          —     

Other

     (400     (1.17     (265     (1.73     132        0.89   
  

 

 

     

 

 

     

 

 

   
   $ 12,868        37.73   $ 6,432        41.93   $ 5,008        33.85
  

 

 

     

 

 

     

 

 

   

The Company’s federal income tax returns for the years ended December 31, 2012 through 2014 are open for examination by federal taxing authorities and the Company’s state income tax returns for the years ended December 2011 through 2014 are open for examination by state taxing authorities.

The Company is undergoing an examination by the California Franchise Tax Board of the Enterprise Zone net interest deduction that the Company included in its California 2011 and 2012 tax returns. The California Franchise Tax Board has issued a closing letter with no material adjustments that impact the consolidated financial statements.

During 2015, the Company concluded an examination of the 2010 and 2011 California tax return of PC Bancorp by the California Franchise Tax Board with no material adjustments that impacted the consolidated financial statements.

The Company has not been notified of any other pending tax examinations by taxing authorities.

 

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Note 20 – Shareholders’ Equity

Common Stock

Holders of shares of the Company’s common stock are entitled to one vote for each share held of record on all matters voted upon by shareholders. Furthermore, the holders of the Company’s common stock have no preemptive rights to subscribe for new issue securities, and shares of the Company’s common stock are not subject to redemption, conversion, or sinking fund provisions.

With respect to the payment of dividends, after the preferential dividends upon all other classes and series of stock entitled thereto have been paid or declared and set apart for payment, then the holders of the Company’s common stock are entitled to such dividends as may be declared by the Company’s board of directors out of funds legally available under the laws of the State of California. Refer to Note 22 – Regulatory Matters for further discussion on restrictions on dividends.

Upon the Company’s liquidation or dissolution, the assets legally available for distribution to holders of the Company’s shares of common stock, after payment of all the Company’s obligations and payment of any liquidation preference of all other classes and series of stock entitled thereto, including the Company’s preferred stock, are distributable ratably among the holders of the Company’s common stock.

During 2015, the Company issued 454,019 shares of stock from the exercise of employee stock options for a total value of $4.3 million. The Company also issued 92,500 shares of restricted stock to the Company’s directors and employees, cancelled 10,675 shares of unvested restricted stock related to employee turnover and cancelled 44,311 shares of restricted stock that had a value of $971 thousand when employees elected to pay their tax obligation via the repurchase of the stock by the Company. The net issuance of restricted stock for 2015 was 81,825 shares. The Equity Plan, as amended, allows employees to make an election to have a portion of their restricted stock that became vested during the year repurchased by the Company to provide funds to pay the employee’s tax obligation related to the vesting of the stock. See Note 16 – Stock Options and Restricted Stock under “Equity Compensation Plans” for a more detailed analysis related to the issuances of these shares.

Preferred Stock

As discussed in Note 2, Business Combinations, the Company completed the merger with 1st Enterprise on November 30, 2014. As part of the Merger Agreement, 16,400 shares of preferred stock issued by 1st Enterprise as part of the Small Business Lending Fund (SBLF) program of the United States Department of the Treasury was converted into 16,400 CU Bancorp shares with substantially identical terms. CU Bancorp Preferred Stock has a liquidation preference amount of $1 thousand per share, designated as the Company’s Non-Cumulative Perpetual Preferred Stock, Series A. The U.S. Department of the Treasury is the sole holder of all outstanding shares of CU Bancorp Preferred Stock. The CU Bancorp Preferred Stock had an estimated life of four years and the fair value was $16 million at the merger date, resulting in a net discount of $479 thousand. The life-to-date and the year-to-date accretion on the net discount as of December 31, 2015 is $1.1 million and $991 thousand, respectively. The net carrying value of the CU Bancorp Preferred Stock is $17 million ($16 million plus of $0.6 million net premium) as of December 31, 2015.

Dividends on the Company’s Series A Preferred Stock are payable quarterly in arrears if authorized and declared by the Company’s board of directors out of legally available funds, on a non-cumulative basis, on the $1 thousand per share liquidation preference amount. Dividends are payable on January 1, April 1, July 1 and October 1 of each year. The current coupon dividend rate is fixed at 1% through January 1, 2016. The coupon dividend rate will adjust to 9% if the preferred stock remains outstanding beyond January 2016. However, the dividend yield through November 30, 2018 approximates 7% as a result of business combination accounting. Dividends on the Series A Preferred Stock are non-cumulative. There is no sinking fund with respect to dividends on the Series A Preferred Stock. So long as the Company’s Series A Preferred Stock remains outstanding, the Company may declare and pay dividends on the common stock only if full dividends on all

 

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outstanding shares of Series A Preferred Stock for the most recently completed dividend period have been or are contemporaneously declared and paid. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company, holders of the Series A Preferred Stock will be entitled to receive for each share of Series A Preferred Stock, out of the Company’s assets or proceeds available for distribution to the Company’s shareholders, subject to any rights of the Company’s creditors, before any distribution of assets or proceeds is made to or set aside for the holders of the common stock, payment of an amount equal to the sum of (i) the $1 thousand liquidation preference amount per share and (ii) the amount of any accrued and unpaid dividends on the Series A Preferred Stock. To the extent the assets or proceeds available for distribution to shareholders are not sufficient to fully pay the liquidation payments owing to the holders of the Series A Preferred Stock and the holders of any other class or series of the stock ranking equally with the Series A Preferred Stock, the holders of the Series A Preferred Stock and such the Company’s stock will share ratably in the distribution. Holders of the Series A Preferred Stock have no right to exchange or convert their shares into common stock or any other securities and do not have voting rights.

Other Comprehensive Income (Loss)

The following table presents the changes in accumulated other comprehensive income (loss) by component for the periods indicated (dollars in thousands):

 

     Before
Tax
    Tax
Effect
    Net of
Tax
 

Year ended December 31, 2015

      

Net unrealized gains (losses) on investment securities:

      

Beginning balance

   $ 333      $ (143   $ 190   
  

 

 

   

 

 

   

 

 

 

Net unrealized gain (losses) arising during the period

     (1,742     736        (1,006
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ (1,409   $ 593      $ (816
  

 

 

   

 

 

   

 

 

 

 

     Before
Tax
    Tax
Effect
    Net of
Tax
 

Year ended December 31, 2014

      

Net unrealized gains (losses) on investment securities:

      

Beginning balance

   $ (348   $ 143      $ (205
  

 

 

   

 

 

   

 

 

 

Net unrealized gain (losses) arising during the period

     681        (286     395   
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 333      $ (143   $ 190   
  

 

 

   

 

 

   

 

 

 

Note 21 – Commitments and Contingencies

The Company follows accounting guidance related to “Accounting for Contingencies” which provides criteria for determining whether a company must accrue or disclose a loss contingency. Under these guidelines, a loss contingency is defined as “an existing condition, situation, or set of circumstances involving uncertainty to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. A potential loss resulting from pending litigation is to be accrued when it is probable that one or more future events will occur confirming the fact of the loss and when “the amount of the loss can be reasonably estimated.” If an enterprise determines that one or both of these conditions have not been met, accounting guidance requires an enterprise to disclose a loss contingency when “there is at least a reasonable possibility that a loss may have occurred.” This disclosure “shall give an estimate of the possible loss or range of losses or state that such an estimate cannot be made.”

Litigation

From time to time the Company is a party to claims and legal proceedings arising in the ordinary course of business. The Company accrues for any probable loss contingencies that are estimable and discloses any material

 

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losses. As of December 31, 2015, there were no legal proceedings against the Company the outcome of which are expected to have a material adverse impact on the Company’s financial position, results of operations or cash flows, as a whole.

Financial Instruments with Off Balance Sheet Risk

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit. To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments.

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 generally have fixed expiration dates or other termination clauses and may require payment of a fee. Some of the Company’s commitments are expected to expire without being drawn upon, with the total commitment amounts not necessarily representing future cash funding requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. 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 accounts receivable, inventory, property, plant and equipment, income-producing commercial properties, residential properties and properties under construction.

Financial instruments with off balance sheet risk include commitments to extend credit of $806 million and $720 million at December 31, 2015 and 2014, respectively. Included in the aforementioned commitments were standby letters of credit outstanding of $73 million and $57 million at December 31, 2015 and 2014, respectively. As of December 31, 2015 and 2014, the Company had established reserve for estimated losses on unfunded loan commitments of $608 thousand and $471 thousand, respectively. These balances are included in other liabilities on the balance sheet.

Note 22 – Regulatory Matters

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital requirements that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company currently includes in Tier 1 capital an amount of subordinated debentures equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity less goodwill, core deposit intangibles and a portion of the SBA servicing assets. On July 2, 2013, the Board of Governors of the Federal Reserve System (“Federal Reserve”) approved a final rule (the “Final Rule”) that revises the current capital rules for U.S. banking organizations including the capital rules for the Company. The FDIC adopted the rule as an “interim final rule” on July 9, 2013. The Final Rule implements the regulatory capital reforms recommended by the Basel Committee. The Final Rule permanently grandfathers non-qualifying capital instruments, such as trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010, for inclusion in the Tier 1 Risk-based capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009, such as the Company. As a result, the Company’s trust preferred securities will continue to be included in Tier 1 Risk-Based Capital. The Company also currently includes in its Tier 1 capital an amount of Non-Cumulative Perpetual Preferred Stock, Series A issued under the

 

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SBLF program. The U.S. Department of the Treasury is the sole holder of all outstanding shares of CU Bancorp Preferred Stock. Under the Final Rule, the CU Bancorp Preferred Stock will continue to be included in Tier 1 risk-based capital.

As of December 31, 2015, the Company and the Bank are categorized as well-capitalized under the regulatory framework for Prompt Corrective Action. To be categorized as well-capitalized the Company and Bank must maintain minimum Total risk-based capital, Tier 1 risk-based capital, Common Equity Tier 1 and Tier 1 leverage ratios, as set forth in the following table.

The following tables present the Total risk-based capital ratio, Tier 1 risk-based capital ratio, Common equity tier 1 ratio and the Tier 1 leverage ratio of the consolidated Company in addition to the Bank as of December 31, 2015, and December 31, 2014, and compare the actual ratios to the capital requirements imposed by government regulations. All amounts reflected in the table below are stated in thousands, except percentages:

CU Bancorp

 

     December 31,
2015
    December 31,
2014
    Adequately
Capitalized
    Well
Capitalized
 
     Amount     Amount     (greater than or equal to)  

Regulatory Capital Ratios:

        

Tier 1 leverage ratio

     9.67     12.92     4.0     5.00

Common Equity Tier 1 ratio

     9.61     —          4.5     6.5

Total Tier 1 risk-based capital ratio

     10.85     10.95     6.0     8.0

Total risk-based capital ratio

     11.54     11.61     8.0     10.0

Regulatory Capital Data:

        

Common Equity Tier 1

   $ 223,977        —         

Total Tier 1 capital

     252,681      $ 218,147       

Total risk-based capital

     268,971        231,228       

Average total assets*

     2,611,774        1,689,096       

Risk-weighted assets

     2,329,770        1,992,043       

 

* Represents the average total assets for the leverage ratio

California United Bank:

 

     December 31,
2015
    December 31,
2014
    Adequately
Capitalized
    Well
Capitalized
 
     Amount     Amount     (greater than or equal to)  

Regulatory Capital Ratios:

        

Tier 1 leverage ratio

     9.34     12.44     4.0     5.0

Common Equity Tier 1 ratio

     10.47     —          4.5     6.5

Total Tier 1 risk-based capital ratio

     10.47     10.55     6.0     8.0

Total risk-based capital ratio

     11.17     11.20     8.0     10.0

Regulatory Capital Data:

        

Common Equity Tier 1

   $ 243,989        —         

Tier 1 capital

     243,989      $ 210,031       

Total risk-based capital

     260,279        223,112       

Average total assets*

     2,612,206        1,688,308       

Risk-weighted assets

     2,329,798        1,991,253       

 

* Represents the average total assets for the leverage ratio

 

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Restrictions on Dividends

As discussed in Note 2, Business Combinations, the Company completed the merger with 1st Enterprise on November 30, 2014. As part of the Merger Agreement, 16,400 shares of preferred stock issued by 1st Enterprise as part of the SBLF program of the United States Department of Treasury was converted into substantially 16,400 identical shares with identical terms. In December 2015, the Board approved a quarterly dividend payment on the preferred shares of $41 thousand to the United States Department of the Treasury.

Payment of stock or cash dividends in the future will depend upon earnings, liquidity, financial condition and other factors deemed relevant by our Board of Directors. Notification to the FRB is required prior to declaring and paying a dividend to shareholders that exceeds earnings for the period for which the dividend is being paid. This notification requirement is included in regulatory guidance regarding safety and soundness surrounding capital and includes other non-financial measures such as asset quality, financial condition, capital adequacy, liquidity, future earnings projections, capital planning and credit concentrations. Should the FRB object to dividend payments, the Company would be precluded from declaring and paying dividends until approval is received or the Company no longer needs to provide notice under applicable guidance.

California law also limits the Company’s ability to pay dividends. A corporation may make a distribution/dividend from retained earnings to the extent that the retained earnings exceed (a) the amount of the distribution plus (b) the amount if any, of dividends in arrears on shares with preferential dividend rights. Alternatively, a corporation may make a distribution/dividend, if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution/dividend.

The Bank is subject to certain restrictions on the amount of dividends that may be declared without regulatory approval. Such dividends shall not exceed the lesser of the Bank’s retained earnings or net income for its last three fiscal years less any distributions to shareholders made during such period. In addition, the Bank may not pay dividends that would result in its capital being reduced below the minimum requirements shown above for capital adequacy purposes.

Note 23 – Fair Value Information

Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including both those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis and a non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value, and for estimating the fair value of financial assets and financial liabilities not recorded at fair value, are discussed below.

In accordance with accounting guidance, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are as follows:

 

   

Level 1 – Observable unadjusted quoted market prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.

 

   

Level 2 – Significant other observable market based inputs, other than Level 1 prices such as quoted prices for similar assets or liabilities or unobservable inputs that are corroborated by market data. This includes quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, either directly or indirectly. This would include those financial instruments that are valued using models or other valuation methodologies where substantially all of

 

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the assumptions are observable in the marketplace, can be derived from observable market data or are supported by observable levels at which transactions are executed in the marketplace.

 

   

Level 3 – Significant unobservable inputs that reflect a reporting entity’s evaluation about the assumptions that market participants would use in pricing an asset or liability. Assets measured utilizing level 3 are for positions that are not traded in active markets or are subject to transfer restrictions, and or where valuations are adjusted to reflect illiquidity and or non-transferability. These assumptions are not corroborated by market data. This is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable from objective sources. Management uses a combination of reviews of the underlying financial statements, appraisals and management’s judgment regarding credit quality to determine the value of the financial asset or liability.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management maximizes the use of observable inputs and attempts to minimize the use of unobservable inputs when determining fair value measurements. The following is a description of both the general and specific valuation methodologies used for certain instruments measured at fair value, as well as the general classification of these instruments pursuant to the valuation hierarchy.

Investment Securities Available-for-Sale and Held-to-Maturity: The fair value of securities available-for-sale and held-to-maturity may be determined by obtaining quoted prices in active markets, when available, from nationally recognized securities exchanges (Level 1 financial assets). If quoted market prices are not available, the fair value is determined by matrix pricing, which is a mathematical technique widely used in the securities industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities which are observable market inputs (Level 2 financial assets). Debt securities’ pricing is generally obtained from one of the matrix pricing models developed from one of the three national pricing agencies. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are classified as Level 3 financial assets.

Securities classified as available-for-sale are accounted for at their current fair value rather than amortized historical cost. Unrealized gains or losses are excluded from net income and reported as an amount net of taxes as a separate component of accumulated other comprehensive income included in shareholders’ equity. Securities classified as held-to-maturity are accounted for at their amortized historical cost.

The Company considers the inputs utilized to fair value the available-for-sale and held-to-maturity investment securities to be observable market inputs and classified these financial assets within the Level 2 fair value hierarchy. Management bases the fair value for these investments primarily on third party price indications provided by independent pricing sources utilized by the Company’s bond accounting system to obtain market pricing on its individual securities. Vining Sparks, who provides the Company with its bond accounting system, utilizes pricing from three independent third party pricing sources for pricing of securities. These third party pricing sources utilize, quoted market prices or when quoted market prices are not available, then fair values are estimated using nationally recognized third-party vendor pricing models of which the inputs are observable. However, the fair value reported may not be indicative of the amounts that could be realized in an actual market exchange.

The fair value of the Company’s available-for-sale and held-to-maturity investment securities are calculated using an option adjusted spread model from one of the nationally recognized third-party pricing models. Depending on the assumptions used and the treasury yield curve and other interest rate assumptions, the fair value could vary significantly in the near term.

 

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Loans: The fair value for loans is estimated by discounting the expected future cash flows using current interest rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities, adjusted for the allowance for loan loss. Loans are segregated by type such as commercial and industrial, commercial real estate, construction and other loans with similar credit characteristics and are further segmented into fixed and variable interest rate loan categories. Expected future cash flows are projected based on contractual cash flows, adjusted for estimated prepayments. The inputs utilized in determining the fair value of loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Impaired Loans: The fair value of impaired loans is determined based on an evaluation at the time the loan is originally identified as impaired, and periodically thereafter, at the lower of cost or fair value. Fair value on impaired loans is measured based on the value of the collateral securing these loans, less costs to sell, if the loan is collateral dependent, or based on the discounted cash flows for non collateral dependent loans. Collateral dependent loans may be secured by either real estate and/or business assets including equipment, inventory and/or accounts receivable and is determined based on appraisals performed by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and unobservable. For unsecured loans, the estimated future discounted cash flows of the business or borrower, are used in evaluating the fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The inputs utilized in determining the fair value of impaired loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Interest Rate Swap Contracts:

The fair value of the interest rate swap contracts are provided by an independent third party vendors that specializes in interest rate risk management and fair value analysis using a model that utilizes current market data to estimate cash flows of the interest rate swaps utilizing the future London Interbank Offered Rate (“LIBOR”) yield curve for accruing and the future Overnight Index Swap Rate (“OIS”) yield curve for discounting through the maturity date of the interest rate swap contract. The future LIBOR yield curve is the primary input in the valuation of the interest rate swap contracts. Both the LIBOR and OIS yield curves are readily observable in the marketplace. Accordingly, the interest rate swap contracts are classified within Level 2 of the fair value hierarchy.

Other Real Estate Owned: The fair value of other real estate owned is generally based on real estate appraisals (unless more current market information is available) less estimated costs to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant. The inputs utilized in determining the fair value of other real estate owned are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

SBA Servicing Asset: The Company acquired an SBA servicing asset with the PC Bancorp merger and has added to the servicing asset with the sale of SBA loans subsequent to the merger. This servicing asset was initially fair valued at the merger date based on an evaluation by a third party who specializes in fair value analysis. The fair value of this asset was based on the estimated discounted future cash flows utilizing market based discount rates and estimated prepayment speeds. The discount rate was based on the current U.S. Treasury yield curve, plus a spread for marketplace risk associated with these assets. Prepayment speeds were selected based on the historical prepayments of similar SBA pools. The prepayment speeds determine the timing of the cash flows. The SBA servicing asset is amortized over the contractual life of the loans based on an effective yield approach. In addition, the Company’s servicing asset is evaluated regularly for impairment by discounting the estimated future cash flows using market-based discount rates and prepayment speeds. If the calculated present value of the servicing asset declines below the Company’s current carrying value, the servicing asset is written down to its present

 

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value. Based on the Company’s methodology in its valuation of the SBA servicing asset, the current carrying value is estimated to approximate the fair value. The inputs utilized in determining the fair value of SBA servicing asset are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Non-Maturing Deposits: The fair values for non-maturing deposits (deposits with no contractual termination date), which include non-interest bearing demand deposits, interest bearing transaction accounts, money market deposits and savings accounts are equal to their carrying amounts, which represent the amounts payable on demand. Because the carrying value and fair value are by definition identical, and accordingly non-maturity deposits are classified within Level 1 of the fair value hierarchy, these balances are not listed in the following tables.

Maturing Deposits: The fair values of fixed maturity certificates of deposit (time deposits) are estimated using a discounted cash flow calculation that applies current market deposit interest rates to the Company’s current certificates of deposit interest rates for similar term certificates. The inputs utilized in determining the fair value of maturing deposits are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.

Securities Sold under Agreements to Repurchase (“Repos”): The fair value of securities sold under agreements to repurchase is estimated based on the discounted value of future cash flows expected to be paid on the deposits. The carrying amounts of Repos with maturities of 90 days or less approximate their fair values. The fair value of Repos with maturities greater than 90 days is estimated based on the discounted value of the contractual future cash flows. The inputs utilized in determining the fair value of securities sold under agreements to repurchase are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.

Subordinated Debentures: The fair value of the three variable rate subordinated debentures (“debentures”) is estimated using a discounted cash flow calculation that applies the three month LIBOR plus the margin index at December 31, 2015, to the cash flows from the debentures, based on the actual interest rate the debentures were accruing at December 31, 2015. Because all three of the debentures re-priced on December 15, 2015 based on the current three month LIBOR index rate plus the index margin at that date, and with relatively little to no change in the three month LIBOR index rate from the re-pricing date through December 31, 2015, the current face value of the debentures and their calculated fair value are approximately equal. The inputs utilized in determining the fair value of subordinated debentures are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.

Fair Value of Commitments: Loan commitments that are priced on an index plus a margin to a market rate of interest are reported at the carrying value of the loan commitment. Loan commitments on which the committed fixed interest rate is less than the current market rate were insignificant at December 31, 2015 and 2014.

Interest Rate Risk: The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. In addition, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall rate risk.

 

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Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes the financial assets and financial liabilities measured at fair value on a recurring basis as of the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

     Fair
Value
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Financial Assets – December 31, 2015

           

Investment securities available-for-sale

   $ 315,785       $ —         $ 315,785       $ —     

Interest Rate Swap Contracts

     881         —           881         —     

Financial Liabilities – December 31, 2015

           

Interest Rate Swap Contracts

   $ 2,545       $ —         $ 2,545       $ —     

Financial Assets – December 31, 2014

           

Investment securities available-for-sale

   $ 226,962       $ —         $ 226,962       $ —     

Interest Rate Swap Contracts

     719         —           719         —     

Financial Liabilities – December 31, 2014

           

Interest Rate Swap Contracts

   $ 3,515       $ —         $ 3,515       $ —     

At December 31, 2015 and 2014, the Company had no financial assets or liabilities that were measured at fair value on a recurring basis that required the use of significant unobservable inputs (Level 3). Additionally, there were no transfers of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a recurring basis for the periods ended December 31, 2015 and 2014.

Assets Measured at Fair Value on a Non-recurring Basis

The Company may be required periodically, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of or during the period.

There were no transfers of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a non-recurring basis for the period ended December 31, 2015.

 

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The following table presents the balances of assets and liabilities measured at fair value on a non-recurring basis by caption and by level within the fair value hierarchy as of the dates indicated (dollars in thousands):

 

     Net
Carrying
Amount
     Quoted Prices
in Active
Markets for
Identical Assets

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Financial Assets – December 31, 2015

           

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs (non-purchased credit impaired loans)

   $ —         $ —         $ —         $ —     

Other real estate owned

     325         —           —           325   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 325       $ —         $ —         $ 325   
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial Assets – December 31, 2014

           

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs offs (non-purchased credit impaired loans)

   $ 1,172       $ —         $ —         $ 1,172   

Other real estate owned

     850         —           —           850   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,022       $ —         $ —         $ 2,022   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the significant unobservable inputs used in the fair value measurements for Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of the dates indicated (dollars in thousands):

 

     Fair
Value
     Valuation
Methodology
   Valuation Model
and/or Factors
   Unobservable
Input Values

Financial Assets – December 31, 2015

           

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off

     $—         —      —      —  

Other real estate owned

     325       Broker opinion of
value
   Sales approach

Estimated selling
costs

   6%
  

 

 

          

Total

   $ 325            
  

 

 

          

Financial Assets – December 31, 2014

           

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off

   $ 1,172       Credit loss
estimate of aged
accounts receivable
collateral
   Credit loss factors
on aging of
accounts receivable
collateral
   10%-80%
         Estimated selling
costs
   15%

Other real estate owned

     850       Residential real
estate appraisal
   Sales approach

Estimated selling
costs

   6%
  

 

 

          

Total

   $ 2,022            
  

 

 

          

 

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Fair Value of Financial Assets and Liabilities

ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or on a non-recurring basis. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could have realized in a current market exchange as of December 31, 2015 and December 31, 2014. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The description of the valuation methodologies used for assets and liabilities measured at fair value and for estimating fair value for financial instruments not recorded at fair value has been described above.

The table below presents the carrying amounts and fair values of financial instruments based on their fair value hierarchy indicated (dollars in thousands):

 

                Fair Value Measurements  
    Carrying
Amount
    Fair Value     Quoted
Prices  in
Active
Markets

for
Identical

Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 

December 31, 2015

         

Financial Assets

         

Investment securities available-for-sale

  $ 315,785        315,785      $ —        $ 315,785      $ —     

Investment securities held-to-maturity

    42,036        42,339        —          42,339        —     

Loans, net

    1,817,481        1,851,220        —          —          1,851,220   

Interest rate swap contracts

    881        881        —          881        —     

Financial Liabilities

            —     

Certificates of deposit

    58,502        58,502        —          58,502        —     

Securities sold under agreements to repurchase

    14,360        14,360        —          14,360        —     

Subordinated debentures

    9,697        12,372        —          12,372        —     

Interest rate swap contracts

    2,545        2,545        —          2,545        —     

 

                Fair Value Measurements  
    Carrying
Amount
    Fair Value     Quoted
Prices  in
Active
Markets

for
Identical

Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 

December 31, 2014

         

Financial Assets

         

Investment securities available-for-sale

  $ 226,962        226,962      $ —        $ 226,962      $ —     

Investment securities held-to-maturity

    47,147        47,159        —          47,159        —     

Loans, net

    1,612,113        1,627,717        —          —          1,627,717   

Interest rate swap contracts

    719        719        —          719        —     

Financial Liabilities

         

Certificates of deposit

    64,840        64,857        —          64,857        —     

Securities sold under agreements to repurchase

    9,411        9,411        —          9,411        —     

Subordinated debentures

    9,538        12,372        —          12,372        —     

Interest rate swap contracts

    3,515        3,515        —          3,515        —     

 

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Note 24 – Reclassification

Certain amounts in the prior year’s financial statements and related disclosures were reclassified to conform to the current year presentation with no effect on previously reported net income or shareholders’ equity.

Note 25 – Summary Quarterly Data (unaudited)

 

    2015 Quarters Ended     2014 Quarters Ended  
(Dollars in thousands, except per share data)   Dec.
31
    Sept.
30
    June
30
    Mar.
31
    Dec.
31
    Sept.
30
    June
30
    Mar.
31
 

Interest income

  $ 23,807      $ 23,106      $ 21,941      $ 21,288      $ 16,264      $ 13,238      $ 13,039      $ 12,636   

Interest expense

    705        704        668        646        528        470        461        463   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    23,102        22,402        21,273        20,642        15,736        12,768        12,578        12,173   

Provision for loan losses

    2,249        705        683        1,443        1,721        35        408        75   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    20,853        21,697        20,590        19,199        14,015        12,733        12,170        12,098   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest income

    3,039        2,988        3,095        2,608        2,132        2,004        1,783        1,790   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense

    15,073        15,067        14,912        14,913        14,107        10,031        9,698        9,549   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income before provision for income tax expense

    8,819        9,618        8,773        6,894        2,040        4,706        4,255        4,339   

Provision for income tax

    3,312        3,355        3,506        2,695        733        2,157        1,869        1,673   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

  $ 5,507      $ 6,263      $ 5,267      $ 4,199      $ 1,307      $ 2,549      $ 2,386      $ 2,666   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Preferred stock dividends and discount accretion

  $ 297      $ 293      $ 312      $ 272      $ 124      $ —        $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Available to Common Shareholders

  $ 5,210      $ 5,970      $ 4,955      $ 3,927      $ 1,183      $ 2,549      $ 2,386      $ 2,666   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic income per share

  $ 0.31      $ 0.36      $ 0.30      $ 0.24      $ 0.09      $ 0.23      $ 0.22      $ 0.25   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted income per share

  $ 0.30      $ 0.35      $ 0.29      $ 0.23      $ 0.09      $ 0.23      $ 0.21      $ 0.24   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Note 26 – Condensed Financial Information of Parent Company

The following tables present the parent company only condensed balance sheets and the related statements of income and condensed statements of cash flows for the dates and periods indicated (dollars in thousands):

 

Parent Company Only Condensed Balance Sheets

   December 31,  
     2015     2014  

ASSETS

    

Cash and due from banks

   $ 6,756      $ 4,612   

Loans

     882        1,410   

Investment in subsidiary

     310,263        284,216   

Accrued interest receivable and other assets

     4        103   
  

 

 

   

 

 

 

Total Assets

   $ 317,905      $ 290,341   
  

 

 

   

 

 

 

LIABILITIES

    

Subordinated debentures

   $ 9,697      $ 9,538   

Accrued interest payable and other liabilities

     1,401        1,611   
  

 

 

   

 

 

 

Total Liabilities

     11,098        11,149   

SHAREHOLDERS’ EQUITY

     306,807        279,192   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 317,905      $ 290,341   
  

 

 

   

 

 

 

Parent Company Only Condensed Statements of Income

   Years Ended
December 31,
 
         2015           2014    

Interest Income

   $ 71      $ 165   
  

 

 

   

 

 

 

Interest Expense

     438        430   

Operating Expenses

     676        911   
  

 

 

   

 

 

 

Total Expenses

     1,114        1,341   
  

 

 

   

 

 

 

Loss Before Income Tax Benefit and Equity in Undistributed Earnings of Subsidiary

     (1,043     (1,176

Income tax benefit

     466        257   

Loss Before Equity in Undistributed Earnings of Subsidiary

     (577     (919
  

 

 

   

 

 

 

Equity in undistributed earnings of subsidiary

     21,813        9,827   
  

 

 

   

 

 

 

Net Income

   $ 21,236      $ 8,908   
  

 

 

   

 

 

 

 

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Table of Contents

Parent Company Only Condensed Statements of Cash Flows

   Years Ended
December 31,
 
     2015     2014  

Cash flows from operating activities:

    

Net income:

   $ 21,236      $ 8,908   

Adjustments to reconcile net income to net cash used in operating activities:

    

Equity in undistributed earnings of subsidiary

     (21,813     (9,827

Provision for loan losses

     —          (100

Net accretion of discounts/premiums

     (19     (26

Accretion of subordinated debenture discount

     159        159   

Decrease (increase) in accrued interest receivable and other assets

     (27     1,351   

Increase (decrease) in accrued interest payable and other liabilities

     (84     396   
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (548     861   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Cash paid for 1st Enterprise fractional shares and dissenting shareholder

     —          (89

Capital contribution made to subsidiary

     (1,000     (2,500

Net decrease in loans

     547        502   
  

 

 

   

 

 

 

Net cash used in investing activities

     (453     (2,087
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net proceeds from exercise of stock options

     4,299        2,029   

Issuance costs of common stock for 1st Enterprise merger

     —          (27

Restricted stock repurchase

     (971     (471

Dividends paid on preferred stock

     (183     (41
  

 

 

   

 

 

 

Net cash provided by financing activities

     3,145        1,490   
  

 

 

   

 

 

 

Net increase in cash

     2,144        264   

Cash, beginning of year

     4,612        4,348   
  

 

 

   

 

 

 

Cash, end of year

   $ 6,756      $ 4,612   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid during the period for interest

   $ 277      $ 270   
  

 

 

   

 

 

 

Note 27 – Related Party Transactions

During 2015 and 2014, there were no existing transactions that are out of the ordinary course of business between CU Bancorp and its affiliates, including executive officers, directors, principal shareholders (beneficial owners of 5% or more of our Common Stock), or the immediate family or associates of any of the foregoing persons, or trust for the benefit of employees such as a 401(k) trust.

Some of CU Bancorp’s directors and executive officers, as well as the companies with which such directors and executive officers are associated, are customers of, and have had banking transactions with California United Bank in the ordinary course of business. All such transactions are on substantially the same terms, including interest and collateral as those prevailing for comparable transactions with others. At the present time, California United Bank has two lending relationships with its directors and officers or entities associated with any of its directors or officers. California United Bank also engages in deposit transactions with its executive officers and directors, and their immediate family or corporations of which the directors or officers may own a controlling interest, or also serve as directors or officers. These transactions are expected to take place on substantially the same terms, including interest, as those prevailing for comparable transactions with others.

Note 28 – Subsequent Events

We have evaluated events that have occurred subsequent to December 31, 2015 and have concluded there are no subsequent events that would require recognition in the accompanying consolidated financial statements.

 

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PART IV

ITEM 15 — EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(b) Index to Exhibits

 

Exhibit
Number

  

Description

 2.1    Agreement and Plan of Merger by and Among CU Bancorp and California United Bank and 1st Enterprise Bank Dated as of June 2, 2014 1
 2.2    Amendment No. 1 to Agreement and Plan of Merger 2
 2.3    Amendment No. 2 to Agreement and Plan of Merger 3
 3.1    Articles of Incorporation of CU Bancorp 4
 3.2 LOGO    Bylaws of CU Bancorp
 3.3    Certificate of Determination of Non-Cumulative Perpetual Preferred Stock, Series A of CU Bancorp 5
  4.1    Specimen form of Certificate for CU Bancorp Common Stock 6
  4.2    Assignment & Assumption Agreement 7
10.1*    2014 CU Bancorp Executive Performance Incentive Plan Amendment # 1 — April 24, 2014 8
10.2*    Separation and Consulting Agreement 9
10.3* LOGO   

Notice of Grant of Restricted Stock Bonus Award and Form of Restricted Stock Bonus Award Agreement

10.4* LOGO    CU Bancorp 2007 Equity and Incentive Plan as Amended and Restated July 31, 2014, as Amended as of December 29, 2015
10.5*    1st Enterprise Bank 2006 Stock Incentive Plan as Amended and Restated March 18, 2009 10
10.6*    Amendment of the 1st Enterprise Bank 2006 Stock Incentive Plan, July 31, 2014 11
10.7*    California United Bank 2005 Stock Option Plan 12
10.8*    CU Bancorp 2012 Change in Control Severance Plan 13
10.9* LOGO    Executive Salary Continuation Plan / Agreement and Schedule of Participants and Benefits 
10.10*    2014 California United Bank Executive Performance Cash Incentive Plan 14
10.11*    Form of Director / Officer Indemnification Agreement and Schedule of Agreements 15
12.1 LOGO    Ratio of Earnings to Fixed Charges 
14.1 LOGO    CU Bancorp Principles of Business Conduct & Ethics 
14.2 LOGO    CU Bancorp Code of Ethics — Financial Officers 
21.1    Subsidiaries of the Registrant 16
23.1 LOGO    Consent of Independent Registered Public Accounting Firm
24.1 LOGO    Power of Attorney (see signature page hereto)
31.1 LOGO    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
31.2 LOGO    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
32.1 LOGO    Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
101.INS LOGO    XBRL Instance Document
101.SCH LOGO    XBRL Taxonomy Extension Schema Document
101.CAL LOGO    XBRL Taxonomy Calculation Linkbase Document
101.DEF LOGO

 

101.LAB LOGO

  

XBRL Taxonomy Extension Definition Linkbase Document

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE LOGO    XBRL Taxonomy Presentation Linkbase Document

 

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* Refers to management contracts or compensatory plans or arrangements
LOGO Attached hereto
1 Incorporated by reference from Exhibit 2.1 to CU Bancorp Registration Statement on Form S-4 as filed on August 20, 2014.
2 Incorporated by reference from Exhibit 2.1 to CU Bancorp Registration Statement on Form S-4 as filed on August 20, 2014.
3 Incorporated by reference from Exhibit 2.2 to CU Bancorp Current Report on Form 8-K filed November 17, 2014.
4 Incorporated by reference from Exhibit 3.1 to CU Bancorp Registration Statement on Form S-4 as filed on April 13, 2012.
5 Incorporated by reference from Exhibit 3.3 to CU Bancorp Current Report on Form 8-K filed November 24, 2014.
6 Incorporated by reference from Exhibit 4.1 to CU Bancorp Registration Statement on Form S-4 as filed on April 13, 2012.
7 Incorporated by reference from Exhibit 4.2 to CU Bancorp Annual Report on Form 10-K filed March 13, 2015.
8 Incorporated by reference from Exhibit 10.1 to CU Bancorp Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2014.
9 Incorporated by reference from Exhibit 10.5 to CU Bancorp Registration Statement on Form S-4 as filed on August 20, 2014.
10 Incorporated by reference from Exhibit 10.5 to CU Bancorp Annual Report on Form 10-K filed March 13, 2015.
11 Incorporated by reference from Exhibit 10.6 to CU Bancorp Annual Report on Form 10-K filed March 13, 2015.
12 Incorporated by reference from Exhibit 10.1 to CU Bancorp Registration Statement on Form S-4 as filed on April 13, 2012.
13 Incorporated by reference from Exhibit 10.3 to CU Bancorp Quarterly Report on Form 10-Q for the Quarter Ended September 30, 2013.
14 Incorporated by reference from Exhibit 10.6 to CU Bancorp Annual Report on Form 10-K filed March 13, 2014.
15 Incorporated by reference from Exhibit 10.7 to CU Bancorp Annual Report on Form 10-K filed March 13, 2014.
16 Incorporated by reference from Exhibit 21.1 to CU Bancorp Registration Statement on Form S-4 as filed on August 20, 2014.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

            CU BANCORP

Dated: March 14, 2016

     

/s/ DAVID I. RAINER

      David I. Rainer
      Chief Executive Officer
     

/s/ KAREN A. SCHOENBAUM

      Karen A. Schoenbaum
      Executive Vice President and Chief Financial Officer

POWERS OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Anita Y. Wolman, Karen A. Schoenbaum, and Anne Williams, and each of them severally, his or her true and lawful attorney-in-fact with power of substitution and resubstitution to sign in his or her name, place and stead, in any and all capacities, to do any and all things and execute any and all instruments that such attorney may deem necessary or advisable under the Securities Exchange Act of 1934 and any rules, regulations and requirements of the U.S. Securities and Exchange Commission in connection with this Annual Report on Form 10-K and any and all amendments hereto, as fully for all intents and purposes as he or she might or could do in person, and hereby ratifies and confirms all said attorneys-in-fact and agents, each acting alone, and his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Dated: March 14, 2016

     

/s/ ROBERTO E. BARRAGAN

     

Roberto E. Barragan

Director

Dated: March 14, 2016

     

/s/ CHARLES R. BEAUREGARD

     

Charles R. Beauregard

Director

Dated: March 14, 2016

     

/s/ KENNETH J. COSGROVE

     

Kenneth J. Cosgrove

Director

Dated: March 14, 2016

     

/s/ DAVID C. HOLMAN

     

David C. Holman

Director

Dated: March 14, 2016

     

/s/ K. BRIAN HORTON

     

K. Brian Horton

Director and President

Dated: March 14, 2016

     

/s/ ERIC S. KENTOR

     

Eric S. Kentor

Director

 

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Dated: March 14, 2016

     

/s/ JEFFREY J. LEITZINGER, Ph.D.

     

Jeffrey J. Leitzinger, Ph.D.

Director

Dated: March 14, 2016

     

/s/ DAVID I. RAINER

     

David I. Rainer

Chairman of the Board and Chief Executive Officer (Principal Executive Officer)

Dated: March 14, 2016

     

/s/ ROY A. SALTER

     

Roy A. Salter

Director

Dated: March 14, 2016

     

/s/ KAREN A. SCHOENBAUM

     

Karen A. Schoenbaum

Executive Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

Dated: March 14, 2016

     

/s/ DANIEL F. SELLECK

     

Daniel F. Selleck

Director

Dated: March 14, 2016

     

/s/ CHARLES H. SWEETMAN

     

Charles H. Sweetman

Director

Dated: March 14, 2016

     

/s/ KAVEH VARJAVAND

     

Kaveh Varjavand

Director

 

171