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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended March 31, 2017

 

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 West 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)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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  
Non Accelerated Filer      Smaller Reporting Company  
     Emerging Growth Company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

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

As of May 1, 2017 the number of shares outstanding of the registrant’s no par value Common Stock was 17,833,438.

 

 

 

 

Page 1 of 72


Table of Contents

CU BANCORP

March 31, 2017 FORM 10-Q

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

 

  ITEM 1.    Financial Statements  
    

Consolidated Balance Sheets March 31, 2017 (Unaudited) and December 31, 2016

     3  
    

Consolidated Statements of Income Three Months Ended March 31, 2017 and 2016 (Unaudited)

     4  
    

Consolidated Statements of Comprehensive Income Three Months Ended March 31, 2017 and 2016 (Unaudited)

     5  
    

Consolidated Statements of Changes in Shareholders’ Equity Three Months Ended March 31, 2017 and 2016 (Unaudited)

     6  
    

Consolidated Statements of Cash Flows Three Months Ended March 31, 2017 and 2016 (Unaudited)

     7  
    

Notes to the Consolidated Financial Statements (Unaudited)

     9  
  ITEM 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      40  
     Overview      42  
     Results of Operations      47  
     Financial Condition      56  
     Liquidity      61  
     Dividends      63  
     Regulatory Matters      64  
  ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk      67  
  ITEM 4.    Controls and Procedures      69  
PART II. OTHER INFORMATION   
  ITEM 1.    Legal Proceedings      70  
  ITEM 1A.    Risk Factors      70  
  ITEM 2.    Unregistered Sales of Equity Securities and Use of Proceeds      70  
  ITEM 3.    Defaults Upon Senior Securities      70  
  ITEM 4.    Mine Safety Disclosures      70  
  ITEM 5.    Other Information      71  
  ITEM 6.    Exhibits      71  
  Signatures          72  

 

Page 2 of 72


Table of Contents

CU BANCORP

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

     March 31,
2017
    December 31,
2016
 
     (Unaudited)     (Audited)  

ASSETS

    

Cash and due from banks

   $ 51,168     $ 41,281  

Interest earning deposits in other financial institutions

     313,609       167,789  
  

 

 

   

 

 

 

Total cash and cash equivalents

     364,777       209,070  

Certificates of deposit in other financial institutions

     48,795       51,245  

Investment securities available-for-sale, at fair value

     469,399       469,950  

Investment securities held-to-maturity, at amortized cost

     40,945       42,027  
  

 

 

   

 

 

 

Total investment securities

     510,344       511,977  

Loans

     2,046,138       2,050,226  

Allowance for loan loss

     (19,605     (19,374
  

 

 

   

 

 

 

Net loans

     2,026,533       2,030,852  

Premises and equipment, net

     3,946       4,184  

Deferred tax assets, net

     15,329       17,181  

Goodwill

     64,603       64,603  

Core deposit and leasehold right intangibles, net

     5,970       6,300  

Bank owned life insurance

     63,595       51,216  

Accrued interest receivable and other assets

     39,376       48,132  
  

 

 

   

 

 

 

Total Assets

   $ 3,143,268     $ 2,994,760  
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

LIABILITIES

    

Non-interest bearing demand deposits

   $ 1,485,730     $ 1,400,097  

Interest bearing transaction accounts

     346,279       332,702  

Money market and savings deposits

     892,143       845,110  

Certificates of deposit

     30,623       29,480  
  

 

 

   

 

 

 

Total deposits

     2,754,775       2,607,389  

Securities sold under agreements to repurchase

     11,939       18,816  

Subordinated debentures, net

     9,896       9,856  

Accrued interest payable and other liabilities

     20,210       20,514  
  

 

 

   

 

 

 

Total Liabilities

     2,796,820       2,656,575  
  

 

 

   

 

 

 

Commitments and Contingencies (Note 13)

    

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 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively

     16,887       16,995  

Common stock – authorized, 75,000,000 shares no par value, 17,834,183 and 17,759,006 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively

     236,308       235,873  

Additional paid-in capital

     25,462       25,213  

Retained earnings

     70,645       63,163  

Accumulated other comprehensive loss

     (2,854     (3,019
  

 

 

   

 

 

 

Total Shareholders’ Equity

     346,448       338,185  
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 3,143,268     $ 2,994,760  
  

 

 

   

 

 

 

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

 

Page 3 of 72


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except per share data)

 

     Three Months Ended
March 31,
 
     2017      2016  

Interest Income

     

Interest and fees on loans

   $ 24,432      $ 22,578  

Interest on investment securities

     2,041        1,232  

Interest on interest bearing deposits in other financial institutions

     710        439  
  

 

 

    

 

 

 

Total Interest Income

     27,183        24,249  
  

 

 

    

 

 

 

Interest Expense

     

Interest on interest bearing transaction accounts

     157        99  

Interest on money market and savings deposits

     670        511  

Interest on certificates of deposit

     26        33  

Interest on securities sold under agreements to repurchase

     9        11  

Interest on subordinated debentures

     130        117  
  

 

 

    

 

 

 

Total Interest Expense

     992        771  
  

 

 

    

 

 

 

Net Interest Income

     26,191        23,478  

Provision for loan losses

     —          622  
  

 

 

    

 

 

 

Net Interest Income After Provision For Loan Losses

     26,191        22,856  
  

 

 

    

 

 

 

Non-Interest Income

     

Gain on sale of securities, net

     141        —    

Gain on sale of SBA loans, net

     202        554  

Deposit account service charge income

     1,160        1,189  

Other non-interest income

     1,332        1,077  
  

 

 

    

 

 

 

Total Non-Interest Income

     2,835        2,820  
  

 

 

    

 

 

 

Non-Interest Expense

     

Salaries and employee benefits (includes stock based compensation expense of $773 and $834 for the three months ended March 31, 2017 and 2016, respectively)

     11,061        10,153  

Occupancy

     1,489        1,436  

Data processing

     656        618  

Legal and professional

     1,009        475  

FDIC deposit assessment

     446        350  

OREO loss and expenses

     —          79  

Office services expenses

     380        403  

Other operating expenses

     1,652        1,673  
  

 

 

    

 

 

 

Total Non-Interest Expense

     16,693        15,187  
  

 

 

    

 

 

 

Net Income Before Provision for Income Tax Expense

     12,333        10,489  

Provision for income tax expense

     4,550        3,905  
  

 

 

    

 

 

 

Net Income

     7,783        6,584  

Preferred stock dividends and discount accretion

     301        303  
  

 

 

    

 

 

 

Net Income Available to Common Shareholders

   $ 7,482      $ 6,281  
  

 

 

    

 

 

 

Earnings Per Share

     

Basic earnings per share

   $ 0.43      $ 0.37  

Diluted earnings per share

   $ 0.42      $ 0.36  

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

 

Page 4 of 72


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

 

     Three Months
Ended
March 31,
 
     2017     2016  

Net Income

   $ 7,783     $ 6,584  

Other Comprehensive Income, net of tax:

    

Net change in unrealized gain on available-for-sale investment securities, net of tax

     247       769  

Reclassification of gain on investment securities available-for-sale to net income, net of tax

     (82     —    
  

 

 

   

 

 

 

Other Comprehensive Income

     165       769  
  

 

 

   

 

 

 

Comprehensive Income

   $ 7,948     $ 7,353  
  

 

 

   

 

 

 

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

 

Page 5 of 72


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

(Dollars in thousands)

 

    Preferred Stock     Common Stock                          
    Issued
and
Outstanding
Shares
    Amount     Issued
and
Outstanding
Shares
    Amount     Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive

Loss
    Total
Shareholders’

Equity
 

Balance at December 31, 2015

    16,400     $ 16,995       17,175,389     $ 230,688     $ 23,017     $ 36,923     $ (816   $ 306,807  

Net issuance of restricted stock

    —         —         37,809       —         —         —         —         —    

Exercise of stock options

    —         —         189,489       1,438       —         —         —         1,438  

Stock based compensation expense

    —         —         —         —         834       —         —         834  

Restricted stock repurchase

    —         —         (13,304     —         (294     —         —         (294

Preferred stock dividends and discount accretion

    —         153       —         —         —         (303     —         (150

Net income

    —         —         —         —         —         6,584       —         6,287  

Other comprehensive income

    —         —         —         —         —         —         769       769  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

    16,400     $ 17,148       17,389,383     $ 232,126     $ 23,557     $ 43,204     $ (47   $ 315,988  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2016

    16,400     $  16,955       17,759,006     $  235,873     $  25,213     $  63,163     $ (3,019    $  338,185  

Net issuance of restricted stock

    —         —         60,531       —         —         —         —         —    

Exercise of stock options

    —         —         27,942       435       —         —         —         435  

Stock based compensation expense

    —         —         —         —         773       —         —         773  

Restricted stock repurchase

    —         —         (13,296     —         (524     —         —         (524

Preferred stock dividends and net premium amortization

    —         (68     —         —         —         (301     —         (369

Net income

    —         —         —         —         —         7,783       —         7,783  

Other comprehensive income

    —         —         —         —         —         —         165       165  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2017

    16,400     $ 16,887       17,834,183     $ 236,308     $ 25,462     $ 70,645     $ (2,854   $ 346,448  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

Page 6 of 72


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

 

     Three Months Ended
March 31,
 
     2017     2016  

Cash flows from operating activities:

    

Net income:

   $ 7,783     $ 6,584  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     —         622  

Provision for unfunded loan commitments

     —         102  

Stock based compensation expense

     773       834  

Depreciation

     341       361  

Net accretion of discounts/premiums for loans acquired and deferred loan fees/costs

     (2,240     (2,140

Net amortization from investment securities

     1,505       1,009  

Increase in bank owned life insurance

     (379     (323

Amortization of core deposit intangibles

     284       321  

Net accretion of leasehold right intangible asset and liabilities

     (34     (22

Accretion of subordinated debenture discount

     40       40  

Loss on sale of OREO

     —         14  

Gain on sale of securities, net

     (141     —    

Gain on sale of SBA loans, net

     (202     (554

Decrease in deferred tax assets

     1,732       2,381  

Decrease (increase) in accrued interest receivable and other assets

     8,756       (272

Increase (decrease) in accrued interest payable and other liabilities

     54       (1,622

Increase (decrease) in fair value of derivative swap liability

     (279     561  
  

 

 

   

 

 

 

Net cash provided by operating activities

     17,993       7,896  
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of investment securities

     (32,586     (11,312

Proceeds from sales of investment securities

     10,601       —    

Proceeds from repayment and maturities of investment securities

     22,540       13,696  

Net loan principal payments (net of loan originations)

     6,761       (33,080

Purchases of premises and equipment

     (103     (58

Proceeds from sale of OREO

     —         311  

Net decrease in certificates of deposit in other financial institutions

     2,450       2,940  

Purchase of bank owned life insurance

     (12,000     —    
  

 

 

   

 

 

 

Net cash used in investing activities

     (2,337     (27,503
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in non-interest bearing demand deposits

     85,633       24,213  

Net increase (decrease) in interest bearing transaction accounts

     13,577       (3,142

Net increase in money market and savings deposits

     47,033       71,717  

Net increase (decrease) in certificates of deposit

     1,143       (3,694

Net increase (decrease) in securities sold under agreements to repurchase

     (6,877     7,607  

Net proceeds from stock options exercised

     435       1,438  

Restricted stock repurchase

     (524     (294

Dividends paid on preferred stock

     (369     (150
  

 

 

   

 

 

 

Net cash provided by financing activities

     140,051       97,695  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     155,707       78,088  

Cash and cash equivalents, beginning of period

     209,070       222,063  
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 364,777     $ 300,151  
  

 

 

   

 

 

 

 

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Table of Contents
     Three Months Ended
March 31,
 
     2017      2016  

Supplemental disclosures of cash flow information:

     

Cash paid for interest

   $ 943      $ 782  

Net cash paid for taxes

   $ —        $ 1,710  

Supplemental disclosures of non-cash investing activities:

     

Net change in unrealized gain on available-for-sale investment securities, net of tax

   $ 247      $ 769  

 

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CU BANCORP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2017

(Unaudited)

Note 1 - Basis of Financial Statement Presentation

CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company”, as used throughout this document, refers to the consolidated 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. Its headquarters office is 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.

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 (“SEC”).

CU Bancorp is the common shareholder of Premier Commercial Statutory Trust I, Premier Commercial Statutory Trust II, and Premier Commercial Statutory Trust III. 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 8 – Borrowings and Subordinated Debentures.

Certain information and footnote disclosures presented in the annual consolidated financial statements are not included in the interim consolidated financial statements. Accordingly, the accompanying unaudited interim consolidated financial statements should be read in conjunction with the 2016 Annual Report on Form 10-K. In the opinion of management, the accompanying interim consolidated financial statements contain all necessary adjustments of a normal recurring nature, to present fairly the consolidated financial position of the Company and the results of its operations for the interim periods presented.

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 on a recurring and nonrecurring basis. 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.

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.

 

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Note 2 - Recent Accounting Pronouncements

Recent Accounting Standards Not Yet Effective

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which replaced almost all existing revenue recognition guidance in current GAAP. However, the effects of the new revenue recognition guidance on the financial statements of reporting entities in the financial institution industry will be somewhat limited because, for the most part, financial instruments and related contractual rights and obligations are excluded from its scope. As such, it is anticipated that interest income recognition and measurement, the largest source of revenue for the Company, will not be impacted by Accounting Standards Codification (“ASC”) Topic 606. However, the recognition and measurement of certain non-interest income items such as gain on sale of other real estate owned and deposit-related fees, could be affected by ASC Topic 606.

Under current U.S. GAAP, when full consideration is not expected and financing is required by the buyer to purchase the property, there are very prescriptive requirements in determining when foreclosed real estate property sold by an institution should be derecognized and a gain or loss be recognized. The new guidance that will be applied to these sales is more principles based. For example, as it pertains to the criteria for determining how a contract should be accounted for under the new guidance, judgment will need to be exercised in evaluating if: (a) a commitment on the buyer’s part exists, (b) collection is probable in circumstances where the initial investment is minimal and (c) the buyer has obtained control of the asset, including the significant risks and rewards of the ownership. If there is no commitment on the buyer’s part, collection is not probable or the buyer has not obtained control of the asset, then a gain cannot be recognized under the new guidance. The initial investment requirement for the buyer along with the various methods for profit recognition are no longer applicable when the new guidance goes into effect. The Company will revise its current policy on the recognition and measurement of gain on sale of other real estate owned to be consistent with the new guidance, but does not expect the new guidance to have a significant impact on the consolidated financial statements of the Company when adopted. Since the inception of the Company, the level of other real estate owned has been very low and in almost all cases, full consideration was received at the time of sale and financing by the Company was not provided.

For deposit-related fees, considering the straightforward nature of the arrangements with the Company’s deposits customers, the Company does not expect the recognition and measurement outcomes of deposit-related fees to be significant differently under the new guidance compared to current GAAP.

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 August 2015, the FASB issued ASU 2015-14 which defers the original effective date for all entities by one year. Public business entities 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 does not expect this ASU to have a material impact on the Company’s consolidated financial statements when adopted on January 1, 2018.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. Changes to the current GAAP model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The most far-reaching ramification of this ASU is the elimination of the available-for-sale classification for equity securities and the requirement to carry most equity securities at fair value through net income. 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. 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 or that have not yet been made available for issuance.

The Company does not have any equity securities in its available-for-sale portfolio, but only investments in the common stock of PCBB, TIB and the FHLB, the Company’s correspondent banks. Under the current accounting policy, the Company’s investments in these common stock are carried at cost because a readily determinable fair value does not exist for these investments. Under ASU 2016-01, investment in FHLB is specifically excluded from the requirement that equity

 

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securities are to be measured at fair value with unrealized holding gains and losses reflected in net income. Furthermore, the ASU allows entities to make an irrevocable practicality exception whereby entities can make an election, on a security-by-security basis, to account for equity securities that do not have readily determinable fair value at cost, with adjustments to fair value when an observable price change occurs or impairment is identified. As such, the Company intends to continue to measure its investments in Pacific Coast Banker’s Bank (“PCBB”), Texas Independent Bank (“TIB”) and Federal Home Loan Bank (“FHLB”) common stock at cost upon adoption on January 1, 2018. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements when adopted.

In February 2016, the FASB issued ASU 2016-02, Leases. 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. Furthermore, 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. 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.

As of March 31, 2017, the Company has 10 operating leases for 10 locations under contract with a term greater than 12 months with future lease payments totaling $11 million. At adoption date, January 1, 2019, the Company will recognize a lease liability for the present value of future lease commitments and a right of use asset. The recognized right of use asset relating to operating leases will consist of the present value of future lease commitments, unamortized initial direct costs, prepaid rent, and the related unamortized balance of lease incentives. The discount rate used to present value future lease payments will be the Company’s incremental borrowing rate at the time of adoption. The Company will take a modified retrospective transition approach with application in all comparative periods presented. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements when adopted.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which introduces new guidance for the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. Current expected credit losses (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes loans, held-to-maturity debt securities, loan commitments, financial guarantees, and net investments in leases, as well as reinsurance and trade receivables. Upon initial recognition of the exposure, the CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. Financial instruments with similar risk characteristics should be grouped together when estimating ECL. ASU 2016-13 is effective for public entities for interim and annual periods beginning after December 15, 2019. Early application of the guidance will be permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Upon adoption, the Company expects the level of ECL will likely be higher, however, the Company is still in the early stages of developing an implementation plan and evaluating the magnitude of the increase and the impact of this ASU on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force), which addresses eight classification issues related to the statement of cash flows:

 

    Debt prepayment of debt extinguishment costs

 

    Settlement of zero-coupon bonds

 

    Contingent consideration payments made after a business combination

 

    Proceeds from the settlement of insurance claims

 

    Proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies

 

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    Distributions received from equity method investees

 

    Beneficial interests in securitization transactions

 

    Separately identifiable cash flows and application of the predominance principle

ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. 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 November 2016, the FASB issued ASU 2016-18, Statement of Cash flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force). The new standard requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Entities will also be required to reconcile such total to amounts on the balance sheet and disclose the nature of the restrictions. ASU 2016-18 is effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. 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 January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of Business, which provides guidance on evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The new standard clarifies that when substantially all of the fair value of gross assets acquired is concentrated in a single asset, or a group of similar assets, the asset acquired would not represent a business. The new ASU introduces this initial required screen, if met, eliminates the need for further assessment. For public business entities with a calendar year end, the standard is effective in 2018. 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 January 2017, the FASB issued ASU 2017-04, Intangibles–Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairment. ASU 2017-04 eliminates step two from the goodwill impairment test, which measures the amount of impairment loss, if any. Instead, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to said reporting unit. For public business entities with a calendar year end, the standard is effective for annual and any interim impairment tests for periods beginning after December 15, 2019. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables–Nonrefundable Fees and Other Costs (Topic 310): Premium Amortization on Purchased Callable Debt Securities, which shortens the period of amortization of the premium on certain callable debt securities to the earliest call date. ASU 2017-08 applies to securities that have explicit, non-contingent call features that are callable at fixed prices and on preset dates. Securities purchased at a discount and mortgage-backed securities in which early repayment is based on prepayment of the underlying assets of the security are outside the scope of ASU 2017-08. For public business entities, the standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period, and applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

 

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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):

 

     March 31,
2017
     December 31,
2016
 

Total Shareholders’ Equity

   $ 346,448      $ 338,185  

Less: Preferred stock

     16,887        16,955  

Less: Goodwill

     64,603        64,603  

Less: Core deposit and leasehold right intangibles, net

     5,970        6,300  
  

 

 

    

 

 

 

Tangible common equity

   $ 258,988      $ 250,327  
  

 

 

    

 

 

 

Common shares issued and outstanding

     17,834,183        17,759,006  

Book value per common share

   $ 18.48      $ 18.09  
  

 

 

    

 

 

 

Tangible book value per common share

   $ 14.52      $ 14.10  
  

 

 

    

 

 

 

Note 4 - Computation of Earnings per Common Share

In calculating potential common shares used to determine diluted earnings per share, U.S. GAAP requires that assumed proceeds under the treasury stock method to exclude the amount of excess tax benefits that would have been recognized in additional paid-in capital.

Basic and diluted earnings per common share were determined by dividing 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):

 

     Three Months Ended
March 31,
 
     2017      2016  

Net Income

   $ 7,783      $ 6,584  

Less: Preferred stock dividends and discount accretion

     301        303  
  

 

 

    

 

 

 

Net Income available to common shareholders

   $ 7,482      $ 6,281  
  

 

 

    

 

 

 

Weighted average basic common shares outstanding

     17,532,104        17,041,427  

Dilutive effect of potential common share issuances from stock options and restricted stock

     224,351        375,733  
  

 

 

    

 

 

 

Weighted average diluted common shares outstanding

     17,756,455        17,417,160  
  

 

 

    

 

 

 

Income per common share

     

Basic

   $ 0.43      $ 0.37  

Diluted

   $ 0.42      $ 0.36  

Anti-dilutive shares not included in the calculation of diluted earnings per share

     4,150        3,000  

 

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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         

March 31, 2017

   Amortized
Cost
     Gains      Losses      Fair Market
Value
 

Available-for-sale investment securities:

        

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

   $ 10,000      $ —        $ 44      $ 9,956  

U.S. Govt Agency - SBA Securities

     121,855        146        687        121,314  

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

     21,122        56        283        20,895  

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

     250,344        75        3,902        246,517  

Asset Backed Securities

     6,913        4        142        6,775  

U.S. Treasury Notes

     64,089        —          147        63,942  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

     474,323        281        5,205        469,399  

Held-to-maturity investment securities:

        

Municipal Securities

     40,945        229        15        41,159  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     40,945        229        15        41,159  
              0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 515,268      $ 510      $ 5,220      $ 510,558  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

            Gross Unrealized         

December 31, 2016

   Amortized
Cost
     Gains      Losses      Fair Market
Value
 

Available-for-sale investment securities:

        

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

   $ 10,000      $ —        $ 31      $ 9,969  

U.S. Govt Agency - SBA Securities

     123,224        365        739        122,850  

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

     22,565        70        265        22,370  

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

     243,159        92        4,351        238,900  

Asset Backed Securities

     7,111        —          215        6,896  

U.S. Treasury Notes

     69,101        7        143        68,965  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

     475,160        534        5,744        469,950  

Held-to-maturity investment securities:

        

Municipal Securities

     42,027        69        159        41,937  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     42,027        69        159        41,937  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 517,187      $ 603      $ 5,903      $ 511,887  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company’s investment securities portfolio at March 31, 2017 consists of A-rated or above investment-grade securities. At March 31, 2017 and December 31, 2016, securities with a market value of $219 million and $205 million, respectively, were pledged 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 8 – 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  

March 31, 2017

   Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
 

Available-for-sale investment securities:

                 

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

   $ 9,956      $ 44      $ —          $ —        $ 9,956      $ 44  

U.S. Govt. Agency SBA Securities

     58,673        422        37,546        265        96,219        687  

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

     9,191        108        7,725        175        16,916        283  

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

     217,719        3,821        7,689        81        225,408        3,902  

Asset Backed Securities

     —          —          4,782        142        4,782        142  

U.S Treasury Notes

     63,943        147        —          —          63,943        147  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 359,482      $ 4,542      $ 57,742      $ 663      $ 417,224      $ 5,205  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity investment securities:

                 

Municipal Securities

   $ 7,162      $ 14      $ 307      $ 1      $ 7,469      $ 15  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

   $ 7,162      $ 14      $ 307      $ 1      $ 7,469      $ 15  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     < 12 Continuous
Months
     > 12 Continuous
Months
     Total  

December 31, 2016

   Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
 

Available-for-sale investment securities:

                 

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

   $ 9,969      $ 31      $ —        $ —        $ 9,969      $ 31  

U.S. Govt Agency – SBA Securities

     54,302      $ 451        39,322        288        93,624        739  

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

     6,652        98        8,264        167        14,916        265  

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

     215,138        4,172        10,879        179        226,017        4,351  

Asset Backed Securities

     —          —          6,896        215        6,896        215  

U.S. Treasury Notes

     51,972        143        —          —          51,972        143  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 338,033      $ 4,895      $ 65,361      $ 849      $ 403,394      $ 5,744  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity investment securities:

                 

Municipal Securities

   $ 28,673      $ 158      $ 310      $ 1      $ 28,983      $ 159  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

   $ 28,673      $ 158      $ 310      $ 1      $ 28,983      $ 159  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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-temporarily impaired at March 31, 2017 or December 31, 2016, and did not recognize any impairment charges in the consolidated statements of income.

 

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The amortized cost, fair value and the weighted average yield of debt securities at March 31, 2017, 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

 

    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.

 

     March 31, 2017  

Maturities Schedule of Securities (Dollars in thousands)

   Amortized
Cost
     Fair
Value
     Weighted
Average
Yield
 

Available-for-sale investment securities:

        

Due through one year

   $ 51,271      $ 51,239        0.87

Due after one year through five years

     37,098        36,794        1.02

Due after five years through ten years

     64,322        63,545        1.79

Due after ten years

     321,632        317,821        2.02
  

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 474,323      $ 469,399        1.78

Held-to-maturity investment securities:

        

Due through one year

   $ 2,148      $ 2,149        1.08

Due after one year through five years

     35,402        35,600        1.63

Due after five years through ten years

     1,924        1,921        1.88

Due after ten years

     1,471        1,489        3.36
  

 

 

    

 

 

    

 

 

 

Total held-to-maturity

   $ 40,945      $ 41,159        1.68
  

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 515,269      $ 510,558        1.77
  

 

 

    

 

 

    

 

 

 

The weighted average yields in the above table are based on effective rates of book balances at the end of the period.

Investment in Federal Home Loan Bank (FHLB) Common Stock

The Company’s investment in the common stock of the FHLB of San Francisco is carried at cost and was $9.1 million at March 31, 2017 and $9.1 million at December 31, 2016. The investment in FHLB stock is included in accrued interest receivable and other assets in the consolidated balance sheets and is periodically evaluated for impairment. Based on the capital adequacy of the FHLB and its overall financial condition, no impairment losses have been recorded.

See Note 8 - Borrowings and Subordinated Debentures for a detailed discussion regarding the Company’s borrowings and the related requirements to hold FHLB common stock.

 

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Note 6 - Loans

The following table presents the composition of the Company’s loan portfolio as of the dates indicated (dollars in thousands):

 

     March 31, 2017  
     Principal      Net Unaccreted
Discounts,

Net Deferred
Fees
     Total  

Commercial and Industrial Loans:

   $ 486,646      $ (2,366    $ 484,280  

Loans Secured by Real Estate:

        

Owner-Occupied Nonresidential Properties

     439,730        (3,461      436,269  

Other Nonresidential Properties

     694,637        (5,622      689,015  

Construction, Land Development and Other Land

     193,613        (1,041      192,572  

1-4 Family Residential Properties

     119,853        (1,585      118,268  

Multifamily Residential Properties

     95,854        (371      95,483  
  

 

 

    

 

 

    

 

 

 

Total Loans Secured by Real Estate

     1,543,687        (12,080      1,531,607  
  

 

 

    

 

 

    

 

 

 

Other Loans:

     30,451        (200      30,251  
  

 

 

    

 

 

    

 

 

 

Total Loans

   $ 2,060,784      $ (14,646    $ 2,046,138  
  

 

 

    

 

 

    

 

 

 

 

     December 31, 2016  
     Principal      Net Unaccreted
Discounts,

Net Deferred
Fees
     Total  

Commercial and Industrial Loans:

   $ 505,374      $ (2,737    $ 502,637  

Loans Secured by Real Estate:

        

Owner-Occupied Nonresidential Properties

     455,120        (3,798      451,322  

Other Nonresidential Properties

     635,856        (5,693      630,163  

Construction, Land Development and Other Land

     195,215        (1,156      194,059  

1-4 Family Residential Properties

     129,261        (2,097      127,164  

Multifamily Residential Properties

     110,336        (478      109,858  
  

 

 

    

 

 

    

 

 

 

Total Loans Secured by Real Estate

     1,525,788        (13,222      1,512,566  
  

 

 

    

 

 

    

 

 

 

Other Loans:

     35,246        (223      35,023  
  

 

 

    

 

 

    

 

 

 

Total Loans

   $ 2,066,408      $ (16,182    $ 2,050,226  
  

 

 

    

 

 

    

 

 

 

Small Business Administration Loans

Included in the loan portfolio is $29 million in loans that were originated under the guidelines of the Small Business Administration (“SBA”) program of which $5 million is guaranteed. The total portfolio of the SBA contractual loan balances serviced by the Company at March 31, 2017 was $102 million, of which $73 million has been sold.

At March 31, 2017, there were no loans classified as held for sale. At March 31, 2017, the balance of SBA 7a loans originated during the quarter is $421 thousand, of which $316 thousand 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.

 

Page 17 of 72


Table of Contents

Allowance for Loan Loss

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

 

     Three Months Ended
March 31,
 
     2017     2016  

Allowance for loan loss at beginning of period

   $ 19,374     $ 15,682  

Provision for loan losses

     —         622  

Net (charge-offs) recoveries:

    

Charge-offs

     —         —    

Recoveries

     231       241  
  

 

 

   

 

 

 

Net (charge-offs) recoveries

     231       241  
  

 

 

   

 

 

 

Allowance for loan loss at end of period

   $ 19,605     $ 16,545  
  

 

 

   

 

 

 

Net (charge-offs) recoveries to average loans

     0.01     0.01

 

     March 31,
2017
    December 31,
2016
 

Allowance for loan loss to total loans

     0.96     0.94

The following tables present, by portfolio segment, the changes in the allowance for loan loss and the recorded investment in loans as of the dates and for the periods indicated (dollars in thousands):

 

     Commercial
and
Industrial
    Construction,
Land
Development
and
Other Land
     Commercial
and
Other
Real Estate
     Other     Total  

Three Months Ended March 31, 2017

            

Allowance for loan loss – Beginning balance

   $ 7,130     $ 3,084      $ 8,487      $ 673     $ 19,374  

Provision for loan losses

     (497     63        739        (305     —    

Net (charge-offs) recoveries:

            

Charge-offs

     —         —          —          —         —    

Recoveries

     229       —          2        —         231  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Net (charge-offs) recoveries

     229       —          2        —         231  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 6,862     $ 3,147      $ 9,228      $ 368     $ 19,605  
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

     Commercial
and
Industrial
     Construction,
Land
Development
and
Other Land
     Commercial
and
Other
Real Estate
    Other     Total  

Three Months Ended March 31, 2016

            

Allowance for loan loss – Beginning balance

   $ 5,924      $ 2,076      $ 6,821     $ 861     $ 15,682  

Provision for loan losses

     561        635        (448     (126     622  

Net (charge-offs) recoveries:

            

Charge-offs

     —          —          —         —         —    

Recoveries

     240        —          1       —         241  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     240        —          1       —         241  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,725      $ 2,711      $ 6,374     $ 735     $ 16,545  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

Page 18 of 72


Table of Contents

The following tables present both the allowance for loan loss and the associated loan balance classified by loan portfolio segment and by credit evaluation methodology (dollars in thousands):

 

     Commercial
and

Industrial
     Construction,
Land
Development
and Other
Land
     Commercial
and
Other
Real Estate
     Other      Total  

March 31, 2017

           

Allowance for loan loss:

           

Individually evaluated for impairment

   $ —        $ —        $ —        $ —        $ —    

Collectively evaluated for impairment

     6,862        3,147        9,228        368        19,605  

Purchased credit impaired (loans acquired with deteriorated credit quality)

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Allowance for Loan Loss

   $ 6,862      $ 3,147      $ 9,228      $ 368      $ 19,605  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans receivable:

           

Individually evaluated for impairment

   $ 243      $ —        $ 239      $ —        $ 482  

Collectively evaluated for impairment

     483,758        192,572        1,337,572        30,251        2,044,153  

Purchased credit impaired (loans acquired with deteriorated credit quality)

     279        —          1,224        —          1,503  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Receivable

   $ 484,280      $ 192,572      $ 1,339,035      $ 30,251      $ 2,046,138  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Commercial
and

Industrial
     Construction,
Land
Development
and Other
Land
     Commercial
and
Other
Real Estate
     Other      Total  

December 31, 2016

           

Allowance for loan loss:

           

Individually evaluated for impairment

   $ —        $ —        $ —        $ —        $ —    

Collectively evaluated for impairment

     7,130        3,084        8,487        673        19,374  

Purchased credit impaired (loans acquired with deteriorated credit quality)

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Allowance for Loan Loss

   $ 7,130      $ 3,084      $ 8,487      $ 673      $ 19,374  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans receivable:

           

Individually evaluated for impairment

   $ 378      $ —        $ 245      $ —        $ 623  

Collectively evaluated for impairment

     501,960        194,059        1,316,849        35,023        2,047,891  

Purchased credit impaired (loans acquired with deteriorated credit quality)

     299        —          1,413        —          1,712  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Receivable

   $ 502,637      $ 194,059      $ 1,318,507      $ 35,023      $ 2,050,226  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Page 19 of 72


Table of Contents

Credit Quality of Loans

The Company utilizes an internal loan classification system as a means of reporting problem and potential problem loans. Under the Company’s loan risk rating system, loans are classified as “Pass,” with problem and potential problem loans as “Special Mention,” “Substandard,” “Doubtful” and “Loss”. Individual loan risk ratings are updated continuously or at any time the situation warrants. In addition, management regularly reviews problem loans to determine whether any loan requires a classification change, in accordance with the Company’s policy and applicable regulations. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The internal loan classification risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

 

    Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. There are several different levels of Pass rated credits, including “Watch” which is considered a transitory grade for pass rated loans that require greater monitoring. Loans not meeting the criteria of special mention, substandard, doubtful or loss that have been analyzed individually as part of the above described process are considered to be pass-rated loans.

 

    Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. Special Mention loans do not currently expose the Company to sufficient risk to warrant classification as a Substandard, Doubtful or Loss classification, but possess weaknesses that deserve management’s close attention.

 

    Substandard – loans that have a well-defined weakness based on objective evidence and can be characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

    Doubtful – loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

    Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

The following tables present the risk category of loans by class of loans based on the most recent internal loan classification as of the dates indicated (dollars in thousands):

 

     Commercial
and
Industrial
     Construction,
Land
Development
and
Other Land
     Commercial
and
Other
Real Estate
     Other      Total  

March 31, 2017

              

Pass

   $ 438,605      $ 192,572      $ 1,315,830      $ 30,124      $ 1,977,131  

Special Mention

     20,672        —          7,028        38        27,738  

Substandard

     25,003        —          16,177        89        41,269  

Doubtful

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 484,280      $ 192,572      $ 1,339,035      $ 30,251      $ 2,046,138  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Commercial
and
Industrial
     Construction,
Land
Development
and
Other Land
     Commercial
and
Other
Real Estate
     Other      Total  

December 31, 2016

              

Pass

   $ 456,885      $ 194,059      $ 1,288,154      $ 32,128      $ 1,971,226  

Special Mention

     12,774        —          7,557        —          20,331  

Substandard

     32,978        —          22,796        2,895        58,669  

Doubtful

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 502,637      $ 194,059      $ 1,318,507      $ 35,023      $ 2,050,226  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Page 20 of 72


Table of Contents

Aging Analysis of Past Due and Non-Accrual Loans

The following tables present an aging analysis of the recorded investment of past due loans and non-accrual loans as of the dates indicated (dollars in thousands):

 

     31-60
Days
Past Due
     61-90
Days
Past Due
     Greater
than

90 Days
Past Due
and
Accruing
     Total
Past Due
and
Accruing
     Total
Non
Accrual
     Current      Total Loans  

March 31, 2017

                    

Commercial and Industrial

   $ 86      $ —        $ —        $ 86      $ 521      $ 483,673      $ 484,280  

Construction, Land Development and Other Land

     —          —          —          —          —          192,572        192,572  

Commercial and Other Real Estate

     209        —          —          209        239        1,338,587        1,339,035  

Other

     —          —          —          —          —          30,251        30,251  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 295      $ 0      $ —        $ 295      $ 760      $ 2,045,083      $ 2,046,138  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     31-60
Days
Past Due
     61-90
Days
Past Due
     Greater
than

90 Days
Past Due
and
Accruing
     Total
Past Due
and
Accruing
     Total
Non
Accrual
     Current      Total Loans  

December 31, 2016

                    

Commercial and Industrial

   $ —        $ —        $ —        $ —        $ 675      $ 501,962      $ 502,637  

Construction, Land Development and Other Land

     —          —          —          —          —          194,059        194,059  

Commercial and Other Real Estate

     212        —          —          212        447        1,317,848        1,318,507  

Other

     —          —          —          —          —          35,023        35,023  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 212      $ —        $ —        $ 212      $ 1,122      $ 2,048,892      $ 2,050,226  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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.

A valuation allowance is established for an impaired loan when the fair value of the loan is less than the recorded investment. In certain cases, portions of impaired loans are charged-off to the fair value of the loan 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 March 31, 2017 and December 31, 2016.

 

Page 21 of 72


Table of Contents

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 (dollars in thousands). This table excludes purchased credit impaired loans (loans acquired in acquisitions with deteriorated credit quality) of $1.5 million and $1.7 million at March 31, 2017 and December 31, 2016, respectively.

 

     March 31, 2017      December 31, 2016  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no specific allowance recorded:

                 

Commercial and Industrial

   $ 243      $ 639      $ —        $ 378      $ 1,383      $ —    

Commercial and Other Real Estate

     239        277        —          245        282        —    

With an allowance recorded:

                 

Commercial and Industrial

     —          —          —          —          —          —    

Total

                 

Commercial and Industrial

     243        639        —          378        1,383        —    

Commercial and Other Real Estate

     239        277        —          245        282        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 482      $ 916      $ —        $ 623      $ 1,665      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended
March 31,
 
     2017      2016  
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no specific allowance recorded:

           

Commercial and Industrial

   $ 245      $ —        $ 256      $ —    

Commercial and Other Real Estate

     242        —          666        —    

With a specific allowance recorded:

           

Commercial and Industrial

     —          —          —          —    

Total:

           

Commercial and Industrial

     245        —          256        —    

Commercial and Other Real Estate

     242        —          666        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 487      $ —        $ 922      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of additional information pertaining to impaired loans for the periods indicated (dollars in thousands):

 

     Three Months Ended
March 31,
 
     2017      2016  

Interest foregone on impaired loans

   $ 13      $ 25  

Cash collections applied to reduce principal balance

   $ 21      $ 24  

Interest income recognized on cash collections

   $ —        $ —    

 

Page 22 of 72


Table of Contents

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 March 31, 2017 and March 31, 2016 (dollars in thousands). 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 March 31, 2017, there were two PCI loans that are considered to be TDR loans with a recorded investment of $92 thousand and unpaid principal balances of $258 thousand.

 

     As of and for the
Three Months Ended
March 31, 2017
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
 

Commercial and Industrial

   $ 319      $ 534      $ —    
  

 

 

    

 

 

    

 

 

 

Total

   $ 319      $ 534      $ —    
  

 

 

    

 

 

    

 

 

 

 

     As of and for the
Three Months Ended
March 31, 2016
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
 

Commercial and Industrial

   $ 393      $ 615      $ —    
  

 

 

    

 

 

    

 

 

 

Total

   $ 393      $ 615      $ —    
  

 

 

    

 

 

    

 

 

 

There were no loans restructured during the three months ended March 31, 2017 or March 31, 2016.

There have been no defaulted restructured loans during the three months ended March 31, 2017 or March 31, 2016 for loans that were restructured in the preceding 12-month periods.

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 March 31, 2017.

 

Page 23 of 72


Table of Contents

Loans Acquired Through Acquisition

The following table reflects the accretable net discount for acquired loans for the periods indicated (dollars in thousands):

 

     Three Months Ended
March 31,
 
     2017      2016  

Balance, beginning of period

   $ 9,611      $ 14,610  

Accretion, included in interest income

     (1,115      (1,133

Reclassifications to non-accretable yield

     —          (7
  

 

 

    

 

 

 

Balance, end of period

   $ 8,496      $ 13,470  
  

 

 

    

 

 

 

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.

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):

 

     March 31, 2017      December 31, 2016  
     Unpaid Principal
Balance
     Carrying
Value
     Unpaid Principal
Balance
     Carrying
Value
 

Commercial and Industrial

   $ 594      $ 279      $ 622      $ 299  

Commercial and Other Real Estate

     1,596        1,224        1,997        1,413  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,190      $ 1,503      $ 2,619      $ 1,712  
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table reflects the activities in the accretable net discount for PCI loans for the period indicated (dollars in thousands):

 

     Three Months Ended
March 31,
 
     2017      2016  

Balance, beginning of period

   $ 161      $ 246  

Accretion, included in interest income

     (23      (20

Reclassifications from non-accretable yield

     —          —    
  

 

 

    

 

 

 

Balance, end of period

   $ 138      $ 226  
  

 

 

    

 

 

 

 

Page 24 of 72


Table of Contents

Note 7 – Qualified Affordable Housing Project Investments

The Company’s investment in Qualified Affordable Housing Projects that generate Low Income Housing Tax Credits (“LIHTC”) was $6.1 million at March 31, 2017 and $6.2 million at December 31, 2016. The funding liability for the LIHTC at March 31, 2017 and December 31, 2016 was $3.4 million. The amount of tax credits and other tax benefits recognized was $560 thousand and $573 thousand for the three months ended March 31, 2017 and March 31, 2016, respectively. Further, the amount of amortization expense included in the provision for income taxes was $439 thousand and $448 thousand for the three months ended March 31, 2017 and March 31, 2016, respectively.

Note 8 - Borrowings and Subordinated Debentures

Securities Sold Under Agreements to Repurchase

The Company enters into certain transactions, the legal form of which are sales of securities under agreements to repurchase (“Repos”) at a later date at a set price. Securities sold under agreements to repurchase generally mature within 1 day to 180 days from the issue date and are routinely renewed.

As discussed in Note 5 – Investment Securities, the Company has pledged certain investments as collateral for these agreements. Securities with a fair value of $50 million and $48 million were pledged to secure the Repos at March 31, 2017 and December 31, 2016, 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):

 

     March 31, 2017  

Date Issued

   Amount      Interest Rate      Original
Term
     Maturity Date  

March 31, 2017

   $ 11,939        0.20% – 0.25%        3 days        April 3, 2017  
  

 

 

          

Total

   $ 11,939        0.24%        
  

 

 

          

 

     December 31, 2016  

Date Issued

   Amount      Interest Rate      Original
Term
     Maturity Date  

December 31, 2016

   $ 18,816        0.2% – 0.25%        4 days        January 4, 2017  
  

 

 

          

Total

   $ 18,816        0.25%        
  

 

 

          

FHLB 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 $749 million, which represents approximately 25% of the Bank’s total assets, as reported by the Bank in its December 31, 2016 Federal Financial Institution Examination Council (“FFIEC”) Call Report.

As of March 31, 2017, the Company had $1 billion of loan collateral pledged with the FHLB which provides $688 million in borrowing capacity. The Company also has $16 million in investment securities pledged with the FHLB serving as collateral for an additional $14 million in borrowing capacity. 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 March 31, 2017 or December 31, 2016.

 

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Subordinated Debentures

The following table summarizes the terms of each issuance of subordinated debentures outstanding as of the dates indicated (dollars in thousands):

 

March 31, 2017

 

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     3.18     06/15/17  

Trust II

     3,093       12/23/05        03/15/36        3 month LIBOR + 1.75     2.88     06/15/17  

Trust III

     3,093       06/30/06        09/18/36        3 month LIBOR + 1.85     2.98     06/15/17  
  

 

 

             

Subtotal

     12,372              

Unamortized fair value adjustment

     (2,476            
  

 

 

             

Net

   $ 9,896              
  

 

 

             

December 31, 2016

 

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     3.01     03/15/17  

Trust II

     3,093       12/23/05        03/15/36        3 month LIBOR + 1.75     2.71     03/15/17  

Trust III

     3,093       06/30/06        09/18/36        3 month LIBOR + 1.85     2.81     03/15/17  
  

 

 

             

Subtotal

     12,372              

Unamortized fair value adjustment

     (2,516            
  

 

 

             

Net

   $ 9,856              
  

 

 

             

The Company had an aggregate outstanding contractual balance of $12.4 million in subordinated debentures at March 31, 2017. 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 London Interbank Offered Rate (“LIBOR”) plus a margin (see tables above). All three subordinated debentures had their interest rates reset in March 2017 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.

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.

 

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Note 9 - 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 Bank

At March 31, 2017, the Company has eleven interest rate swap agreements with customers and eleven offsetting interest-rate swaps with a counterparty bank. 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.

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. The interest rate swap derivatives acquired from 1st Enterprise Bank are subject to a master netting arrangement with one counterparty bank. None of the 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 March 31, 2017 and December 31, 2016, the total notional amount of the Company’s swaps with the counterparty bank was $21 million and $24 million, respectively. The outstanding swaps have remaining maturities of up to 5 years as of March 31, 2017.

The following tables present the fair values of the asset and liability of the Company’s derivative instruments acquired from 1st Enterprise Bank as of the dates and periods indicated (dollars in thousands):

 

     Asset Derivatives  
     March 31,
2017
     December 31,
2016
 

Interest rate swap contracts fair value

   $ 421      $ 523  
  

 

 

    

 

 

 

Balance sheet location

    

Accrued Interest

Receivable and Other

Assets

 

 

 

    

Accrued Interest

Receivable and Other

Assets

 

 

 

     Liability Derivatives  
     March 31,
2017
     December 31,
2016
 

Interest rate swap contracts fair value

   $ 421      $ 523  
  

 

 

    

 

 

 

Balance sheet location

    

Accrued Interest
Payable and Other
Liabilities
 
 
 
    

Accrued Interest
Payable and Other
Liabilities
 
 
 

 

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Derivative Financial Instruments Acquired from PC Bancorp

At March 31, 2017, the Company also has fourteen pay-fixed, receive-variable, interest rate swaps with one counterparty bank that are designed to convert fixed rate loans into variable rate loans.

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  
     March 31,
2017
     December 31,
2016
 

Fair Value Hedges

     

Total interest rate contracts notional amount

   $ 17,392      $ 17,642  
  

 

 

    

 

 

 

Derivatives not designated as hedging instruments:

     

Interest rate swap contracts fair value

   $ 40      $ 95  

Derivatives designated as hedging instruments:

     

Interest rate swap contracts fair value

     467        589  
  

 

 

    

 

 

 

Total interest rate contracts fair value

   $ 507      $ 684  
  

 

 

    

 

 

 

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):

 

     Three Months Ended
March 31,
 
     2017      2016  

Derivatives not designated as hedging instruments:

     

Interest rate swap contracts – loans

     

Increase in fair value of interest rate swap contracts

   $ 55      $ 39  

Payments on interest rate swap contracts on loans

     (54      (61
  

 

 

    

 

 

 

Net increase (decrease) in other non-interest income

     1        (22
  

 

 

    

 

 

 

Derivatives designated as hedging instruments:

     

Interest rate swap contracts – loans

     

Increase in fair value of interest rate swap contracts

   $ 122      $ 23  

Increase (decrease) in fair value of hedged loans

     (12      212  

Payment on interest rate swap contracts on loans

     (114      (230
  

 

 

    

 

 

 

Net increase (decrease) in interest income on loans

   $ (4    $ 5  
  

 

 

    

 

 

 

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 March 31, 2017, the Company has pledged $1.7 million in investment securities, $2.7 million in certificates of deposit, for a total of $4.4 million, as collateral under the swap agreements.

 

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Note 10 – Balance Sheet Offsetting

Assets and liabilities relating to certain financial instruments, including derivatives, and securities sold under repurchase agreements (“Repos”), may be eligible for offset in the consolidated balance sheets as permitted under accounting guidance. The Company’s interest rate swap derivatives are subject to a master bilateral netting and offsetting arrangement under specific conditions as defined within a master agreement governing all interest rate swap contracts that the Company and the counterparty 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.

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 /
Liabilities
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
    

March 31, 2017

                 

Financial Assets:

                 

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

   $ 421      $ —        $ 421      $ 421      $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 421      $ —        $ 421      $ 421      $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities:

                 

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

   $ 928      $ —        $ 928      $ 928      $ 4,451      $ 3,523  

Securities sold under agreements to repurchase (See Note 8 – Borrowings and Subordinated Debentures)

     11,939        —          11,939        11,939        49,901        37,962  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 12,867      $ —        $ 12,867      $ 12,867      $ 54,352      $ 41,485  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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     Gross
Amounts
Recognized
in the
Consolidated
Balance
Sheets
     Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
     Net Amounts
of Assets /
Liabilities
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, 2016

                 

Financial Assets:

                 

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

   $ 523      $ —        $ 523      $ 523      $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 523      $ —        $ 523      $ 523      $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities:

                 

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

   $ 1,207      $ —        $ 1,207      $ 1,207      $ 4,555      $ 3,348  

Securities sold under agreements to repurchase (See Note 8 – Borrowings and Subordinated Debentures)

     18,816        —          18,816        18,816        48,204        29,388  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,023      $ —        $ 20,023      $ 20,023      $ 52,759      $ 32,736  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Note 11 - 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 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. 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.

At March 31, 2017 future compensation expense related to unvested restricted stock grants are reflected in the table below (dollars in thousands):

 

Future Restricted Stock Expense

      

Remainder of 2017

   $ 2,451  

2018

     1,596  

2019

     539  

2020

     171  

Thereafter

     22  
  

 

 

 

Total

   $ 4,779  
  

 

 

 

At March 31, 2017, the weighted-average period over which the total compensation cost related to unvested restricted stock grants not yet recognized is 2.75 years.

 

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Stock Options

The following table summarizes the share option activity under the plans as of the date and for the period indicated:

 

     Shares      Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term

(in years)
     Aggregate
Intrinsic
Value

(in thousands)
 

Outstanding stock options at December 31, 2016

     47,697      $ 12.69        1.43      $ 1,102  

Granted

     —             

Exercised

     (27,942         

Forfeited

     —             

Expired

     —             
  

 

 

          

Outstanding stock options at March 31, 2017

     19,755      $ 8.67        2.13      $ 612  
  

 

 

          

Exercisable options at March 31, 2017

     19,755      $ 8.67        2.13      $ 612  

Unvested options at March 31, 2017

     —             

The total intrinsic value of options exercised during the three months ended March 31, 2017 and 2016 was $642 thousand and $2.9 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 period indicated:

 

     Number of Shares      Weighted-Average
Grant-Date Fair Value
per Share
 

Restricted Stock:

     

Unvested at December 31, 2016

     282,082      $ 21.98  

Granted

     65,615        38.04  

Vested

     (30,582      20.87  

Forfeited

     (5,084      21.59  
  

 

 

    

Unvested at March 31, 2017

     312,031      $ 25.79  
  

 

 

    

Restricted stock compensation expense was $773 thousand and $834 thousand for the three month period ended March 31, 2017 and 2016, 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. In 2015, the Company granted 40 thousand 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 thousand shares of RSU will not be issued until the RSUs vest and meet certain conditions as stipulated in the RSU agreement and are not included in the Company’s shares issued and outstanding as of March 31, 2017. 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.

 

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Note 12 – 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.

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 2017, the Company issued 27,942 shares of stock from the exercise of stock options for a total value of $435 thousand. The Company also issued 65,615 shares of restricted stock to the Company’s directors and employees, 5,084 shares of unvested restricted stock were forfeited related to employee turnover and 13,296 shares that had a value of $524 thousand were repurchased when employees elected to pay their tax obligation via the repurchase of the stock by the Company. 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.

Preferred Stock

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 preferred 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 accretion on the net discount as of March 31, 2017 is $1.0 million. The net carrying value of the CU Bancorp Preferred Stock is $17 million ($16 million plus of $0.5 million net premium) as of March 31, 2017.

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 was adjusted to 9% on March 1, 2016 through perpetuity. 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 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.

 

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Accumulated Other Comprehensive Income (Loss)

The following table presents the changes in accumulated other comprehensive loss by component for the periods indicated (dollars in thousands):

 

     Three Months Ended March 31,    

Consolidated

Statement of

Income Line Item

for Reclassified

Items

     2017     2016    

Beginning balance, net of tax

   $ (3,019   $ (816  

Net unrealized gain arising during the period

     426       1,328    

Related tax effect

     (179     (559  

Reclassification of gain on investment securities available-for-sale to net income

     (141     —       Gain on sale of securities, net

Related tax effect

     59       —      

Provision for

income tax expense

  

 

 

   

 

 

   

Other Comprehensive Income

     165       769    
  

 

 

   

 

 

   

Ending balance

   $ (2,854   $ (47  
  

 

 

   

 

 

   

Note 13 - Commitments and Contingencies

Litigation

From time to time the Company is a party to claims and legal proceedings arising in the ordinary course of business. The Company accrues for any probable loss contingencies that are estimable and discloses any material losses. As of March 31, 2017, 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

Financial instruments with off balance sheet risk include commitments to extend credit of $986 million and $1 billion at March 31, 2017 and December 31, 2016, respectively. Included in the aforementioned commitments were standby letters of credit outstanding of $85 million at March 31, 2017 and December 31, 2016. The Company also has a reserve for estimated losses on unfunded loan commitments of $886 thousand at March 31, 2017 and December 31, 2016. These balances are included in other liabilities on the consolidated balance sheets.

Note 14 - Fair Value Information

Fair Value Hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The 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

 

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quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, either directly or indirectly. This would include those financial instruments that are valued using models or other valuation methodologies where substantially all of the assumptions are observable in the marketplace, can be derived from observable market data or are supported by observable levels at which transactions are executed in the marketplace.

 

    Level 3 – Significant unobservable inputs that reflect a reporting entity’s 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.

Securities available-for-sale and interest rate swaps are recorded at fair value on a recurring basis. Additionally, certain assets 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, such as other real estate owned, SBA servicing asset and impaired loans that are collateral dependent.

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 March 31, 2017. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

Recurring Fair Value Measurements

The valuation methodologies for estimating the fair value of financial assets and financial liabilities measured and reported at fair value on a recurring basis are discussed below.

Investment Securities Available-for-Sale: The fair value of investment securities available-for-sale are primarily based on price indications provided by nationally recognized, independent pricing sources utilized by the Company’s bond accounting system provider. The fair value of investment securities may be determined by obtaining quoted prices for identical assets in active markets at measurement date (Level 1 financial assets). The Company’s investments in U.S. Treasury Notes are Level 1 financial assets. For the Company’s investments in U.S. Agency and U.S. Sponsored Agency issued debt securities (callable and non-callable notes), mortgage backed securities guaranteed by those agencies, collateralized mortgage obligations issued by those agencies and corporate bond securities, the fair value may be determined by obtaining quoted market prices for similar assets in active markets at measurement date (Level 2 financial assets), or if quoted market prices are not available, the pricing sources may determine fair value by matrix pricing. Matrix pricing 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). The pricing sources may also determine the fair value of certain debt securities by using an option adjusted spread model with observable inputs such as the treasury yield curve and other interest rate assumptions. Other observable inputs utilized in these alternative valuation techniques or models when quoted prices are not available include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are classified as Level 3 financial assets.

Interest Rate Swap Contracts: The fair value of the interest rate swap contracts are provided by independent third party vendors that specialize 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

 

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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.

The following table presents 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 – March 31, 2017

           

Investment securities available-for-sale:

           

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

   $ 9,956      $ —        $ 9,956        —    

U.S. Govt Agency – SBA Securities

     121,314        —          121,314        —    

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

     20,895        —          20,895        —    

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

     246,517        —          246,517        —    

Asset Backed Securities

     6,775        —          6,775        —    

U.S. Treasury Notes

     63,942        63,942        —          —    

Interest Rate Swap Contracts

     421        —          421        —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 469,820      $ 63,942      $ 405,878      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities – March 31, 2017

           

Interest Rate Swap Contracts

   $ 928      $ —        $ 928      $ —    

Financial Assets – December 31, 2016

           

Investment securities available-for-sale:

           

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

   $ 9,969      $ —        $ 9,969        —    

U.S. Govt Agency – SBA Securities

     122,850        —          122,850        —    

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

     22,370        —          22,370        —    

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

     238,900        —          238,900        —    

Asset Backed Securities

     6,896        —          6,896        —    

U.S. Treasury Notes

     68,965        68,965        —          —    

Interest Rate Swap Contracts

     523        —          523        —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 470,473      $ 68,965      $ 401,508      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities – December 31, 2016

           

Interest Rate Swap Contracts

   $ 1,207      $ —        $ 1,207      $ —    

At March 31, 2017 and December 31, 2016, 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). Furthermore, 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 March 31, 2017 or December 31, 2016.

 

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Nonrecurring Fair Value Measurements

The valuation methodologies for estimating the fair value of certain assets measured and reported at fair value on a nonrecurring basis are discussed below.

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 SBA servicing asset is amortized over the estimated life of the loans based on an effective yield approach. In addition, the Company’s servicing asset is evaluated regularly for impairment by discounting the estimated future cash flows using market-based discount rates and prepayment speeds. 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 determined based on the historical prepayments of the Company’s SBA loans. The prepayment speeds determine the timing of the cash flows. If the calculated present value of the servicing asset declines below the Company’s current carrying value, the servicing asset is written down to its present value. Based on the Company’s methodology in its valuation of the SBA servicing asset, the current carrying value is estimated to approximate the fair value. The inputs utilized in determining the fair value of SBA servicing asset are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Impaired Loans: The fair value of impaired loans is determined based on an evaluation at the time the loan is originally identified as impaired, and periodically thereafter, at the lower of cost or fair value. Fair value on impaired loans is measured based on the value of the collateral securing these loans, less costs to sell, if the loan is collateral dependent, or based on the discounted cash flows for non-collateral dependent loans. Collateral on collateral dependent loans may be real estate and/or business assets including equipment, inventory and/or accounts receivable and is determined based on appraisals performed by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and unobservable. For unsecured loans, the estimated future discounted cash flows of the business or borrower, are used in evaluating the fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The inputs utilized in determining the fair value of impaired loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

 

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The following table presents the balances of assets measured at fair value on a non-recurring basis 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 – March 31, 2017

           

SBA Servicing Asset

   $ 876      $ —        $ —        $ 876  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 876      $ —        $ —        $ 876  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     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, 2016

           

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs (non-purchased credit impaired loans)

   $ 73      $ —        $ —        $ 73  

SBA Servicing Asset

     940        —          —          940  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,013      $ —        $ —        $ 1,013  
  

 

 

    

 

 

    

 

 

    

 

 

 

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 periods ended March 31, 2017 or December 31, 2016.

The following table presents the significant unobservable inputs used in the fair value measurements for Level 3 assets measured at fair value on a non-recurring basis as of the dates indicated (dollars in thousands):

 

     Fair
Value
    

Valuation

Methodology

  

Unobservable

Valuation Inputs

  

Unobservable
Valuation

Input Values

Financial Assets – March 31, 2017

           
         Discount Rates    13%

SBA Servicing Asset

   $ 876      Discounted Cash Flow   

Estimated Average

Remaining Life of

SBA Portfolio

   39 months
  

 

 

          

Total

   $ 876           
  

 

 

          
     Fair
Value
    

Valuation

Methodology

  

Unobservable

Valuation Inputs

  

Unobservable
Valuation

Input Values

Financial Assets – December 31, 2016

           

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off

   $ 73     

Credit loss estimate

of aged accounts

receivable collateral

  

Credit loss factors on

aging of accounts

receivable collateral

   20%
         Discount Rates    13%

SBA Servicing Asset

     940      Discounted Cash Flow   

Estimated Average

Remaining Life of

SBA Portfolio

   39 months
  

 

 

          

Total

   $ 1,013           
  

 

 

          

 

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Fair Value of Financial Instruments

The following are the valuation methodologies utilized for estimating the fair value of certain financial instruments presented in the tables below.

Cash and due from banks: The carrying amount is assumed to be the fair value because of the liquidity of these instruments.

Interest earning deposits in other financial institutions: The carrying amount is assumed to be the fair value given the short-term nature of these deposits.

Investment Securities Held-to-Maturity: The fair value of investment securities held-to-maturity are based on price indications provided by nationally recognized, independent pricing sources utilized by the Company’s bond accounting system provider. The Company’s held-to-maturity portfolio consists of municipal securities only. The fair value of the municipal securities are calculated using proprietary pricing models or matrices with inputs such as market information (MSRB reported trade data, bids, offers, new issue data) and benchmark curves (Treasury, Swap, Libor and AAA municipal yield curve). These inputs are observable and as such, municipal securities are classified within the Level 2 fair value hierarchy.

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.

Bank owned life insurance: The carrying amount of bank owned life insurance represents the total cash surrender value of each policy, which approximates fair value.

FHLB Stock: FHLB stock has no trading market, and is required as part of membership and is redeemable at par. FHLB is recorded at cost, which approximates fair value.

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 March 31, 2017, to the cash flows from the debentures, based on the actual interest rate the debentures were accruing at March 31, 2017. Because all three of the debentures re-priced on March 15, 2017 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 March 31, 2017, 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.

 

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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 March 31, 2017 and December 31, 2016.

The table below presents the carrying amounts and fair values of certain financial instruments based on their fair value hierarchy indicated (dollars in thousands):

 

                   Fair Value Measurements  
     Carrying
Amount
     Estimated Fair
Value
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

March 31, 2017

              

Financial Assets

              

Cash and due from banks

   $ 51,168      $ 51,168      $ 51,168      $ —        $ —    

Interest earning deposits in other financial institutions

     313,609        313,609        313,609        —          —    

Investment securities held-to-maturity

     40,945        41,159        —          41,159        —    

Loans, net

     2,026,533        2,044,209        —          —          2,044,209  

Bank owned life insurance

     63,595        63,595        —          —          63,595  

FHLB Stock

     9,182        9,182        —          —          9,182  

Financial Liabilities

              

Certificates of deposit

     30,623        30,625        —          30,625        —    

Securities sold under agreements to repurchase

     11,939        11,939        —          11,939        —    

Subordinated debentures

     9,896        12,372        —          12,372        —    

December 31, 2016

              

Financial Assets

              

Cash and due from banks

   $ 41,281      $ 41,281      $ 41,281      $ —        $ —    

Interest earning deposits in other financial institutions

     167,789        167,789        167,789        —          —    

Investment securities held-to-maturity

     42,027        41,937        —          41,937        —    

Loans, net

     2,030,852        2,054,701        —          —          2,054,701  

Bank owned life insurance

     51,216        51,216        —          —          51,216  

FHLB Stock

     9,182        9,182        —          —          9,182  

Financial Liabilities

              

Certificates of deposit

     29,480        29,480        —          29,480        —    

Securities sold under agreements to repurchase

     18,816        18,816        —          18,816        —    

Subordinated debentures

     9,856        12,372        —          12,372        —    

Note 15 - Subsequent Events

On April 5, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with PacWest Bancorp (“PacWest”), wherein CU Bancorp will merge with and into PacWest (the “Merger”), with PacWest surviving the Merger. Immediately following the Merger, CU Bancorp’s wholly-owned bank subsidiary, California United Bank, will merge with and into PacWest’s wholly-owned bank subsidiary, Pacific Western Bank (the “Bank Merger”). Pacific Western Bank will be the surviving bank in the Bank Merger. The Merger Agreement was approved and adopted by the Board of Directors of each of CU Bancorp and PacWest.

Management of the Company has evaluated events that have occurred subsequent to March 31, 2017 and have concluded there are no subsequent events that would require recognition in the accompanying consolidated financial statements.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

See “Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” below relating to “forward-looking” statements included in this report.

The following is management’s discussion and analysis of the major factors that influenced the results of the operations and financial condition of CU Bancorp, (“the Company”) for the current period. This analysis should be read in conjunction with the audited financial statements and accompanying notes included in the Company’s 2016 Annual Report on Form 10-K and with the unaudited financial statements and notes as set forth in this report.

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

In addition to the historical information, this Quarterly Report on Form 10-Q (this “Report”) includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Those sections of the Securities Act and the Exchange 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 management’s plans or objectives for future operations, products or services, and forecasts of the Company’s revenues, earnings or other measures of economic performance. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this report was prepared and 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,” “approximate,” “anticipate,” “project,” “assume,” “plan,” “predict,” “likely,” or variations of these words as well as 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, the pending merger between the Company and PacWest Bancorp, dividends, adequacy of our allowance for loan loss and provision for loan loss, our loan portfolio and subsequent charge-offs. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the SEC, Item 1A of our Annual Report on Form 10-K, and the following:

 

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

 

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

 

    Possible losses of businesses and population in the 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.

 

    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, including but not limited to concentration in real estate related loans and concentrations in deposits.

 

    Loss of significant customers.

 

    A continued low interest rate environment or 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.

 

    Changes in legal or regulatory requirements.

 

    The inability of our risk management controls to prevent or detect all errors or fraudulent acts.

 

    Inability of our framework to manage risks associated with our business, including but not limited to operational risk, regulatory risk, cyber risk, liquidity risk, customer 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”, account takeover, ransomware and identity theft.

 

    The effects of man-made and natural disasters, including, but not limited to earthquakes, floods, droughts, brush fires, tornadoes and hurricanes.

 

    Our ability to recruit and retain key management and staff.

 

    The ability to complete the proposed merger between the Company and PacWest Bancorp, including obtaining regulatory approvals and approval by the shareholders of the Company, or any future transaction, successfully integrating such acquired entities, or achieving expected beneficial synergies and/or operating efficiencies, in each case within expected time-frames or at all.

 

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

 

    Changes in PacWest Bancorp’s stock price before completion of the merger, including as a result of the financial performance of PacWest Bancorp before closing.

 

    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 federal and state laws and regulations on the Company’s business operations and competitiveness.

 

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

 

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

For a more detailed discussion of some of these risks and uncertainties, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 and particularly, Item 1A, titled “Risk Factors.”

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 and specifically disclaims any obligation to revise or update such forward looking statements for any reason, except as may be required by applicable law. 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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OVERVIEW

CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company”, as used throughout this document, refers to the consolidated 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 in Los Angeles, Orange, Ventura, San Bernardino and Riverside counties, to non-profit organizations, to business principals and entrepreneurs, and to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors. The Bank opened for business in 2005, with its current 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, (the “DBO”) and the Federal Deposit Insurance Corporation (“FDIC”). The deposits of the Bank are insured by the FDIC, to the maximum amount allowed by law.

Total assets increased $149 million or 5% from December 31, 2016 to $3.1 billion mainly due to deposit growth of $147 million and net income of $7.8 million. During the three months ended March 31, 2017, the Company had $33 million of net organic loan production. Pay downs in the acquired loan portfolios were approximately $37 million during the same quarter. Loans secured by real estate grew $19 million in the first quarter of 2017, compared to the prior quarter, with all of the growth coming in other nonresidential properties. At March 31, 2017, commercial and industrial loans, and owner-occupied real estate loans combined were $921 million or 45% of total loans, compared to $954 million or 47% of total loans at December 31, 2016.

Funding the Company’s asset growth for the three months ended March 31, 2017 were increases in non-interest bearing demand deposits of $86 million, interest bearing transaction accounts of $14 million, and money market and savings deposits of $47 million. At both March 31, 2017 and December 31, 2016, non-interest bearing deposits represented 54% of total deposits. Tangible book value per common share was $14.52, $14.10 and $13.05 at March 31, 2017, December 31, 2016 and March 31, 2016, respectively.

Recent Development

On April 5, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with PacWest Bancorp (“PacWest”), wherein CU Bancorp will merge with and into PacWest (the “Merger”), with PacWest surviving the Merger. Immediately following the Merger, CU Bancorp’s wholly-owned bank subsidiary, California United Bank, will merge with and into PacWest’s wholly-owned bank subsidiary, Pacific Western Bank (the “Bank Merger”). Pacific Western Bank will be the surviving bank in the Bank Merger. The Merger Agreement was approved and adopted by the Board of Directors of each of CU Bancorp and PacWest. Under terms of the agreement, CU Bancorp shareholders will receive 0.5308 shares of PacWest common stock and $12.00 in cash for each share of CU Bancorp.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these consolidated 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.

 

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Our critical accounting policies are described in greater detail in our 2016 Annual Report on Form 10-K, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessment, are as follows:

Business Combinations

The Company has a number of fair value adjustments recorded within the consolidated financial statements that at March 31, 2017 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 include fair value adjustments on loans, core deposit intangible assets, other intangible assets, fair value adjustments to acquired lease obligations, 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 2016 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 5 years at March 31, 2017. 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 and a credit component 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 March 31, 2017 is adequate to absorb known and probable losses inherent in the loan portfolio.

 

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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 recorded investment 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, a specific allowance is not assessed.

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 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.

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

 

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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.

Derivative Financial Instruments and Hedging Activities

All derivative instruments (interest rate swap contracts) are recognized on the consolidated balance sheet at their current fair value. Every derivative instrument (including certain derivative instruments embedded in other contracts) is required to 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 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

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 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

 

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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.

 

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RESULTS OF OPERATIONS

Key Performance Measures

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

 

     Three Months Ended March 31,  
     Amounts     Increase
(Decrease)
 
     2017     2016     $     %  

Net Income Available to Common Shareholders

   $ 7,482     $ 6,281     $ 1,201       19.12
  

 

 

   

 

 

     

Earnings per share

        

Basic

   $ 0.43     $ 0.37     $ 0.06       16.22

Diluted

   $ 0.42     $ 0.36     $ 0.06       16.67

Return on average assets (1)

     0.97     0.93     0.04     4.30

Return on average tangible common equity (2)

     11.87     11.29     0.58     5.14

Net interest margin (3)

     3.67     3.77     (0.10 )%      (2.65 )% 

Efficiency ratio (4)

     57.79     57.75     0.04     0.07

 

(1) Return on average assets is calculated by dividing 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 average tangible common equity for the period. See the tables for return on average tangible common equity calculation and reconciliation to average common equity.
(3) Net interest margin represents net interest income as a percent of interest earning assets.
(4) Efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net.

Non-GAAP Financial Measure - Average Tangible Common Equity (TCE) Calculation and Reconciliation to Total Average Shareholders’ Equity

The Company utilizes the term TCE, a non-GAAP financial measure. The Company’s management believes TCE is useful because it is a measure utilized by both regulators and market analysts in evaluating the 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 annualized net income available to common shareholders as a percent of average tangible common equity. A calculation of the Company’s Return on Average Tangible Common Equity is provided in the table below for the periods indicated (dollars in thousands):

 

     Three Months Ended
March 31,
 
     2017     2016  

Average Tangible Common Equity Calculation

    

Total average shareholders’ equity

   $ 343,217     $ 313,014  

Less: Average serial preferred stock

     16,930       17,088  

Less: Average goodwill

     64,603       64,603  

Less: Average core deposit and leasehold right intangibles

     6,132       7,515  
  

 

 

   

 

 

 

Average Tangible Common Equity

   $ 255,552     $ 223,808  
  

 

 

   

 

 

 

Annualized Net Income Available to Common Shareholders

   $ 30,344     $ 25,262  

Return on Average Tangible Common Equity

     11.87     11.29

 

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Operations Performance Summary

Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2016

Net income available to common shareholders for the three months ended March 31, 2017 was $7.5 million, or $0.42 per diluted share, compared to $6.3 million, or $0.36 per diluted share for the three months ended March 31, 2016. Net income increased 18% over prior year and earnings per share increased 17% over prior year. The $1.2 million increase, or 19%, was primarily due to a $3.3 million increase in net interest income after provision for loan losses, offset by a $1.5 million increase in non-interest expense and a $645 thousand increase in provision for income tax expense. The increase in net interest income after provision for loan losses was mainly driven by strong organic loan growth. The increase in income tax expense is directionally consistent with the increase in profitability while the effective tax rates are comparable for both periods. Non-interest income had a modest increase of $15 thousand or 0.5% and non-interest expense had an increase of $1.5 million, or 9.9%. Salaries and other benefits expense increased $969 thousand, or 10.4%, as the Company’s active full-time equivalent employees grew to 294 at March 31, 2017, an increase of 21 from March 31, 2016.

 

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Average Balances, Interest Income and Expense, Yields and Rates

Three Months Ended March 31, 2017 and 2016

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

 

     Three Months Ended  
     March 31, 2017     March 31, 2016  
     Average
Balance
     Interest      Average
Yield/Rate (5)
    Average
Balance
     Interest      Average
Yield/Rate (5)
 

Interest Earning Assets:

                

Loans (1)

   $ 2,043,693      $ 24,432        4.85   $ 1,849,201      $ 22,578        4.91

Investment securities (2)

     518,303        2,041        1.58     352,929        1,232        1.40

Deposits in other financial institutions

     334,660        710        0.85     301,402        439        0.58
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest earning assets

     2,896,656        27,183        3.81     2,503,532        24,249        3.90

Non-interest earning assets

     218,536             214,581        
  

 

 

         

 

 

       

Total Assets

   $ 3,115,192           $ 2,718,113        
  

 

 

         

 

 

       

Interest Bearing Liabilities:

                

Interest bearing transaction accounts

   $ 339,230      $ 157        0.19   $ 270,796      $ 99        0.15

Money market and savings deposits

     878,035        670        0.31     726,681        511        0.28

Certificates of deposit

     29,626        26        0.36     55,920        33        0.24
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing deposits

     1,246,891        853        0.28     1,053,397        643        0.25

Securities sold under agreements to repurchase

     15,017        9        0.24     20,540        11        0.22

Subordinated debentures

     9,877        130        5.26     9,719        117        4.76
  

 

 

    

 

 

      

 

 

    

 

 

    

Total borrowings

     24,894        139        2.26     30,259        128        1.70

Total interest bearing liabilities

     1,271,785        992        0.32     1,083,656        771        0.29

Non-interest bearing demand deposits

     1,480,366             1,305,018        
  

 

 

         

 

 

       

Total funding sources

     2,752,151             2,388,674        

Non-interest bearing liabilities

     19,824             16,425        

Shareholders’ Equity

     343,217             313,014        
  

 

 

         

 

 

       

Total Liabilities and Shareholders’ Equity

   $ 3,115,192           $ 2,718,113        
  

 

 

         

 

 

       

Excess of interest earning assets over funding sources

   $ 144,505           $ 114,858        

Net interest income

      $ 26,191           $ 23,478     
     

 

 

         

 

 

    

Net interest margin (3)

           3.67           3.77

Core net interest margin (4)

           3.53           3.67

 

 

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

 

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Net Changes in Average Balances, Composition, Yields and Rates

Three Months Ended March 31, 2017 and 2016

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

 

     Three Months Ended March 31,                    
     2017     2016     Increase (Decrease)  
     Average
Balance
     % of
Total
    Average
Yield/

Rate (5)
    Average
Balance
     % of
Total
    Average
Yield/

Rate (5)
    Average
Balance
    % of
Total
    Average
Yield/

Rate (5)
 

Interest Earning Assets:

                    

Loans (1)

   $ 2,043,693        70.6     4.85   $ 1,849,201        73.9     4.91   $ 194,492       (3.3 )%      (0.06 )% 

Investment securities (2)

     518,303        17.9     1.58     352,929        14.1     1.40     165,374       3.8     0.18

Deposits in other financial institutions

     334,660        11.5     0.85     301,402        12.0     0.58     33,258       (0.5 )%      0.27
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total interest earning assets

   $ 2,896,656        100     3.81   $ 2,503,532        100.0     3.90   $ 393,124         (0.09 )% 

Interest Bearing Liabilities:

                    

Non-interest bearing demand deposits

   $ 1,480,366        53.8     $ 1,305,018        54.6     $ 175,348       (0.8 )%   

Interest bearing transaction accounts

     339,230        12.3     0.19     270,796        11.4     0.15     68,434       0.9     0.04

Money market and savings deposits

     878,035        31.9     0.31     726,681        30.4     0.28     151,354       1.5     0.03

Certificates of deposit

     29,626        1.1     0.36     55,920        2.3     0.24     (26,294     (1.2 )%      0.12
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total deposits

     2,727,257        99.1     0.13     2,358,415        98.7     0.11     368,842       0.4     0.02

Securities sold under agreements to repurchase

     15,017        0.5     0.24     20,540        0.9     0.22     (5,523     (0.4 )%      0.02

Subordinated debentures

     9,877        0.4     5.26     9,719        0.4     4.76     158       —       0.50
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total borrowings

     24,894        0.9     2.26     30,259        1.3     1.70     (5,365     (0.4 )%      0.56
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

     

Total funding sources

   $ 2,752,151        100     0.15   $ 2,388,674        100     0.13   $ 363,477         0.02
  

 

 

        

 

 

        

 

 

     

Excess of interest earning assets over funding sources

   $ 144,505          $ 114,858          $ 29,647      

Net interest margin (3)

          3.67          3.77         (0.10 )% 

Core net interest margin (4)

          3.53          3.67         (0.14 )% 

 

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

 

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Volume and Rate Variance Analysis of Net Interest Income

Three Months Ended March 31, 2017 and 2016

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

 

     Three Months Ended
March 31,
2017 vs. 2016
 
     Increase (Decrease)
Due To
 
     Volume      Rate      Total  

Interest Income

        

Loans

   $ 2,130      $ (276    $ 1,854  

Investment securities

     576        233        809  

Deposits in other financial institutions

     50        221        271  
  

 

 

    

 

 

    

 

 

 

Total interest income

     2,756        178        2,934  
  

 

 

    

 

 

    

 

 

 

Interest Expense

        

Interest bearing transaction accounts

     25        33        58  

Money market and savings deposits

     98        61        159  

Certificates of deposit

     (17      10        (7
  

 

 

    

 

 

    

 

 

 

Total deposits

     106        104        210  

Securities sold under agreements to repurchase

     (3      1        (2

Subordinated debentures, net