Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x Quarterly report pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2014

 

¨ Transition report pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     .

001-35542

(Commission File number)

 

 

 

LOGO

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   27-2290659

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

1015 Penn Avenue

Suite 103

Wyomissing PA 19610

(Address of principal executive offices)

(610) 933-2000

(Registrant’s telephone number, including area code)

N/A

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

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company   ¨

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

On August 1, 2014, 25,607,630 shares of Voting Common Stock and 1,121,730 shares of Class B Non-Voting Common Stock were issued and outstanding.

 

 

 


Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

Table of Contents

 

Part I

    
Item 1.  

Consolidated Financial Statements as of June 30, 2014 and for the three and six month periods ended June 30, 2014 (unaudited)

     3   
Item 2.  

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

     42   
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     61   
Item 4.  

Controls and Procedures

     61   

PART II

    
Item 1.  

Legal Proceedings

     61   
Item 1A.  

Risk Factors

     61   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     62   
Item 3.  

Defaults Upon Senior Securities

     62   
Item 4.  

Mine Safety Disclosures

     62   
Item 5.  

Other Information

     62   
Item 6.  

Exhibits

     63   

SIGNATURES

     64   

Ex-31.1

    

Ex-31.2

    

Ex-32.1

    

Ex-32.2

    

Ex-101

    

 

2


Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET — UNAUDITED

(amounts in thousands, except share and per share data)

 

     June 30,
2014
    December 31,
2013
 
ASSETS     

Cash and due from banks

   $ 48,521      $ 60,709   

Interest-earning deposits

     217,013        172,359   
  

 

 

   

 

 

 

Cash and cash equivalents

     265,534        233,068   

Investment securities available for sale, at fair value

     425,061        497,573   

Loans held for sale, at fair value

     1,061,395        747,593   

Loans receivable not covered under Loss Sharing Agreements with the FDIC

     3,589,630        2,398,353   

Loans receivable covered under Loss Sharing Agreements with the FDIC

     54,474        66,725   

Allowance for loan losses

     (28,186     (23,998
  

 

 

   

 

 

 

Total loans receivable, net of allowance for loan losses

     3,615,918        2,441,080   

FHLB, Federal Reserve Bank, and other restricted stock

     75,558        43,514   

Accrued interest receivable

     11,613        8,362   

FDIC loss sharing receivable

     8,919        10,046   

Bank premises and equipment, net

     11,075        11,625   

Bank-owned life insurance

     106,668        104,433   

Other real estate owned (includes $6,177 and $6,953, respectively, covered under Loss Sharing Agreements with the FDIC)

     12,885        12,265   

Goodwill and other intangibles

     3,670        3,676   

Other assets

     37,432        39,938   
  

 

 

   

 

 

 

Total assets

   $ 5,635,728      $ 4,153,173   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Liabilities:

    

Deposits:

    

Demand, non-interest bearing

   $ 555,936      $ 478,103   

Interest bearing

     3,134,958        2,481,819   
  

 

 

   

 

 

 

Total deposits

     3,690,894        2,959,922   

Federal funds purchased

     0        13,000   

FHLB advances

     1,301,500        706,500   

Other borrowings

     88,250        63,250   

Subordinated debt

     112,000        2,000   

Accrued interest payable and other liabilities

     29,344        21,878   
  

 

 

   

 

 

 

Total liabilities

     5,221,988        3,766,550   

Shareholders’ equity:

    

Preferred stock, no par value or as set by the board; 100,000,000 shares authorized, none issued

     0        0   

Common stock, par value $1.00 per share; 200,000,000 shares authorized; 27,261,620 and 24,756,411 shares issued as of June 30, 2014 and December 31, 2013; 26,729,360 and 24,224,151 shares outstanding as of June 30, 2014 and December 31, 2013

     27,262        24,756   

Additional paid in capital

     353,371        307,231   

Retained earnings

     43,581        71,008   

Accumulated other comprehensive loss, net

     (2,220     (8,118

Treasury stock, at cost (532,260 shares as of June 30, 2014 and December 31, 2013)

     (8,254     (8,254
  

 

 

   

 

 

 

Total shareholders’ equity

     413,740        386,623   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 5,635,728      $ 4,153,173   
  

 

 

   

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME — UNAUDITED

(amounts in thousands, except share data)

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2014      2013      2014      2013  

Interest income:

           

Loans receivable

   $ 35,220       $ 19,196       $ 63,576       $ 35,295   

Loans held for sale

     6,715         11,157         11,798         22,041   

Investment securities

     2,543         1,082         5,583         1,911   

Other

     614         238         1,011         447   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     45,092         31,673         81,968         59,694   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest expense:

           

Deposits

     5,727         5,136         11,142         10,272   

Other borrowings

     1,184         74         2,340         79   

FHLB advances

     1,141         330         1,637         568   

Subordinated debt

     110         17         126         33   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     8,162         5,557         15,245         10,952   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     36,930         26,116         66,723         48,742   

Provision for loan losses

     2,886         2,116         7,253         1,998   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     34,044         24,000         59,470         46,744   

Non-interest income:

           

Mortgage warehouse transactional fees

     2,215         3,868         3,974         7,536   

Mortgage loan and banking income

     1,554         0         1,963         0   

Bank-owned life insurance

     836         567         1,670         1,043   

Gain on sale of SBA loans

     572         358         571         408   

Gain on sale of investment securities

     359         0         3,191         0   

Deposit fees

     212         159         426         289   

Other

     1,163         598         2,425         1,070   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

     6,911         5,550         14,220         10,346   
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest expense:

           

Salaries and employee benefits

     11,591         8,508         20,942         15,905   

FDIC assessments, taxes, and regulatory fees

     3,078         1,058         5,209         2,405   

Occupancy

     2,595         2,110         5,231         4,020   

Professional services

     1,881         1,252         4,163         1,958   

Technology, communications and bank operations

     1,621         1,061         3,181         1,902   

Other real estate owned

     890         525         1,242         561   

Loan workout

     477         72         918         746   

Advertising and promotion

     428         408         843         523   

Loss contingency

     0         0         0         2,000   

Other

     2,644         1,901         4,642         3,355   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

     25,205         16,895         46,371         33,375   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income tax expense

     15,750         12,655         27,319         23,715   

Income tax expense

     5,517         4,429         8,945         8,300   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 10,233       $ 8,226       $ 18,374       $ 15,415   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share (1)

   $ 0.38       $ 0.35       $ 0.69       $ 0.71   

Diluted earnings per share (1)

     0.37         0.34         0.66         0.69   

 

(1) Earnings per share amounts have been adjusted to give effect to the 10% stock dividend declared on May 15, 2014 and issued on June 30, 2014.

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME — UNAUDITED

(amounts in thousands)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2014     2013     2014     2013  

Net income

   $ 10,233      $ 8,226      $ 18,374      $ 15,415   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains (losses) on securities:

        

Unrealized holding gains (losses) on securities arising during the period (1)

     4,101        (5,976     13,222        (7,069

Income tax effect (1)

     (1,435     2,092        (4,628     2,475   

Less: reclassification adjustment for gains on securities included in net income

     (359     0        (3,191     0   

Income tax effect

     125        0        1,117        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses)

     2,432        (3,884     6,520        (4,594

Unrealized losses on cash flow hedges:

        

Unrealized losses on cash flow hedges arising during the period

     (1,621     0        (957     0   

Income tax effect

     567        0        335        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized losses

     (1,054     0        (622     0   

Other comprehensive income (loss), net of tax

     1,378        (3,884     5,898        (4,594
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 11,611      $ 4,342      $ 24,272      $ 10,821   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes immaterial gains or losses on foreign currency items for the three and six months ended June 30, 2014.

See accompanying notes to the unaudited consolidated financial statements.

 

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CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY — UNAUDITED

(amounts in thousands, except share data)

 

     For the six months ended June 30, 2014  
     Shares of
Common
Stock
Outstanding
     Common
Stock
     Additional
Paid in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Income/(loss)
    Treasury
Stock
    Total  

Balance, January 1, 2014

     24,224,151       $ 24,756       $ 307,231       $ 71,008      $ (8,118   $ (8,254   $ 386,623   

Net income

              18,374            18,374   

Other comprehensive income

                5,898          5,898   

Stock dividend

     2,429,375         2,429         43,364         (45,801         (8

Share-based compensation expense

           2,034               2,034   

Issuance of common stock under share-based compensation arrangements

     75,834         77         742               819   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2014

     26,729,360       $ 27,262       $ 353,371       $ 43,581      $ (2,220   $ (8,254   $ 413,740   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

     For the six months ended June 30, 2013  
     Shares of
Common
Stock
Outstanding
     Common
Stock
     Additional
Paid in
Capital
     Retained
Earnings
     Accumulated
Other
Comprehensive
Income/(loss)
    Treasury
Stock
    Total  

Balance, January 1, 2013

     18,459,502       $ 18,507       $ 212,090       $ 38,314       $ 1,064      $ (500   $ 269,475   

Net income

              15,415             15,415   

Other comprehensive loss

                 (4,594       (4,594

Share-based-compensation expense

           1,535                1,535   

Public offering of common stock, net of costs of $5,811

     6,179,104         6,179         91,511                97,690   

Issuance of common stock under share-based-compensation arrangements

     23,413         24         228                252   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, June 30, 2013

     24,662,019       $ 24,710       $ 305,364       $ 53,729       $ (3,530   $ (500   $ 379,773   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

(amounts in thousands)

 

     Six Months Ended
June 30,
 
     2014     2013  

Cash Flows from Operating Activities

    

Net income

   $ 18,374      $ 15,415   

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

    

Provision for loan losses, net of change to FDIC receivable

     7,253        1,998   

Loss contingency

     0        2,000   

Provision for depreciation and amortization

     1,807        1,279   

Share-based compensation

     2,034        1,535   

Deferred taxes

     2,216        1   

Net amortization of investment securities premiums and discounts

     370        228   

Gain on sale of investment securities

     (3,191     0   

Gain on sale of loans

     (2,424     (408

Origination of loans held for sale

     (6,893,530     (12,445,164

Proceeds from the sale of loans held for sale

     6,581,581        12,467,413   

Increase in FDIC loss sharing receivable

     (1,972     (1,093

Amortization (accretion) of fair value discounts

     (203     (273

Net loss on sales of other real estate owned

     555        180   

Valuation and other adjustments to other real estate owned

     442        13   

Earnings on investment in bank-owned life insurance

     (1,670     (1,043

Increase in accrued interest receivable and other assets

     (5,048     (3,492

Increase (decrease) in accrued interest payable and other liabilities

     7,303        (1,913
  

 

 

   

 

 

 

Net Cash (Used In) Provided by Operating Activities

     (286,103     36,676   

Cash Flows from Investing Activities

    

Proceeds from maturities, calls and principal repayments of investment securities available for sale

     22,055        9,252   

Proceeds from sales of investment securities available for sale

     213,249        0   

Purchases of investment securities available for sale

     (149,940     (69,770

Net increase in loans

     (897,928     (377,601

Purchase of loan portfolios

     (294,615     (155,306

Proceeds from sales of SBA loans

     5,967        3,900   

Purchases of bank-owned life insurance

     (465     (10,465

Net purchases of FHLB, Federal Reserve Bank, and other restricted stock

     (32,044     (3,025

Reimbursements from the FDIC on loss sharing agreements

     1,477        3,128   

Purchases of bank premises and equipment

     (644     (1,344

Proceeds from sales of other real estate owned

     5,281        2,599   
  

 

 

   

 

 

 

Net Cash Used In Investing Activities

     (1,127,607     (598,632

Cash Flows from Financing Activities

    

Net increase in deposits

     730,954        334,935   

Net increase in short-term borrowed funds

     382,000        99,000   

Proceeds from long-term FHLB borrowings

     200,000        50,000   

Net proceeds from issuance of long-term debt

     133,222        0   

Net proceeds from stock offering

     0        97,690   
  

 

 

   

 

 

 

Net Cash Provided by Financing Activities

     1,446,176        581,625   
  

 

 

   

 

 

 

Net Increase in Cash and Cash Equivalents

     32,466        19,669   

Cash and Cash Equivalents – Beginning

     233,068        186,016   
  

 

 

   

 

 

 

Cash and Cash Equivalents – Ending

   $ 265,534      $ 205,685   
  

 

 

   

 

 

 

Supplementary Cash Flows Information

    

Interest paid

   $ 15,084      $ 10,955   

Income taxes paid

     11,038        5,574   

Non-cash items:

    

Transfer of loans to other real estate owned

   $ 6,898      $ 5,424   

Issuance of common stock under share-based compensation arrangements

     819        252   

See accompanying notes to the unaudited consolidated financial statements.

 

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Table of Contents

CUSTOMERS BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

NOTE 1 — DESCRIPTION OF THE BUSINESS

Customers Bancorp, Inc. (the “Bancorp”, “Customers Bancorp”, or the “Company”) is a bank holding company engaged in banking activities through its wholly owned subsidiary, Customers Bank (the “Bank”). Customers Bancorp also has made certain equity investments through its wholly owned subsidiaries CB Green Ventures Pte Ltd. and CUBI India Ventures Pte Ltd.

Customers Bancorp, Inc. and its wholly owned subsidiary, Customers Bank, serve residents and businesses in Southeastern Pennsylvania (Bucks, Berks, Chester, Philadelphia and Delaware Counties), Rye, New York (Westchester County); Hamilton, New Jersey (Mercer County); Boston, Massachusetts; and Providence, Rhode Island. The Bank has 14 branches and provides commercial and consumer banking products, primarily loans and deposits. The Bank also provides liquidity to residential mortgage originators nationwide through commercial loans to mortgage companies. Customers Bank is subject to regulation of the Pennsylvania Department of Banking and Securities and the Federal Reserve Bank and is periodically examined by those regulatory authorities.

NOTE 2 — ACQUISITION ACTIVITY

Acquisition Activity

New England Lending Acquisitions

On January 15, 2014, Customers Bank purchased $277.9 million of residential adjustable-rate jumbo mortgage loans (indexed to one-year LIBOR) from Michigan-based Flagstar Bank. The purchase price was 100.75% of loans outstanding.

On March 28, 2013, Customers Bank completed the purchase of certain commercial loans from Flagstar Bank. Under the terms of the agreement, Customers Bank acquired $182.3 million in commercial loan and related commitments, of which $155.1 million was drawn at the date of acquisition. Also, as part of the agreement, Customers Bank assumed the leases for two of Flagstar’s commercial lending offices in New England. The purchase price was 98.7% of loans outstanding.

NOTE 3 — SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION

Basis of Presentation

The interim unaudited consolidated financial statements of Customers Bancorp, Inc. and subsidiaries have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). These interim unaudited consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary to present a fair statement of the financial position and the results of operations and cash flows of Customers Bancorp and subsidiaries for the interim periods presented. Certain information and footnote disclosures normally included in the annual consolidated financial statements have been omitted from these interim unaudited consolidated financial statements as permitted by SEC rules and regulations. The December 31, 2013 consolidated balance sheet presented in this report has been derived from Customers Bancorp’s audited 2013 consolidated financial statements. Management believes that the disclosures are adequate to present fairly the consolidated financial statements as of the dates and for the periods presented. These interim unaudited consolidated financial statements should be read in conjunction with the 2013 consolidated financial statements of Customers Bancorp and subsidiaries included in Customers’ Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 12, 2014. That Form 10-K describes Customers Bancorp’s significant accounting policies, which include its policies on Principles of Consolidation; Cash and Cash Equivalents; Restrictions on Cash and Amounts due from Banks; Investment Securities; Loan Accounting Framework; Allowance for Loan Losses; Goodwill; Investments in FHLB, Federal Reserve Bank, and other restricted stock; Other Real Estate Owned; FDIC Loss Sharing Receivable; Bank Owned Life Insurance; Bank Premises and Equipment; Treasury Stock; Income Taxes; Share-Based Compensation; Comprehensive Income; Earnings per Share; Segment Information; and Accounting Changes. Certain prior period amounts have been reclassified to conform to current period presentation. Results for interim periods are not necessarily indicative of those that may be expected for the fiscal year. Presented below are Customers Bancorp’s significant accounting policies that were updated during the six months ended June 30, 2014 to address new or evolving activities and recently issued accounting standards and updates that were issued or effective during 2014.

Derivative Instruments and Hedging Activities

The Financial Accounting Standards Board (“FASB”) ASC 815, Derivatives and Hedging (“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Bancorp’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

 

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As required by ASC 815, Customers Bancorp records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether Customers has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Bancorp may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

Prior to first quarter 2014, none of Customer Bancorp’s financial derivatives were designated in qualifying hedge relationships in accordance with the applicable accounting guidance. As such, all changes in fair value of the financial derivatives were recognized directly in earnings. In March 2014, Customers Bancorp entered into a $150.0 million notional balance forward starting pay fixed interest rate swap to hedge the variable cash flows associated with the forecasted issuance of debt. The Bancorp documented and designated this swap as a cash flow hedge. The effective portion of changes in the fair value of financial derivatives designated and qualifying as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the financial derivatives is recognized directly in earnings. Amounts reported in accumulated other comprehensive income related to financial derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt.

Customers Bancorp purchased credit derivatives with a notional balance of $13.4 million to hedge the performance risk of one of its counterparties during first quarter 2014. These derivatives were not designated in hedge relationships for accounting purposes and are being recorded at their fair value, with fair value changes recorded directly in earnings.

In accordance with the FASB’s fair value measurement guidance, Customers Bancorp made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Recently Issued Accounting Standards

In June 2014, the FASB issued Accounting Standard Update (“ASU”) 2014-12, Compensation—Stock Compensation. The guidance in this ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite period, the remaining unrecognized cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2015. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing. The amendments in this update require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the tenor of those transactions. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2014. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

 

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In May 2014, the FASB issued ASU2014-09, Revenue from Contracts with Customers. This ASU establishes a comprehensive revenue recognition standard for virtually all industries in U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate and construction industries. The revenue standard’s core principal is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this, the standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) identify the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, (v) recognize revenue when (or as) the entity satisfies the performance obligation. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the cumulative effect alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. The guidance in this ASU is effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2016. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, a consensus of the FASB Emerging Issues Task Force. The ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The ASU also requires additional related interim and annual disclosures. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2014. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

In January 2014, the FASB issued ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, a consensus of the FASB Emerging Issues Task Force. The ASU provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The guidance in this ASU is effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. The Bancorp does not expect this ASU to have a significant impact on its financial condition or results of operation.

In February 2013, the FASB issued ASU 2013-04, Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, a consensus of the FASB Emerging Issues Task Force. The guidance in this ASU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the following: (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this ASU was effective in first quarter 2014. This ASU has not had a significant impact on the Bancorp’s financial condition or results of operation.

 

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NOTE 4 — CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) BY COMPONENT (1)

The following tables present the changes in accumulated other comprehensive income by component for the three months and six months ended June 30, 2014 and 2013.

 

     For the three months ended June 30, 2014  
(amounts in thousands)    Unrealized Gains
and (Losses) on
Available-for-sale
Securities
    Unrealized Gains
and (Losses) on
Cash Flow Hedges
    Total  

Beginning balance - April 1, 2014

   $ (4,030   $ 432      $ (3,598
  

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss) before reclassifications

     2,666        (1,054     1,612   

Amounts reclassified from accumulated other comprehensive loss to net income (2)

     (234     0        (234
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive income (loss)

     2,432        (1,054     1,378   
  

 

 

   

 

 

   

 

 

 

Ending balance - June 30, 2014

   $ (1,598   $ (622   $ (2,220
  

 

 

   

 

 

   

 

 

 

 

 

     For the six months ended June 30, 2014  
(amounts in thousands)    Unrealized Gains
and (Losses) on
Available-for-sale
Securities
    Unrealized Losses
on
Cash Flow Hedges
    Total  

Beginning balance - January 1, 2014

   $ (8,118   $ 0      $ (8,118
  

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss) before reclassifications

     8,594        (622     7,972   

Amounts reclassified from accumulated other comprehensive loss to net income (2)

     (2,074     0        (2,074
  

 

 

   

 

 

   

 

 

 

Net current-period other comprehensive income (loss)

     6,520        (622     5,898   
  

 

 

   

 

 

   

 

 

 

Ending balance - June 30, 2014

   $ (1,598   $ (622   $ (2,220
  

 

 

   

 

 

   

 

 

 

 

     For the three
months ended

June 30, 2013
 
(amounts in thousands)    Unrealized Gains
and (Losses)  on
Available-for-sale
Securities (3)
 

Beginning balance - April 1, 2013

   $ 354   
  

 

 

 

Other comprehensive loss before reclassifications

     (3,884

Amounts reclassified from accumulated other comprehensive loss to net income

     0   
  

 

 

 

Net current-period other comprehensive (loss)

     (3,884
  

 

 

 

Ending balance – June 30, 2013

   $ (3,530
  

 

 

 

 

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For the six months ended June 30, 2013

      
(amounts in thousands)    Unrealized Gains
and (Losses)  on
Available-for-sale
Securities (3)
 

Beginning balance - January 1, 2013

   $ 1,064   
  

 

 

 

Other comprehensive loss before reclassifications

     (4,594

Amounts reclassified from accumulated other comprehensive loss to net income

     0   
  

 

 

 

Net current-period other comprehensive (loss) income

     (4,594
  

 

 

 

Ending balance – June 30, 2013

   $ (3,530
  

 

 

 

 

(1) All amounts are net of tax. Amounts in parentheses indicate debits.
(2) Reclassification amounts are reported as gain on sale of investment securities on the Consolidated Statements of Income.
(3) Prior to first quarter 2014, all amounts deferred in accumulated other comprehensive income/(loss) were related to available-for-sale securities.

NOTE 5 — EARNINGS PER SHARE

The following are the components and results of the Bancorp’s earnings per share calculation for the periods presented. Share and per share amounts have been adjusted to give effect to the 10% stock dividend declared on May 15, 2014 and issued on June 30, 2014.

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2014      2013      2014      2013  
(dollars in thousands, except per share data)                            

Net income available to common shareholders

   $ 10,233       $ 8,226       $ 18,374       $ 15,415   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average number of common shares outstanding - basic

     26,724,499         23,393,557         26,705,620         21,864,419   

Share-based compensation plans

     997,012         438,052         924,398         376,221   

Warrants

     260,893         208,468         251,796         190,007   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average number of common shares - diluted

     27,982,404         24,040,077         27,881,814         22,430,647   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share

   $ 0.38       $ 0.35       $ 0.69       $ 0.71   

Diluted earnings per share

   $ 0.37       $ 0.34       $ 0.66       $ 0.69   

The following is a summary of securities that could potentially dilute basic earnings per share in future periods that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented. Share-based compensation awards and warrants have been adjusted to give effect to the 10% stock dividend declared on May 15, 2014 and issued on June 30, 2014.

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2014      2013      2014      2013  

Anti-dilutive securities:

           

Share-based compensation awards

     118,386         61,117         86,786         89,729   

Warrants

     118,745         130,620         118,745         130,620   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total anti-dilutive securities

     237,131         191,737         205,531         220,349   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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NOTE 6 — INVESTMENT SECURITIES

The amortized cost and approximate fair value of investment securities as of June 30, 2014 and December 31, 2013 are summarized in the tables below:

 

     June 30, 2014  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
(amounts in thousands)                           

Available for Sale:

          

Mortgage-backed securities (1)

   $ 404,445       $ 2,181       $ (5,015   $ 401,611   

Equity securities (2)

     23,074         377         (1     23,450   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 427,519       $ 2,558       $ (5,016   $ 425,061   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31, 2013  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
(amounts in thousands)                           

Available for Sale:

          

Mortgage-backed securities (1)

   $ 461,988       $ 207       $ (10,659   $ 451,536   

Corporate notes

     25,000         344         (21     25,323   

Equity securities(2)

     23,074         0         (2,360     20,714   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 510,062       $ 551       $ (13,040   $ 497,573   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Comprised primarily of mortgage-backed securities issued by government-sponsored agencies, including FHLMC, FNMA, and GNMA.
(2) Comprised primarily of equity securities in a foreign entity.

The following table presents proceeds from the sale of available-for-sale investment securities and gross gains and gross losses realized on those sales for the three and six months ended June 30, 2014 and 2013:

 

     Three months ended June 30,      Six months ended June 30,  
     2014      2013      2014      2013  
(amounts in thousands)                            

Proceeds from sale of available-for-sale securities

   $ 25,359       $ 0       $ 213,249       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross gains

   $ 359       $ 0       $ 3,191       $ 0   

Gross losses

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net gains

   $ 359       $ 0       $ 3,191       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

These gains and losses were determined using the specific identification method and were reported as gains on sale of investment securities included in non-interest income.

 

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The following table presents available-for-sale debt securities by stated maturity. Debt securities backed by mortgages have expected maturities that differ from contractual maturities because borrowers have the right to call or prepay and are, therefore, classified separately with no specific maturity date:

 

     June 30, 2014  
     Amortized
Cost
     Fair
Value
 
(amounts in thousands)              

Due in one year or less

   $ 0       $ 0   

Due after one year through five years

     0         0   

Due after five years through ten years

     0         0   

Due after ten years

     0         0   

Mortgage-backed securities

     404,445         401,611   
  

 

 

    

 

 

 

Total debt securities

   $ 404,445       $ 401,611   
  

 

 

    

 

 

 

The Bancorp’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013 were as follows:

 

     June 30, 2014  
     Less Than 12 Months     12 Months or More     Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
 
(amounts in thousands)                                        

Available for Sale:

               

Mortgage-backed securities (1)

   $ 59,038       $ (613   $ 121,905       $ (4,402   $ 180,943       $ (5,015

Equity securities (2)

     0         0        5         (1     5         (1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 59,038       $ (613   $ 121,910       $ (4,403   $ 180,948       $ (5,016
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     December 31, 2013  
     Less Than 12 Months     12 Months or More     Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
 
(amounts in thousands)                                        

Available for Sale:

               

Mortgage-backed securities (1)

   $ 425,623       $ (10,061   $ 5,274       $ (598     430,897       $ (10,659

Corporate notes

     4,982         (18     4,997         (3     9,979         (21

Equity securities (2)

     20,714         (2,360     0         0        20,714         (2,360
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 451,319       $ (12,439   $ 10,271       $ (601   $ 461,590       $ (13,040
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Comprised primarily of mortgage-backed securities issued by government-sponsored agencies, including FHLMC, FNMA, and GNMA.
(2) Comprised primarily of equity securities in a foreign entity.

At June 30, 2014, there were five available-for-sale investment securities in the less-than-twelve-month category and twenty-one available-for-sale investment securities in the twelve-month-or-more category. The unrealized losses on the mortgage backed securities are guaranteed by government-sponsored entities and primarily relate to changes in market interest rates. All amounts are expected to be recovered when market prices recover or at maturity. The Company intends to hold these securities for the foreseeable future, and does not intend to sell the securities before the price recovers. Customers considers it more likely than not that it will not be required to sell the securities. Accordingly, Customers has concluded that the securities are not other-than-temporarily impaired as of June 30, 2014.

At June 30, 2014 and December 31, 2013, Customers Bank had pledged investment securities aggregating $401.2 million and $451.1 million fair value, respectively, as collateral against its borrowings primarily with the FHLB. The FHLB does not have the ability to sell or repledge these securities.

 

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NOTE 7 – LOANS HELD FOR SALE

The composition of loans held for sale as of June 30, 2014 and December 31, 2013 was as follows:

 

     June 30,
2014
     December 31,
2013
 
(amounts in thousands)              

Mortgage warehouse loans at fair value

   $ 1,053,641       $ 740,694   

Residential mortgage loans at fair value

     7,754         6,899   
  

 

 

    

 

 

 

Loans held for sale

   $ 1,061,395       $ 747,593   
  

 

 

    

 

 

 

NOTE 8 — LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The following table presents loans receivable as of June 30, 2014 and December 31, 2013:

 

     June 30,
2014
    December 31,
2013
 
(amounts in thousands)             

Construction

   $ 11,544      $ 14,627   

Commercial real estate/multi-family

     21,150        24,258   

Commercial and industrial

     4,039        5,814   

Residential real estate

     14,600        18,733   

Manufactured housing

     3,141        3,293   
  

 

 

   

 

 

 

Total loans receivable covered under FDIC loss sharing agreements (1)

     54,474        66,725   

Construction

     51,377        36,901   

Commercial real estate/multi-family

     2,820,492        1,835,186   

Commercial and industrial

     299,122        239,509   

Mortgage warehouse

     9        866   

Manufactured housing

     133,307        139,471   

Residential real estate

     283,713        145,188   

Consumer

     2,015        2,144   
  

 

 

   

 

 

 

Total loans receivable not covered under FDIC loss sharing agreements

     3,590,035        2,399,265   

Total loans receivable

     3,644,509        2,465,990   

Deferred (fees) costs, net

     (405     (912

Allowance for loan losses

     (28,186     (23,998
  

 

 

   

 

 

 

Loans receivable, net

   $ 3,615,918      $ 2,441,080   
  

 

 

   

 

 

 

 

(1) Loans that were acquired in two FDIC-assisted transactions and are covered under loss sharing agreements with the FDIC are referred to as covered loans throughout these financial statements.

 

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Table of Contents

Non-Covered Loans

The following tables summarize non-covered loans by class and performance status as of June 30, 2014 and December 31, 2013:

 

     June 30, 2014  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due(1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased-
Credit-
Impaired
Loans (3)
     Total
Loans (4)
 
(amounts in thousands)                                                 

Commercial and industrial

   $ 478       $ 0       $ 478       $ 1,974       $ 295,073       $ 1,597       $ 299,122   

Commercial real estate

     267         0         267         8,714         2,777,671         33,840         2,820,492   

Construction

     0         0         0         451         50,419         507         51,377   

Residential real estate

     597         0         597         834         272,555         9,727         283,713   

Consumer

     4         0         4         0         1,673         338         2,015   

Mortgage warehouse

     0         0         0         0         9         0         9   

Manufactured housing (5)

     6,228         4,208         10,436         727         117,817         4,327         133,307   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,574       $ 4,208       $ 11,782       $ 12,700       $ 3,515,217       $ 50,336       $ 3,590,035   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due(1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased-
Credit-
Impaired
Loans (3)
     Total
Loans (4)
 
(amounts in thousands)                                                 

Commercial and industrial

   $ 10       $ 0       $ 10       $ 123       $ 237,453       $ 1,923       $ 239,509   

Commercial real estate

     0         0         0         9,924         1,788,144         37,118         1,835,186   

Construction

     0         0         0         2,049         33,922         930         36,901   

Residential real estate

     555         0         555         969         133,158         10,506         145,188   

Consumer

     0         0         0         0         1,728         416         2,144   

Mortgage warehouse

     0         0         0         0         866         0         866   

Manufactured housing (5)

     7,921         3,772         11,693         448         122,416         4,914         139,471   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 8,486       $ 3,772       $ 12,258       $ 13,513       $ 2,317,687       $ 55,807       $ 2,399,265   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes past due loans that are accruing interest because collection is considered probable.
(2) Loans where next payment due is less than 30 days from the report date.
(3) Purchased-credit-impaired loans aggregated into a pool are accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, and the past due status of the pools, or that of the individual loans within the pools, is not meaningful. Because of the credit impaired nature of the loans, the loans are recorded at a discount reflecting estimated future cash flows and the Bank recognizes interest income on each pool of loans reflecting the estimated yield and passage of time. Such loans are considered to be performing. Purchased-credit-impaired loans that are not in pools accrete interest when the timing and amount of their expected cash flows are reasonably estimable, and are reported as performing loans.
(4) Amounts exclude deferred costs and fees and the allowance for loan losses.
(5) Manufactured housing loans purchased in 2010 are subject to cash reserves held at the Bank that are used to fund past-due payments when the loan becomes 90 days or more delinquent. Subsequent purchases are subject to varying provisions in the event of borrowers’ delinquencies.

 

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Table of Contents

Covered Loans

The following tables summarize covered loans by class and performance status as of June 30, 2014 and December 31, 2013:

 

     June 30, 2014  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due (1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased
- Credit
Impaired
Loans (3)
     Total
Loans (4)
 
(amounts in thousands)                                                 

Commercial and industrial

   $ 0       $ 0       $ 0       $ 217       $ 3,304       $ 518       $ 4,039   

Commercial real estate

     0         0         0         628         13,070         7,452         21,150   

Construction

     0         0         0         2,412         526         8,606         11,544   

Residential real estate

     3         0         3         1,012         11,770         1,815         14,600   

Manufactured housing

     53         0         53         83         2,863         142         3,141   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 56       $ 0       $ 56       $ 4,352       $ 31,533       $ 18,533       $ 54,474   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     30-89 Days
Past Due (1)
     90 Days
Or More
Past Due (1)
     Total Past
Due (1)
     Non-
Accrual
     Current (2)      Purchased-
Credit
Impaired
Loans (3)
     Total
Loans (4)
 
(amounts in thousands)                                                 

Commercial and industrial

   $ 295       $ 0       $ 295       $ 2       $ 3,172       $ 2,345       $ 5,814   

Commercial real estate

     245         0         245         1,691         13,586         8,736         24,258   

Construction

     0         0         0         3,382         1,967         9,278         14,627   

Residential real estate

     90         0         90         564         14,108         3,971         18,733   

Manufactured housing

     56         0         56         11         3,081         145         3,293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 686       $ 0       $ 686       $ 5,650       $ 35,914       $ 24,475       $ 66,725   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes past due loans that are accruing interest because collection is considered probable.
(2) Purchased loans in FDIC assisted transactions with no evidence of credit deterioration since origination.
(3) Purchased-credit-impaired loans aggregated into a pool are accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, and the past due status of the pools, or that of the individual loans within the pools, is not meaningful. Because of the credit impaired nature of the loans, the loans are recorded at a discount reflecting estimated future cash flows and the Bank recognizes interest income on each pool of loans reflecting the estimated yield and passage of time. Such loans are considered to be performing. Purchased-credit-impaired loans that are not in pools accrete interest when the timing and amount of their expected cash flows are reasonably estimable, and are reported as performing loans.
(4) Amounts exclude deferred costs and fees and allowance for loan losses.

Allowance for Loan Losses and FDIC Loss Sharing Receivable

Losses incurred on covered loans are eligible for partial reimbursement by the FDIC. Subsequent to the purchase date, the expected cash flows on the covered loans are subject to evaluation. Decreases in the present value of expected cash flows on the covered loans are recognized by increasing the allowance for loan losses with a related charge to the provision for loan losses. At the same time, the FDIC indemnification asset is increased reflecting an estimated future collection from the FDIC with a related credit to the provision for loan losses. If the expected cash flows on the covered loans increase such that a previously recorded impairment can be reversed, the Bancorp records a reduction in the allowance for loan losses with a related credit to the provision for loan losses accompanied by a reduction in the FDIC receivable and a charge to the provision for loan losses. Increases in expected cash flows of covered loans and decreases in expected cash flows of the FDIC loss sharing receivable, when there are no previously recorded impairments, are considered together and recognized over the remaining life of the loans as interest income.

 

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The following tables present changes in the allowance for loan losses and the FDIC loss sharing receivable for the three and six months ended June 30, 2014 and 2013.

 

     Allowance for Loan Losses  
     For the three months ended June 30,  
(amounts in thousands)    2014     2013  

Beginning balance

   $ 26,704      $ 26,439   

Provision for loan losses (1)

     2,730        4,620   

Charge-offs

     (1,405     (3,093

Recoveries

     157        176   
  

 

 

   

 

 

 

Ending balance

   $ 28,186      $ 28,142   
  

 

 

   

 

 

 

 

     FDIC Loss Sharing Receivable  
     For the three months ended June 30,  
(amounts in thousands)    2014     2013  

Beginning balance

   $ 8,272      $ 12,043   

(Decreased)/Increased estimated cash flows (2)

     (156     2,504   

Other activity, net (a)

     983        380   

Cash receipts from FDIC

     (180     (758
  

 

 

   

 

 

 

Ending balance

   $ 8,919      $ 14,169   
  

 

 

   

 

 

 

(1)    Provision for loan losses

   $ 2,730      $ 4,620   

(2)    Effect attributable to FDIC loss share arrangements

     156        (2,504
  

 

 

   

 

 

 

Net amount reported as provision for loan losses

   $ 2,886      $ 2,116   
  

 

 

   

 

 

 

 

(a) Includes external costs, such as legal fees, real estate taxes, and appraisal expenses, which qualify for reimbursement under loss sharing arrangements

 

     Allowance for Loan Losses  
     For the six months ended June 30,  
(amounts in thousands)    2014     2013  

Beginning balance

   $ 23,998      $ 25,837   

Provision for loan losses (1)

     5,631        5,720   

Charge-offs

     (1,941     (3,656

Recoveries

     498        241   
  

 

 

   

 

 

 

Ending balance

   $ 28,186      $ 28,142   
  

 

 

   

 

 

 
     FDIC Loss Sharing Receivable  
     For the six months ended June 30,  
(amounts in thousands)    2014     2013  

Beginning balance

   $ 10,046      $ 12,343   

(Decreased)/Increased estimated cash flows (2)

     (1,622     3,722   

Other activity, net (a)

     1,972        1,232   

Cash receipts from FDIC

     (1,477     (3,128
  

 

 

   

 

 

 

Ending balance

   $ 8,919      $ 14,169   
  

 

 

   

 

 

 

(1)    Provision for loan losses

   $ 5,631      $ 5,720   

(2)    Effect attributable to FDIC loss share arrangements

     1,622        (3,722
  

 

 

   

 

 

 

Net amount reported as provision for loan losses

   $ 7,253      $ 1,998   
  

 

 

   

 

 

 

 

(a) Includes external costs, such as legal fees, real estate taxes, and appraisal expenses, which qualify for reimbursement under loss sharing arrangements.

 

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Table of Contents

Impaired Loans — Covered and Non-Covered

The following tables present the recorded investment (net of charge-offs), unpaid principal balance and related allowance for impaired loans as of June 30, 2014 and December 31, 2013 and the average recorded investment and interest income recognized for the three and six months ended June 30, 2014 and 2013. Purchased-credit-impaired loans are considered to be performing and are not included in the tables below.

 

     June 30, 2014      For the three months
ended June 30, 2014
     For the six months
ended June 30, 2014
 
     Recorded
Investment
Net of
Charge offs
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 
(amounts in thousands)                                                 

With no related allowance recorded:

                    

Commercial and industrial

   $ 14,988       $ 15,406       $ —         $ 12,949       $ 57       $ 12,998       $ 66   

Commercial real estate

     17,640         18,491         —           18,761         45         17,306         103   

Construction

     2,325         3,594         —           2,325         —           2,476         —     

Consumer

     83         83         —           44         —           29         —     

Residential real estate

     1,934         1,934         —           1,943         —           2,239         6   

With an allowance recorded:

                    

Commercial and industrial

     1,655         1,655         915         1,246         7         1,653         12   

Commercial real estate

     2,913         2,913         812         2,676         —           2,537         1   

Construction

     1,553         1,553         671         1,561         —           1,418         —     

Consumer

     53         53         5         59         1         60         2   

Residential real estate

     248         248         175         249         1         250         2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 43,392       $ 45,930       $ 2,578       $ 41,813       $ 111       $ 40,966       $ 192   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013      For the three months
ended June 30, 2013
     For the six months
ended June 30, 2013
 
     Recorded
Investment
Net of
Charge offs
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 
(amounts in thousands)                                                 

With no related allowance recorded:

                    

Commercial and industrial

   $ 13,097       $ 13,159       $ —         $ 6,068       $ 92       $ 5,249       $ 118   

Commercial real estate

     14,397         15,249         —           27,251         206         24,277         337   

Construction

     2,777         4,046         —           6,214         10         7,075         10   

Consumer

     —           —           —           89         —           100         —     

Residential real estate

     2,831         2,831         —           2,168         6         2,436         10   

With an allowance recorded:

                    

Commercial and industrial

     2,469         3,739         829         1,419         32         886         63   

Commercial real estate

     2,261         3,167         946         5,838         19         8,095         34   

Construction

     1,132         1,132         351         5,238         —           6,172         —     

Consumer

     64         64         17         50         —           45         —     

Residential real estate

     252         252         199         1,023         1         1,035         2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 39,280       $ 43,639       $ 2,342       $ 55,358       $ 366       $ 55,370       $ 574   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings

At June 30, 2014 and 2013, there were $5.3 million and $9.2 million, respectively, in loans reported as troubled debt restructurings (“TDRs”). TDRs are reported as impaired loans in the calendar year of their restructuring and are evaluated to determine whether they should be placed on non-accrual status. In subsequent years, a TDR may be returned to accrual status if it satisfies a minimum six-month performance requirement; however, it will remain classified as impaired. Generally, the Bancorp requires sustained performance for nine months before returning a TDR to accrual status.

 

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Table of Contents

Modification of purchased-credit-impaired loans that are accounted for within loan pools in accordance with the accounting standards for purchased-credit-impaired loans do not result in the removal of these loans from the pool even if modifications would otherwise be considered a TDR. Accordingly, as each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, modifications of loans within such pools are not considered TDRs.

The following is an analysis of loans modified in a troubled debt restructuring by type of concession for the three and six months ended June 30, 2014 and 2013. There were no modifications that involved forgiveness of debt.

 

     TDRs in
Compliance
with Their
Modified
Terms and
Accruing
Interest
     TDRs in
Compliance
with Their
Modified
Terms and
Not
Accruing
Interest
     Total  
(amounts in thousands)                     

Three months ended June 30, 2014

        

Extended under forbearance

   $ 167       $ 0       $ 167   

Multiple extensions resulting from financial difficulty

     0         0         0   

Interest-rate reductions

     0         176         176   
  

 

 

    

 

 

    

 

 

 

Total

   $ 167       $ 176       $ 343   
  

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2014

        

Extended under forbearance

   $ 167       $ 0       $ 167   

Multiple extensions resulting from financial difficulty

     0         0         0   

Interest-rate reductions

     247         303         550   
  

 

 

    

 

 

    

 

 

 

Total

   $ 414       $ 303       $ 717   
  

 

 

    

 

 

    

 

 

 

Three months ended June 30, 2013

        

Extended under forbearance

   $ 0       $ 0       $ 0   

Multiple extensions resulting from financial difficulty

     0         0         0   

Interest-rate reductions

     93         910         1,003   
  

 

 

    

 

 

    

 

 

 

Total

   $ 93       $ 910       $ 1,003   
  

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2013

        

Extended under forbearance

   $ 0       $ 0       $ 0   

Multiple extensions resulting from financial difficulty

     0         0         0   

Interest-rate reductions

     93         1,167         1,260   
  

 

 

    

 

 

    

 

 

 

Total

   $ 93       $ 1,167       $ 1,260   
  

 

 

    

 

 

    

 

 

 

The following table provides, by class, the number of loans modified in troubled debt restructurings and the recorded investments and unpaid principal balances during the three and six months ended June 30, 2014 and 2013.

 

     TDRs in Compliance with Their
Modified Terms and Accruing
Interest
     TDRs in
Compliance
with Their
Modified
Terms and Not
Accruing Interest
 
     Number
of Loans
     Recorded
Investment
     Number
of Loans
     Recorded
Investment
 
(amounts in thousands)                            

Three months ended June 30, 2014

           

Commercial and industrial

     0       $ 0         0       $ 0   

Commercial real estate

     0         0         0         0   

Construction

     0         0         0         0   

Manufactured housing

     0         0         3         176   

Residential real estate

     0         0         0         0   

Consumer

     4         167         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4       $ 167         3       $ 176   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     TDRs in Compliance with Their
Modified Terms and Accruing
Interest
     TDRs in
Compliance
with Their
Modified
Terms and Not
Accruing Interest
 
     Number
of Loans
     Recorded
Investment
     Number
of Loans
     Recorded
Investment
 
(amounts in thousands)                            

Six months ended June 30, 2014

           

Commercial and industrial

     0       $ 0         0       $ 0   

Commercial real estate

     0         0         0         0   

Construction

     0         0         0         0   

Manufactured housing

     1         47         5         303   

Residential real estate

     3         200         0         0   

Consumer

     4         167         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     8       $ 414         5       $ 303   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended June 30, 2013

           

Commercial and industrial

     0       $ 0         0       $ 0   

Commercial real estate

     0         0         0         0   

Construction

     0         0         0         0   

Manufactured housing

     2         60         7         910   

Residential real estate

     0         0         0         0   

Consumer

     1         33         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     3       $ 93         7       $ 910   
  

 

 

    

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2013

           

Commercial and industrial

     0       $ 0         0       $ 0   

Commercial real estate

     0         0         0         0   

Construction

     0         0         0         0   

Manufactured housing

     2         60         10         1,167   

Residential real estate

     0         0         0         0   

Consumer

     1         33         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     3       $ 93         10       $ 1,167   
  

 

 

    

 

 

    

 

 

    

 

 

 

At June 30, 2014 and 2013, there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructuring.

For the three and six months ended June 30, 2014 and 2013, the recorded investment of loans determined to be TDRs was $0.3 million, $0.7 million, $1.0 million and $1.2 million, respectively, both before and after restructuring. During the three month period ended June 30, 2014, three TDR loans defaulted with a recorded investment of $0.2 million. During the six month period ended June 30, 2014, six TDR loans defaulted with a recorded investment of $0.5 million. There were no TDRs that defaulted in the three and six month periods ended June 30, 2013.

Loans modified in troubled debt restructurings are evaluated for impairment. The nature and extent of impairment of TDRs, including those which have experienced a subsequent default, is considered in the determination of an appropriate level of allowance for credit losses. There were no specific allowances resulting from TDR modifications during the three and six months ended June 30, 2014 and 2013.

Credit Quality Indicators

Commercial and industrial, commercial real estate, residential real estate and construction loans are rated based on an internally assigned risk rating system which is assigned at the time of loan origination and reviewed on a periodic or on an “as needed” basis. Consumer, mortgage warehouse and manufactured housing loans are evaluated based on the payment activity of the loan and are not assigned internal risk ratings.

To facilitate the monitoring of credit quality within the commercial and industrial, commercial real estate, construction, and residential real estate classes, and for purposes of analyzing historical loss rates used in the determination of the allowance for loan losses for the respective portfolio class, the Bank utilizes the following categories of risk ratings: pass/satisfactory (includes risk rating 1 through 6), special mention, substandard, doubtful, and loss. The risk rating categories, which are derived from standard regulatory rating

 

21


Table of Contents

definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter. Pass/satisfactory ratings, which are assigned to those borrowers who do not have identified potential or well-defined weaknesses and for whom there is a high likelihood of orderly repayment, are updated periodically based on the size and credit characteristics of the borrower. All other categories are updated on a quarterly basis during the month preceding the end of the calendar quarter. While assigning risk ratings involves judgment, the risk-rating process allows management to identify riskier credits in a timely manner and allocate the appropriate resources to manage those loans.

The risk rating grades are defined as follows:

“1” – Pass/Excellent

Loans rated 1 represent a credit extension of the highest quality. The borrower’s historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has access to alternative financial markets.

“2” – Pass/Superior

Loans rated 2 are those for which the borrower has a strong financial condition, balance sheet, operations, cash flow, debt capacity and coverage with ratios better than industry norms. The borrowers of these loans exhibit a limited leverage position, borrowers are virtually immune to local economies in stable growing industries, and where management is well respected and the company has ready access to public markets.

“3” – Pass/Strong

Loans rated 3 are those loans for which the borrower has above average financial condition and flexibility; more than satisfactory debt service coverage, balance sheet and operating ratios are consistent with or better than industry peers, have little industry risk, move in diversified markets and are experienced and competent in their industry. These borrowers’ access to capital markets is limited mostly to private sources, often secured, but the borrower typically has access to a wide range of refinancing alternatives.

“4” – Pass/Good

Loans rated 4 have a sound primary and secondary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher grade borrower. These loans carry a normal level of risk, with very low loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the higher quality loans.

“5” – Satisfactory

Loans rated 5 are extended to borrowers who are determined to be a reasonable credit risk and demonstrate the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. The borrower’s historical financial information may indicate erratic performance, but current trends are positive and the quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher grade loans. If adverse circumstances arise, the impact on the borrower may be significant.

“6” – Satisfactory/Bankable with Care

Loans rated 6 are those for which the borrower has higher than normal credit risk; however, cash flow and asset values are generally intact. These borrowers may exhibit declining financial characteristics, with increasing leverage and decreasing liquidity and may have limited resources and access to financial alternatives. Signs of weakness in these borrowers may include delinquent taxes, trade slowness and eroding profit margins.

“7” – Special Mention

Loans rated Special Mention are credit facilities that may have potential developing weaknesses and deserve extra attention from the account manager and other management personnel. In the event that potential weaknesses are not corrected or mitigated, deterioration in the ability of the borrower to repay the debt in the future may occur. This grade is not assigned to loans that bear certain peculiar risks normally associated with the type of financing involved, unless circumstances have caused the risk to increase to a level higher than would have been acceptable when the credit was originally approved. Loans where significant actual, not potential, weaknesses or problems are clearly evident are graded in the category below.

 

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Table of Contents

“8” – Substandard

Loans are classified Substandard when the loans are inadequately protected by the current sound worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the Company will sustain some loss if the weaknesses are not corrected.

“9” – Doubtful

The Bank assigns a doubtful rating to loans that have all the attributes of a substandard rating with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors that may work to the advantage of and strengthen the credit quality of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceeding, capital injection, perfecting liens on additional collateral or refinancing plans.

“10” – Loss

The Bank assigns a loss rating to loans considered uncollectible and of such little value that their continuance as an active asset is not warranted. Amounts classified as loss are immediately charged off.

Risk ratings are not established for home equity loans, consumer loans, and installment loans, mainly because these portfolios consist of a larger number of homogenous loans with smaller balances. Instead, these portfolios are evaluated for risk mainly based upon aggregate payment history through the monitoring of delinquency levels and trends and are classified as performing and nonperforming.

 

23


Table of Contents

The following tables present the credit ratings of the non-covered loan portfolio as of June 30, 2014 and December 31, 2013:

 

     June 30, 2014  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
(amounts in thousands)                            

Pass/Satisfactory

   $ 283,044       $ 2,793,438       $ 50,899       $ 281,713   

Special Mention

     13,750         14,838         27         467   

Substandard

     2,328         12,216         451         1,533   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 299,122       $ 2,820,492       $ 51,377       $ 283,713   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Consumer      Mortgage
Warehouse
     Manufactured
Housing
 
(amounts in thousands)                     

Performing

   $ 2,015       $ 9       $ 122,144   

Nonperforming (1)

     0         0         11,163   
  

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 2,015       $ 9       $ 133,307   
  

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
(amounts in thousands)                            

Pass/Satisfactory

   $ 228,748       $ 1,808,804       $ 34,822       $ 142,588   

Special Mention

     10,314         12,760         29         940   

Substandard

     447         13,622         2,050         1,660   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 239,509       $ 1,835,186       $ 36,901       $ 145,188   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Consumer      Mortgage
Warehouse
     Manufactured
Housing
 
(amounts in thousands)                     

Performing

   $ 2,144       $ 866       $ 127,330   

Nonperforming (1)

     0         0         12,141   
  

 

 

    

 

 

    

 

 

 

Total loans receivable, non-covered

   $ 2,144       $ 866       $ 139,471   
  

 

 

    

 

 

    

 

 

 

 

(1) Includes loans that are past due and still accruing interest and loans on nonaccrual status.

The following tables present the credit ratings of the covered loan portfolio as of June 30, 2014 and December 31, 2013:

 

     June 30, 2014  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
(amounts in thousands)                            

Pass/Satisfactory

   $ 3,700       $ 13,325       $ 526       $ 12,194   

Special Mention

     0         3,159         0         0   

Substandard

     339         4,666         11,018         2,406   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, covered

   $ 4,039       $ 21,150       $ 11,544       $ 14,600   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

24


Table of Contents
     Manufactured
Housing
 
(amounts in thousands)       

Performing

   $ 3,005   

Nonperforming (1)

     136   
  

 

 

 

Total loans receivable, covered

   $ 3,141   
  

 

 

 

 

     December 31, 2013  
     Commercial
and
Industrial
     Commercial
Real Estate
     Construction      Residential
Real Estate
 
(amounts in thousands)                            

Pass/Satisfactory

   $ 3,688       $ 14,330       $ 1,967       $ 14,137   

Special Mention

     223         2,989         0         455   

Substandard

     1,903         6,939         12,660         4,141   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans receivable, covered

   $ 5,814       $ 24,258       $ 14,627       $ 18,733   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Manufactured
Housing
 
(amounts in thousands)       

Performing

   $ 3,226   

Nonperforming (1)

     67   
  

 

 

 

Total loans receivable, covered

   $ 3,293   
  

 

 

 

 

(1) Includes loans that are past due and still accruing interest and loans on nonaccrual status.

 

25


Table of Contents

Allowance for loan losses

The changes in the allowance for loan losses for the three and six months ended June 30, 2014 and 2013 and the loans and allowance for loan losses by loan class based on impairment evaluation method are as follows. The amounts presented for the provision for loan losses below do not include the effect of changes to estimated benefits resulting from the FDIC loss share arrangements for the covered loans.

 

    Commercial
and
Industrial
    Commercial
Real Estate
    Construction     Residential
Real Estate
    Manufactured
Housing
    Consumer     Mortgage
Warehouse
    Residual
Reserve
    Total  
(amounts in thousands)                                                      

Three months ended June 30, 2014

                 

Beginning Balance, April 1, 2014

  $ 2,443      $ 18,852      $ 2,342      $ 2,307      $ 593      $ 127      $ 40      $ 0      $ 26,704   

Charge-offs

    (445     (912     0        (15     0        (33     0        0        (1,405

Recoveries

    135        1        3        18        0        0        0        0        157   

Provision for loan losses

    1,060        2,148        (158     (282     (192     44        110        0        2,730   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance, June 30, 2014

  $ 3,193      $ 20,089      $ 2,187      $ 2,028      $ 401      $ 138      $ 150      $ 0      $ 28,186   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six months ended June 30, 2014

                 

Beginning Balance, January 1, 2014

  $ 2,638      $ 15,705      $ 2,385      $ 2,490      $ 614      $ 130      $ 36      $ 0      $ 23,998   

Charge-offs

    (445     (1,160     0        (303     0        (33     0        0        (1,941

Recoveries

    225        26        3        242        0        2        0        0        498   

Provision for loan losses

    775        5,518        (201     (401     (213     39        114        0        5,631   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance, June 30, 2014

  $ 3,193      $ 20,089      $ 2,187      $ 2,028      $ 401      $ 138      $ 150      $ 0      $ 28,186   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At June 30, 2014

                 

Loans:

                 

Individually evaluated for impairment

  $ 16,643      $ 20,553      $ 3,878      $ 2,182      $ 0      $ 136      $ 0      $ 0      $ 43,392   

Collectively evaluated for impairment

    284,403        2,779,797        49,930        284,589        131,979        1,541        9        0        3,532,248   

Loans acquired with credit deterioration

    2,115        41,292        9,113        11,542        4,469        338        0        0        68,869   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans receivable, excluding deferred fees and costs

  $ 303,161      $ 2,841,642      $ 62,921      $ 298,313      $ 136,448      $ 2,015      $ 9        0      $ 3,644,509   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses:

                 

Individually evaluated for impairment

  $ 915      $ 812      $ 671      $ 175      $ 0      $ 5      $ 0      $ 0      $ 2,578   

Collectively evaluated for impairment

    2,017        14,270        390        861        86        32        150        0        17,806   

Loans acquired with credit deterioration

    261        5,007        1,126        992        315        101        0        0        7,802   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Allowance for loan losses

  $ 3,193      $ 20,089      $ 2,187      $ 2,028      $ 401      $ 138      $ 150      $ 0      $ 28,186   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents
    Commercial
and
Industrial
    Commercial
Real Estate
    Construction     Residential
Real Estate
    Manufactured
Housing
    Consumer     Mortgage
Warehouse
    Residual
Reserve
    Total  
(amounts in thousands)                                                      

Three months ended June 30, 2013

                 

Beginning Balance, April 1, 2013

  $ 1,990      $ 15,223      $ 4,279      $ 3,248      $ 846      $ 141      $ 54      $ 658      $ 26,439   

Charge-offs

    (76     (1,481     (1,471     (65     0        0        0        0        (3,093

Recoveries

    154        8        0        10        0        4        0        0        176   

Provision for loan losses

    417        2,935        1,509        359        (168     (39     2        (395     4,620   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance, June 30, 2013

  $ 2,485      $ 16,685      $ 4,317      $ 3,552      $ 678      $ 106      $ 56      $ 263      $ 28,142   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six months ended June 30, 2013

                 

Beginning Balance, January 1, 2013

  $ 1,477      $ 15,439      $ 3,991      $ 3,233      $ 750      $ 154      $ 71      $ 722      $ 25,837   

Charge-offs

    (96     (1,891     (1,471     (198     0        0        0        0        (3,656

Recoveries

    165        60        0        7        0        9        0        0        241   

Provision for loan losses

    939        3,077        1,797        510        (72     (57     (15     (459     5,720   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance, June 30, 2013

  $ 2,485      $ 16,685      $ 4,317      $ 3,552      $ 678      $ 106      $ 56      $ 263      $ 28,142   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At June 30, 2013

                 

Loans:

                 

Individually evaluated for impairment

  $ 10,147      $ 33,344      $ 10,970      $ 2,901      $ 0      $ 77      $ 0      $ 0      $ 57,439   

Collectively evaluated for impairment

    180,933        1,200,004        31,695        121,973        143,925        1,228        7,560        0        1,687,318   

Loans acquired with credit deterioration

    5,159        58,034        16,563        15,121        5,507        503        0        0        100,887   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans receivable, excluding deferred fees and costs

  $ 196,239      $ 1,291,382      $ 59,228      $ 139,995      $ 149,432      $ 1,808      $ 7,560      $ 0      $ 1,845,644   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses:

                 

Individually evaluated for impairment

  $ 602      $ 1,818      $ 1,533      $ 327      $ 0      $ 0      $ 0      $ 0      $ 4,280   

Collectively evaluated for impairment

    1,477        9,402        279        1,022        76        48        56        263        12,623   

Loans acquired with credit deterioration

    406        5,465        2,505        2,203        602        58        0        0        11,239   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Allowance for loan losses

  $ 2,485      $ 16,685      $ 4,317      $ 3,552      $ 678      $ 106      $ 56      $ 263      $ 28,142   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The non-covered manufactured housing portfolio was purchased in August 2010. A portion of the purchase price may be used to reimburse the Bank under the specified terms in the purchase agreement for defaults of the underlying borrower and other specified items. At June 30, 2014 and 2013, funds available for reimbursement, if necessary, were $3.2 million and $2.7 million, respectively. Each quarter, these funds are evaluated to determine if they would be sufficient to absorb probable losses within the manufactured housing portfolio.

 

27


Table of Contents

The changes in accretable yield related to purchased-credit-impaired loans for the three and six months ended June 30, 2014 and 2013 were as follows:

 

For the three months ended June 30,

   2014     2013  
(amounts in thousands)             

Accretable yield balance, beginning of period

   $ 20,619      $ 29,665   

Accretion to interest income

     (543     (1,601

Reclassification from nonaccretable difference and disposals, net

     (385     (415
  

 

 

   

 

 

 

Accretable yield balance, end of period

   $ 19,691      $ 27,649   
  

 

 

   

 

 

 

For the six months ended June 30,

   2014     2013  
(amounts in thousands)             

Accretable yield balance, beginning of period

   $ 22,557      $ 32,174   

Accretion to interest income

     (1,623     (3,672

Reclassification from nonaccretable difference and disposals, net

     (1,243     (853
  

 

 

   

 

 

 

Accretable yield balance, end of period

   $ 19,691      $ 27,649   
  

 

 

   

 

 

 

NOTE 9 — BORROWINGS

On June 26, 2014, Customers Bancorp, Inc. closed a private placement transaction in which it issued $25 million of 4.625% senior notes due 2019, and Customers Bank closed a private placement transaction in which it issued $110 million of fixed-to-floating-rate subordinated notes due 2029. The aggregate net proceeds from the sale of the notes totaled $133.2 million.

The senior notes bear interest at a rate of 4.625%, and interest will be paid semi-annually in arrears in June and December. The subordinated notes will bear interest at an annual fixed rate of 6.125% until June 26, 2024, and interest will be paid semiannually. From June 26, 2024, the subordinated notes will bear an annual interest rate equal to three-month LIBOR plus 344.3 basis points until maturity on June 26, 2029. Customers Bank has the ability to call the subordinated notes, in whole or in part, at a redemption price equal to 100 percent of the principal balance at certain times on or after June 26, 2024.

The subordinated notes qualify as Tier 2 capital for regulatory capital purposes.

During second quarter 2014, Customers Bank borrowed $200 million of long-term FHLB advances. On May 13, 2014, $100 million was issued at a fixed rate of 1.04% with a maturity on May 15, 2017. On May 20, 2014, there were two additional issuances of $50 million, at fixed rates of 0.54 % and 1.44%, maturing on May 20, 2016 and May 21, 2018, respectively.

NOTE 10 — SHARE-BASED COMPENSATION

The following information includes the effects of changes in stock options and exercise prices and restricted stock units resulting from the 10% stock dividend declared on May 15, 2014 and issued on June 30, 2014.

Stock Options

During the six months ended June 30, 2014, options to purchase an aggregate of 114,978 shares of voting common stock were granted to certain officers and team members. The options are subject to five-year cliff vesting. The fair values of the options were estimated using the Black-Scholes option pricing model. The following table presents the weighted-average assumptions used and the resulting weighted-average fair value of the options granted.

 

     June 30, 2014  

Weighted-average risk-free interest rate

     2.20

Expected dividend yield

     0.00

Weighted-average expected volatility

     17.55

Weighted-average expected life (in years)

     7.00   

Weighted-average fair value of each option granted

   $ 4.45   

 

28


Table of Contents

The following table summarizes stock option activity for the six months ended June 30, 2014.

 

     Number
of Options
    Weighted-
average

Exercise
Price
     Weighted-
average
Remaining
Contractual
Term in Years 
     Aggregate
Intrinsic
Value
 
     (dollars in thousands, except Weighted-average exercise price)  

Outstanding at January 1, 2014

     3,057,435      $ 12.42         

Granted

     114,978        17.71         

Forfeited

     (7,696     17.69         
  

 

 

         

Outstanding at June 30, 2014

     3,164,717      $ 12.60         7.70       $ 23,478   
  

 

 

         

 

 

 

Exercisable at June 30, 2014

     13,683      $ 16.67         3.04       $ 71   
  

 

 

         

 

 

 

Also during the six months ended June 30, 2014, 157,459 restricted stock units were granted to certain officers and team members. Of the aggregate restricted stock units, 52,537 were granted under the Bonus Recognition and Retention Program and are subject to five-year cliff vesting. The remainders are subject to three-year cliff vesting. The following table summarizes restricted stock activity for the six months ended June 30, 2014.

 

     Restricted
Stock Units
    Weighted-
average grant-
date fair value
 

Outstanding and unvested at January 1, 2014

     674,810      $ 11.81   

Granted

     157,459        17.65   

Vested

     (37,857     10.91   

Forfeited

     (2,901     11.45   
  

 

 

   

Outstanding and unvested at June 30, 2014

     791,511      $ 13.01   
  

 

 

   

Total share-based compensation expense for the six months ended June 30, 2014 and 2013 was $2.0 million and $1.5 million, respectively.

Customers Bancorp has a policy that permits its directors to elect to receive shares of voting common stock in lieu of their cash retainers. In January 2014, Customers Bancorp issued 28,095 shares of voting common stock with a fair value of $0.5 million to the directors as compensation for their services during 2013. During the six months ended June 30, 2014, Customers Bancorp issued 16,885 shares of voting common stock with a fair value of $0.3 million to directors as compensation for their services during the first six months of 2014. The fair values were determined based on the opening price of the common stock on the day the shares were issued.

 

29


Table of Contents

NOTE 11 — REGULATORY MATTERS

The Bank and the Bancorp are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can result in certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bancorp’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank and Bancorp must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items, as calculated under the regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Bank and Bancorp to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (as defined in the regulations). At June 30, 2014 and December 31, 2013, the Bank and Bancorp met all capital adequacy requirements to which they were subject.

To be categorized as well capitalized, an institution must maintain minimum total risk based, Tier 1 risk based and Tier 1 leveraged ratios as set forth in the following table:

 

     Actual     For Capital Adequacy
Purposes
    To Be Well Capitalized
Under
Prompt Corrective Action
Provisions
 
(dollars in thousands)    Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of June 30, 2014:

               

Total capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 548,583         12.82   $ 342,299         8.0     N/A         N/A   

Customers Bank

   $ 572,550         13.47   $ 339,919         8.0   $ 424,899         10.0

Tier 1 capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 410,397         9.59   $ 171,149         4.0     N/A         N/A   

Customers Bank

   $ 434,364         10.22   $ 169,960         4.0   $ 254,939         6.0

Tier 1 capital (to average assets)

               

Customers Bancorp, Inc.

   $ 410,397         7.82   $ 209,853         4.0     N/A         N/A   

Customers Bank

   $ 434,364         8.33   $ 208,696         4.0   $ 260,870         5.0

As of December 31, 2013:

               

Total capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 411,527         13.21   $ 249,196         8.0     N/A         N/A   

Customers Bank

   $ 435,432         14.11   $ 246,936         8.0   $ 308,670         10.0

Tier 1 capital (to risk weighted assets)

               

Customers Bancorp, Inc.

   $ 387,529         12.44   $ 124,598         4.0     N/A         N/A   

Customers Bank

   $ 411,434         13.33   $ 123,468         4.0   $ 185,202         6.0

Tier 1 capital (to average assets)

               

Customers Bancorp, Inc.

   $ 387,529         10.11   $ 153,310         4.0     N/A         N/A   

Customers Bank

   $ 411,434         10.81   $ 152,191         4.0   $ 190,239         5.0

NOTE 12 — DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The Bancorp uses fair value measurements to record fair value adjustments to certain assets and liabilities to disclose the fair value of its financial instruments. FASB ASC 825, Financial Instruments, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Bancorp, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments. However, many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. For fair value disclosure purposes, the Bancorp utilized certain fair value measurement criteria under the FASB ASC 820, Fair Value Measurements and Disclosures, as explained below.

In accordance with ASC 820, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bancorp’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

 

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The fair value guidance provides a consistent definition of fair value, focusing on an exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

 

Level 1:    Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:    Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:    Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

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.

The following methods and assumptions were used to estimate the fair values of the Bancorp’s financial instruments as of June 30, 2014 and December 31, 2013:

Cash and cash equivalents:

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values. These assets are included as Level 1 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Investment securities:

The fair value of investment securities available for sale are determined by obtaining quoted market prices on nationally recognized and foreign securities exchanges (Level 1), matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3). These assets are included as Level 1, 2, or 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

The carrying amount of FHLB, Federal Reserve Bank, and other restricted stock approximates fair value, and considers the limited marketability of such securities. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans held for sale - Residential mortgage loans:

The Bancorp generally estimates the fair values of loans held for sale based on commitments on hand from investors within the secondary market for loans with similar characteristics. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans held for sale - Mortgage warehouse loans:

The fair value of mortgage warehouse loans is the amount of cash initially advanced to fund the mortgage, plus accrued interest and fees, as specified in the respective agreements. The loan is used by mortgage companies as short-term bridge financing between the funding of mortgage loans and the finalization of the sale of the loans to an investor. Changes in fair value are not expected to be recognized since at inception of the transaction the underlying loans have already been sold to an approved investor. Additionally, the interest rate is variable, and the transaction is short-term, with an average life of 17 days from purchase to sale. These assets are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

 

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Loans receivable, net of allowance for loan losses:

The fair values of loans held for investment are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Impaired loans:

Impaired loans are those that are accounted for under ASC 450, Contingencies, in which the Bancorp has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties that collateralize the loans, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

FDIC loss sharing receivable:

The FDIC loss sharing receivable is measured separately from the related covered assets, as it is not contractually embedded in the assets and is not transferable with the assets should the assets be sold. Fair value is estimated using projected cash flows related to the loss sharing agreements based on the estimated losses to be incurred on the loans and the expected reimbursements for losses using the applicable loss share percentages. These cash flows are discounted to reflect the estimated timing of the receipt of the loss share reimbursement from the FDIC. This asset is included as Level 3 fair value, based upon the lowest level of input that is significant to the fair value measurements.

Other real estate owned:

The fair value of OREO is determined using appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs). All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice (“USPAP”). Appraisals are certified to the Bancorp and performed by appraisers on the Bancorp’s approved list of appraisers. Evaluations are completed by a person independent of management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value”. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Accrued interest receivable and payable:

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value. These assets and liabilities are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Deposit liabilities:

The fair values disclosed for deposits (e.g., interest and noninterest checking, passbook savings and money market deposit accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). These liabilities are included as Level 1 fair values, based upon the lowest level of input that is significant to the fair value measurements. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits. These liabilities are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Federal funds purchased:

For these short-term instruments, the carrying amount is considered a reasonable estimate of fair value. These liabilities are included as Level 1 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Borrowings:

Borrowings consist of long-term and short-term FHLB advances, five-year senior unsecured notes, and subordinated debt. For the short-term borrowings, the carrying amount is considered a reasonable estimate of fair value and is included as Level 1. Fair values of long-term FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. The prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. Fair values of subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk

 

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characteristics, terms and remaining maturity. For the newly issued $25 million senior unsecured notes, the carrying value was considered a reasonable estimate of fair value as of second quarter 2014 because the notes were issued in an orderly transaction between willing market participants on June 26, 2014. These liabilities are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements. The $63 million senior unsecured notes issued during third quarter 2013 are traded on The NASDAQ Stock Market, and their price can be obtained daily. This fair value measurement is classified as Level 1.

Derivatives (Assets and Liabilities):

The fair values of interest rate swaps and credit derivatives are determined using models that incorporate readily observable market data into a market standard methodology. This methodology nets the discounted future fixed cash receipts and the discounted expected variable cash payments. The discounted variable cash payments are based on expectations of future interest rates derived from observable market interest rate curves. In addition, fair value is adjusted for the effect of nonperformance risk by incorporating credit valuation adjustments for the Bancorp and its counterparties. These assets and liabilities are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

The fair values of the residential mortgage loan commitments are derived from the estimated fair values that can be generated when the underlying mortgage loan is sold in the secondary market. The Bancorp uses commitments on hand from third party investors to estimate an exit price, and adjusts for the probability of the commitment being exercised based on the Bancorp’s internal experience (i.e., pull-through rate). These assets and liabilities are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Off-balance-sheet financial instruments:

Fair values for the Bancorp’s off-balance-sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. These financial instruments are included as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements. At June 30, 2014 and December 31, 2013, there were no off-balance-sheet financial instruments in excess of their contract value.

The following information should not be interpreted as an estimate of the fair value of the entire Bancorp since a fair value calculation is only provided for a limited portion of the Bancorp’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making these estimates, comparisons between the Bancorp’s disclosures and those of other companies may not be meaningful.

 

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The estimated fair values of the Bancorp’s financial instruments were as follows at June 30, 2014 and December 31, 2013.

 

                                                                                         
                   Fair Value Measurements at June 30, 2014  
       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)
 
(amounts in thousands)                                   

Assets:

              

Cash and cash equivalents

   $ 265,534       $ 265,534       $ 265,534       $ 0       $ 0   

Investment securities, available for sale

     425,061         425,061         23,450         401,611         0   

Loans held for sale

     1,061,395         1,061,395         0         1,061,395         0   

Loans receivable, net of allowance for loan losses

     3,615,918         3,642,418         0         0         3,642,418   

FHLB, Federal Reserve Bank and other restricted stock

     75,558         75,558         0         75,558         0   

Accrued interest receivable

     11,613         11,613         0         11,613         0   

FDIC loss sharing receivable

     8,919         8,919         0         0         8,919   

Derivatives

     6,097         6,097         0         6,043         54   

Liabilities:

              

Deposits

   $ 3,690,894       $ 3,656,978       $ 555,936       $ 3,101,042       $ 0   

FHLB advances

     1,301,500         1,303,876         991,500         312,376         0   

Other borrowings

     88,250         90,780         65,780         25,000         0   

Subordinated debt

     112,000         111,987         0         111,987         0   

Derivatives

     7,189         7,189         0         7,189         0   

Accrued interest payable

     1,836         1,836         0         1,836         0   

 

                                                                                         
                   Fair Value Measurements at December 31, 2013  
     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)
 
(amounts in thousands)                                   

Assets:

              

Cash and cash equivalents

   $ 233,068       $ 233,068       $ 233,068       $ 0       $ 0   

Investment securities, available for sale

     497,573         497,573         20,714         476,859         0   

Loans held for sale

     747,593         747,593         0         747,593         0   

Loans receivable, net of allowance for loan losses

     2,441,080         2,444,900         0         0         2,444,900   

FHLB, Federal Reserve Bank and other stock

     43,514         43,514         0         43,514         0   

Accrued interest receivable

     8,362         8,362         0         8,362         0   

FDIC loss sharing receivable

     10,046         10,046         0         0         10,046   

Derivatives

     3,763         3,763         0         3,523         240   

Liabilities:

              

Deposits

   $ 2,959,922       $ 2,919,935       $ 478,103       $ 2,441,832       $ 0   

Federal funds purchased

     13,000         13,000         13,000         0         0   

FHLB advances

     706,500         708,025         596,500         111,525         0   

Other borrowings

     63,250         64,768         64,768         0         0   

Subordinated debt

     2,000         2,000         0         2,000         0   

Derivatives

     3,537         3,537         0         3,537         0   

Accrued interest payable

     1,675         1,675         0         1,675         0   

 

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For financial assets and liabilities measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2014 and December 31, 2013 were as follows:

 

     June 30, 2014  
     Fair Value Measurements at the End of the Reporting Period Using  
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total  
(amounts in thousands)                            

Measured at Fair Value on a Recurring Basis:

           

Assets

           

Available-for-sale securities:

           

Mortgage-backed securities

   $ 0       $ 401,611       $ 0       $ 401,611   

Equity securities

     23,450         0         0         23,450   

Derivatives (1)

     0         6,043         54         6,097   

Loans held for sale – fair value option

     0         1,061,395         0         1,061,395   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets - recurring fair value measurements

   $ 23,450       $ 1,469,049       $ 54       $ 1,492,553   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Derivatives (2)

   $ 0       $ 7,189       $ 0       $ 7,189   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured at Fair Value on a Nonrecurring Basis:

           

Assets

           

Impaired loans, net of specific reserves of $2,578

   $ 0       $ 0       $ 3,844       $ 3,844   

Other real estate owned

     0         0         793         793   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets - nonrecurring fair value measurements

   $ 0       $ 0       $ 4,637       $ 4,637   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     Fair Value Measurements at the End of the Reporting Period Using  
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total  
(amounts in thousands)                            

Measured at Fair Value on a Recurring Basis:      

           

Assets

           

Available-for-sale securities:

           

Mortgage-backed securities

   $ 0       $ 451,536       $ 0       $ 451,536   

Corporate notes

     0         25,323         0         25,323   

Equity securities

     20,714         0         0         20,714   

Derivatives (1)

     0       $ 3,523            240       $ 3,736   

Loans held for sale – fair value option

     0         747,593         0         747,593   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets - recurring fair value measurements

   $ 20,714       $ 1,227,975       $ 240       $ 1,248,929   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Derivatives (2)

     0       $ 3,537         0       $ 3,537   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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     December 31, 2013  
     Fair Value Measurements at the End of the Reporting Period Using  
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total  
(amounts in thousands)                            

Measured at Fair Value on a Nonrecurring Basis:

           

Assets

           

Impaired loans, net of specific reserves of $2,342

   $ 0       $ 0       $ 3,836       $ 3,836   

Other real estate owned

     0         0         335         335   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets - nonrecurring fair value measurements

   $ 0       $ 0       $ 4,171       $ 4,171   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in Other Assets
(2) Included in Other Liabilities

The changes in Level 3 assets measured at fair value on a recurring basis for the three and six months ended June 30, 2014 and 2013 are summarized as follows.

 

     Residential
Mortgage
Loan
Commitments
 
(amounts in thousands)       

Balance at April 1, 2014

   $ 103   

Issuances

     54   

Settlements

     (103
  

 

 

 

Balance at June 30, 2014

   $ 54   
  

 

 

 

 

     Loans
Held for
      Sale (1)      
 
(amounts in thousands)       

Balance at April 1, 2013

   $ 3,173   

Recoveries

     (1,463

Sales

     (1,013

Transfer from loans held for sale to other assets (1)

     (697
  

 

 

 

Balance at June 30, 2013

   $ 0   
  

 

 

 

 

     Residential
Mortgage
Loan
Commitments
 
(amounts in thousands)       

Balance at January 1, 2014

   $ 240   

Issuances

     157   

Settlements

     (343
  

 

 

 

Balance at June 30, 2014

   $ 54   
  

 

 

 

 

     Loans
Held for
      Sale (1)      
 
(amounts in thousands)       

Balance at January 1, 2013

   $ 0   

Transfer from Level 2 to Level 3 (1)

     3,173   

Recoveries

     (1,463

Sales

     (1,013

Transfer from loans held for sale to other assets (1)

     (697
  

 

 

 

Balance at June 30, 2013

   $ 0   
  

 

 

 

 

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(1) The Bancorp’s policy is to recognize transfers between levels when events or circumstances warrant transfers. There were no transfers between levels during the first six months of 2014. During first quarter 2013, a suspected fraud was discovered in the Bank’s loans held-for-sale portfolio. Total loans involved in this fraud initially appeared to be $5.2 million, and management believed the range of possible loss to have been between $1.5 million and $3.2 million. Accordingly, management provided a loss contingency of $2.0 million at March 31, 2013. Due to the uncertainty surrounding the amount of loss, management transferred these loans and the related loss contingency from Level 2 to Level 3. During second quarter 2013, the Bank determined that an aggregate of $1.0 million of the loans were not involved in the fraud, and these loans were subsequently sold. In addition, the Bank recovered $1.5 million in cash from the alleged perpetrator. Since it was determined that these assets no longer met the definition of a loan, and since the Bank is pursuing restitution through the involved parties, the Bank determined this to be a receivable. As a result, the remaining aggregate $2.7 million of loans and the related $2.0 million reserve were transferred to other assets.

The following table summarizes financial assets and financial liabilities measured at fair value as of June 30, 2014 and December 31, 2013 on a recurring and nonrecurring basis for which the Bancorp utilized Level 3 inputs to measure fair value.

 

     Quantitative Information about Level 3 Fair Value Measurements  

June 30, 2014

   Fair Value
Estimate
     Valuation Technique   Unobservable Input   Range (Weighted
Average) (3)
 
(amounts in thousands)                      

Impaired loans

   $ 3,844       Collateral appraisal (1)   Liquidation expenses (2)     -8

Other real estate owned

   $ 793       Collateral appraisal (1)   Liquidation expenses (2)     -8

Residential mortgage loan commitments

   $ 54       Adjusted market bid   Pull-through rate     75
     Quantitative Information about Level 3 Fair Value Measurements  

December 31, 2013

   Fair Value
Estimate
     Valuation Technique   Unobservable Input   Range (Weighted
Average) (3)
 
(amounts in thousands)                      

Impaired loans

   $ 3,836       Collateral appraisal (1)   Liquidation expenses (2)     -3% to -8% (-5.5%)   

Other real estate owned

   $ 335       Collateral appraisal (1)   Liquidation expenses (2)     -3% to -8% (-5.5%)   

Residential mortgage loan commitments

   $ 240       Adjusted market bid   Pull-through rate     80%   

 

(1) Obtained from approved independent appraisers. Appraisals are current and in compliance with credit policy. The Bancorp does not discount appraisals.
(2) Fair value is adjusted for costs to sell.
(3) Presented as a percentage of the value determined by appraisal.

NOTE 13 — DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Risk Management Objectives of Using Derivatives

Customers Bancorp is exposed to certain risks arising from both its business operations and economic conditions. Customers Bancorp manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and durations of its assets and liabilities. Specifically, Customers Bancorp enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Customers Bancorp’s derivative financial instruments are used to manage differences in the amount, timing, and duration of Customers Bancorp’s known or expected cash receipts and its known or expected cash payments principally related to certain fixed-rate borrowings. Customers Bancorp also has interest-rate derivatives resulting from a service provided to certain qualifying customers, and therefore, they are not used to manage the Bank’s interest-rate risk in assets or liabilities. The Bank manages a matched book with respect to its derivative instruments used in this customer service in order to minimize its net risk exposure resulting from such transactions.

Cash Flow Hedges of Interest Rate Risk

Customers Bancorp’s objectives in using interest-rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, the Bancorp primarily uses interest rate swaps as part of its interest-rate-risk management strategy. Interest-rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Bancorp making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

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The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three and six months ended June 30, 2014, such derivatives were used to hedge the variable cash flows associated with a forecasted issuance of debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three and six months ended June 30, 2014, Customers Bancorp did not record any hedge ineffectiveness.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Bancorp’s variable-rate debt. The Bancorp does not expect to reclassify any amounts from accumulated other comprehensive income to interest expense during the next 12 months as Customers Bancorp’s derivatives are effective after April 2016.

Customers Bancorp is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 24 months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

At June 30, 2014, Customers Bancorp had one outstanding interest rate derivative with a notional amount of $150.0 million that was designated as a cash flow hedge of interest rate risk.

Derivatives Not Designated as Hedging Instruments

The Bank executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies (typically the loan customers will swap a floating rate loan to a fixed rate loan). The customer interest rate swaps are simultaneously offset by interest rate swaps that the Bank executes with a third party in order to minimize interest rate risk exposure resulting from such transactions. Since the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting third-party market swaps are recognized directly in earnings. At June 30, 2014, the Bancorp had 42 interest rate swaps with an aggregate notional amount of $251.1 million related to this program. At December 31, 2013, the Bancorp had 28 interest rate swaps with an aggregate notional amount of $150.3 million related to this program.

The Bank enters into residential mortgage loan commitments in connection with its mortgage banking activities to fund mortgage loans at specified rates and times in the future. These commitments are short-term in nature and generally expire in 30 to 60 days. The residential mortgage loan commitments that relate to the origination of mortgage loans that will be held for sale are considered derivative instruments under applicable accounting guidance and are reported at fair value, with changes in fair value recorded directly to earnings. At June 30, 2014 and December 31, 2013, the Bank had an outstanding notional balance of residential mortgage loan commitments of $7.6 million and $7.1 million, respectively.

During first quarter 2014, the Bank purchased credit derivatives to hedge the performance risk associated with one of its counterparties. These derivatives are not designated as hedging instruments and are reported at fair value, with changes in fair value reported directly in earnings. At June 30, 2014, the Bank had an outstanding notional balance of credit derivatives of $13.4 million.

Fair Value of Derivative Instruments on the Balance Sheet

The following table presents the fair value of the Bancorp’s derivative financial instruments as well as the classification on the balance sheet as of June 30, 2014 and December 31, 2013.

 

     June 30, 2014  
     Derivative Assets      Derivative Liabilities  
     Balance Sheet
Location
   Fair Value      Balance Sheet
Location
   Fair Value  
(amounts in thousands)                        

Derivatives designated as cash flow hedges:

           

Interest rate swaps

   Other assets    $ 0       Other liabilities    $ 957   
     

 

 

       

 

 

 

Total

      $ 0          $ 957   
     

 

 

       

 

 

 

Derivatives not designated as hedging instruments:

           

Interest rate swaps

   Other assets    $ 5,910       Other liabilities    $ 6,232   

Credit contracts

   Other assets      133       Other liabilities      0   

Residential mortgage loan commitments

   Other assets      54       Other liabilities      0   
     

 

 

       

 

 

 

Total

      $ 6,097          $ 6,232   
     

 

 

       

 

 

 

 

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Table of Contents
     December 31, 2013  
     Derivative Assets      Derivative Liabilities  
     Balance Sheet
Location
   Fair Value      Balance Sheet
Location
   Fair Value  
(amounts in thousands)                        

Derivatives not designated as hedging instruments:

           

Interest rate swaps

   Other assets    $ 3,523       Other liabilities    $ 3,537   

Residential mortgage loan commitments

   Other assets      240       Other liabilities      0   
     

 

 

       

 

 

 

Total

      $ 3,763          $ 3,537   
     

 

 

       

 

 

 

Effect of Derivative Instruments on Comprehensive Income

The following tables present the effect of the Bancorp’s derivative financial instruments on comprehensive income for the three and six months ended June 30, 2014 and 2013.

 

    

Three Months Ended June 30, 2014

 
    

Income Statement Location

   Amount of income (loss)
recognized in earnings
 
(amounts in thousands)            

Derivatives not designated as hedging instruments:

     

Interest rate swaps

   Other non-interest income    $ (250

Credit contracts

   Other non-interest income      14   

Residential mortgage loan commitments

   Mortgage loan and banking income      (49
     

 

 

 

Total

      $ (285
     

 

 

 

 

    

Three Months Ended June 30, 2013

 
    

Income Statement Location

   Amount of income (loss)
recognized in earnings
 
(amounts in thousands)            

Derivatives not designated as hedging instruments:

     

Interest rate swaps

   Other non-interest income                  $ 155   
     

 

 

 

 

    

Six Months Ended June 30, 2014

 
    

Income Statement Location

   Amount of income (loss)
recognized in earnings
 
(amounts in thousands)            

Derivatives not designated as hedging instruments:

     

Interest rate swaps

   Other non-interest income    $ (309

Credit contracts

   Other non-interest income      (135

Residential mortgage loan commitments

   Mortgage loan and banking income      (186
     

 

 

 

Total

      $ (630
     

 

 

 

 

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     Six Months Ended June 30, 2013  
     Income Statement Location    Amount of income (loss)
recognized in earnings
 
(amounts in thousands)            

Derivatives not designated as hedging instruments:

     

Interest rate swaps

   Other non-interest income    $ 198   
     

 

 

 

 

     Three Months Ended June 30, 2014  
           Location of Loss    Amount of Loss  
     Amount of Loss     Reclassified from    Reclassified from  
     Recognized in OCI on     Accumulated OCI into    Accumulated OCI into  
     Derivatives (Effective Portion) (1)     Income (Effective Portion)    Income (Effective Portion)  
(amounts in thousands)                  

Derivative in cash flow hedging relationships:

       

Interest rate swaps

   $ (1,054   Interest expense    $ 0   
  

 

 

      

 

 

 

 

     Six Months Ended June 30, 2014  
           Location of Loss    Amount of Loss  
     Amount of Loss     Reclassified from    Reclassified from  
     Recognized in OCI on     Accumulated OCI into    Accumulated OCI into  
     Derivatives (Effective Portion) (1)     Income (Effective Portion)    Income (Effective Portion)  
(amounts in thousands)                  

Derivative in cash flow hedging relationships:

       

Interest rate swaps

   $ (622   Interest expense    $ 0   
  

 

 

      

 

 

 

 

(1) Net of taxes

Credit-risk-related Contingent Features

By entering into derivative contracts, the Bank is exposed to credit risk. The credit risk associated with derivatives executed with Bank customers is the same as that involved in extending the related loans and is subject to the same standard credit policies. To mitigate the credit-risk exposure to major derivative dealer counterparties, the Bancorp only enters into agreements with those counterparties that maintain credit ratings of high quality.

Agreements with major derivative dealer counterparties contain provisions whereby default on any of the Bancorp’s indebtedness would be considered a default on its derivative obligations. The Bancorp also has entered into agreements that contain provisions under which the counterparty could require the Bancorp to settle its obligations if the Bancorp fails to maintain its status as a well/adequately-capitalized institution. As of June 30, 2014, the fair value of derivatives in a net liability position (which includes accrued interest but excludes any adjustment for nonperformance-risk) related to these agreements was $7.3 million. In addition, the Bancorp has minimum collateral posting thresholds with certain of these counterparties, and at June 30, 2014 had posted $7.4 million as collateral. The Bancorp records cash posted as collateral as a reduction in the outstanding balance of cash and cash equivalents and an increase in the balance of other assets.

 

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Disclosures about Offsetting Assets and Liabilities

The following tables present derivative instruments that are subject to enforceable master netting arrangements. The Bancorp’s interest rate swaps with institutional counterparties are subject to master netting arrangements and are included in the table below.

Interest rate swaps with commercial banking customers and residential mortgage loan commitments are not subject to master netting arrangements and are excluded from the table below. The Bancorp has not made a policy election to offset its derivative positions.

Offsetting of Financial Assets and Derivative Assets

At June 30, 2014

 

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Assets Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Assets      Balance Sheet      Balance Sheet      Instruments      Received      Net Amount  
(amounts in thousands)                                          

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 53       $ 0       $ 53       $ 53       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Offsetting of Financial Liabilities and Derivative Liabilities

At June 30, 2014

 

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Liabilities Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Liabilities      Balance Sheet      Balance Sheet      Instruments      Pledged      Net Amount  
(amounts in thousands)                                          

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 7,141       $ 0       $ 7,141       $ 53       $ 7,088       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Offsetting of Financial Assets and Derivative Assets

At December 31, 2013

 

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Assets Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Assets      Balance Sheet      Balance Sheet      Instruments      Received      Net Amount  
(amounts in thousands)                                          

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 392       $ 0       $ 392       $ 392       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Offsetting of Financial Liabilities and Derivative Liabilities

At December 31, 2013

 

            Gross Amounts      Net Amounts of      Gross Amounts not Offset in the         
            Offset in the      Liabilities Presented      Consolidated Balance Sheet         
     Gross Amount of      Consolidated      in the Consolidated      Financial      Cash Collateral         
     Recognized Liabilities      Balance Sheet      Balance Sheet      Instruments      Pledged      Net Amount  
(amounts in thousands)                                          

Description

                 

Interest rate swap derivatives with institutional counterparties

   $ 3,191       $ 0       $ 3,191       $ 392       $ 2,799       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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

Cautionary Note Regarding Forward-Looking Statements

This report and all attachments hereto as well as other written or oral communications made from time to time by Customers Bancorp may contain certain forward-looking information within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. These statements relate to future events or future predictions, including events or predictions relating to future financial performance, and are generally identifiable by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “plan,” “intend,” “anticipates,” “strategies” or the negative thereof or comparable terminology, or by discussion of strategy that involve risks and uncertainties. These forward-looking statements are only predictions and estimates regarding future events and circumstances and involve known and unknown risks, uncertainties and other factors, including the risks described under “Risk Factors” that may cause actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. This information is based on various assumptions that may not prove to be correct. These forward-looking statements are subject to significant uncertainties and contingencies, many of which are beyond the control of the Bancorp and the Bank. Although the expectations reflected in the forward-looking statements are currently believed to be reasonable, future results, levels of activity, performance or achievements cannot be guaranteed. Accordingly, there can be no assurance that actual results will meet expectations or will not be materially lower than the results contemplated in this report and attachments hereto. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report or, in the case of documents referred to, the dates of those documents. Neither Customers Bancorp nor the Bank undertakes any obligation to release publicly or otherwise provide any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as may be required under applicable law.

Management’s discussion and analysis represents an overview of the financial condition and results of operations, and highlights the significant changes in the financial condition and results of operations, as presented in the accompanying consolidated financial statements for Customers Bancorp, a financial holding company, and its wholly owned subsidiaries, including Customers Bank. This information is intended to facilitate your understanding and assessment of significant changes and trends related to Customers Bancorp’s financial condition and results of operations as of and for the three and six months ended June 30, 2014. All quarterly information in this Management’s Discussion and Analysis is unaudited. You should read this section in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operation” included in Customers Bancorp’s filing on Form 10-K for the fiscal year ended December 31, 2013.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and that are consistent with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in “NOTE 3 — SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION” to our audited financial statements included in our 2013 Form 10-K and updated in this report on Form 10-Q for the quarterly period ended June 30, 2014.

Certain accounting policies involve significant judgments and assumptions by Customers Bancorp that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions used are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions management makes, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. There have been no material changes in our critical accounting policies, judgments and estimates, including assumptions or estimation techniques utilized, as compared to those disclosed in our 2013 Form 10-K.

Second Quarter Events of Note

Following a successful 2013 and first quarter of 2014, Customers Bancorp continued its strong performance through second quarter 2014. Most notably, total assets were $5.6 billion as of June 30, 2014, an increase of $0.6 billion from March 31, 2014 and $1.5 billion from December 31, 2013. During second quarter 2014, the Bancorp achieved significant organic loan growth in its multi-family loans (up $246 million) and commercial real estate and commercial and industrial loans (up $157 million). Loans held for sale grew $364 million during second quarter 2014 driven by increased lending to mortgage companies as home sales and refinancing activity rebounded nationally. Asset quality remained high and capital ratios exceeded levels established for “well-capitalized” banks. During second quarter 2014, the Bank issued $110 million in fixed-to-floating rate subordinated debt, which increased the Tier 2 capital for the Bank and the Bancorp, and the Bancorp issued $25 million in senior unsecured debt. Financial results for second quarter 2014 included strong earnings of $10.2 million, a record high, or $0.37 per diluted share. Customers Bancorp also declared a 10 percent stock dividend on May 15, 2014 which was issued on June 30, 2014. Amounts reported in common stock, additional paid in capital and retained earnings as of June 30, 2014, as well as all per share amounts in this Form 10-Q for the quarterly period ended June 30, 2014, have been adjusted to give effect to this stock dividend.

 

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Results of Operations

Second Quarter 2014 Compared to Second Quarter 2013

Net income available to common shareholders increased $2.0 million (24.4%) to $10.2 million for the three months ended June 30, 2014, compared to $8.2 million for the three months ended June 30, 2013. The increased net income resulted from increased net interest income of $10.8 million and increased non-interest income of $1.4 million, partially offset by increased non-interest expense of $8.3 million, increased income tax expense of $1.1 million, and increased provision for loan losses of $0.8 million.

Net interest income increased $10.8 million (41.4%) for the three months ended June 30, 2014 to $36.9 million, compared to $26.1 million for the three months ended June 30, 2013. This increase resulted principally from an increase in average loan balances of $1.8 billion, offset in part by a 33 basis point decrease in average yields on interest earning assets to 3.60% net of a 5 basis point decrease in the cost of funding. The reduced yields are primarily driven by a decrease in market interest rates on loans, payoffs on maturing higher yielding loans, and growth of multi-family loans, which have high credit quality but yield less than the average yield on the current loan portfolio.

The provision for loan losses increased by $0.8 million to $2.9 million for the three months ended June 30, 2014, compared to $2.1 million for the same period in 2013. The increase in the provision for loan losses during second quarter 2014 was primarily driven by growth in the portfolio of loans held for investment and reduced estimated benefits from the FDIC loss sharing receivable.

Non-interest income increased $1.4 million during the three months ended June 30, 2014 to $6.9 million, compared to $5.6 million for the three months ended June 30, 2013. The increase in 2014 was attributable to mortgage loan and banking income, which includes a gain realized from the sale of loans acquired from Flagstar Bank (up $1.6 million), management advisory fees earned in conjunction with an equity investment in a foreign entity (up $0.5 million), gains realized from sales of investment securities (up $0.4 million), increased income from bank owned life insurance (up $0.3 million), and increased gains realized from sales of SBA loans (up $0.2 million), offset in part by decreased mortgage warehouse transactional fees (down $1.7 million).

Non-interest expense increased $8.3 million during the three months ended June 30, 2014 to $25.2 million, compared to $16.9 million during the three months ended June 30, 2013. Expenses increased in 2014 principally for salaries and employee benefits as staffing levels grew to support the growing business (up $3.1 million), assessment for FDIC insurance and other regulatory fees as the bank grew and other costs were incurred (up $2.0 million), professional services for loan workout, litigation, and development of materials to respond to increased regulatory inquiries triggered by increasing levels of growth and complexity (up $1.0 million), technology, communication and bank operations to further support and build infrastructure (up $0.6 million), occupancy as the business expansion into new markets and increased activity in existing markets required additional facilities (up $0.5 million), and increased expenses associated with other real estate owned (up $0.4 million).

Income tax expense increased $1.1 million in the three months ended June 30, 2014 to $5.5 million compared to $4.4 million in the same period of 2013. The increase in the income tax expense was primarily due to an increase of $3.1 million in net income before taxes over the same period in 2013.

 

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Net Interest Income

Net interest income (the difference between the interest earned on loans, investments and interest-earning deposits with banks, and interest paid on deposits, borrowed funds and subordinated debt) is the primary source of Customers Bancorp’s earnings. The following table summarizes the Bancorp’s net interest income and related spread and margin for the periods indicated.

 

     Three Months Ended June 30,  
     2014     2013  
     Average
Balance
    Interest
Income or
Expense
     Average
Yield or
Cost
    Average
Balance
    Interest
Income or
Expense
     Average
Yield or
Cost
 
(amounts in thousands)                                       
Assets               

Interest earning deposits

   $ 211,438      $ 133         0.25   $ 178,628      $ 114         0.25

Investment securities, taxable (A)

     448,059        2,543         2.27     181,557        1,082         2.38

Loans held for sale

     777,000        6,715         3.47     1,158,974        11,157         3.86

Loans, taxable (B)

     3,520,211        35,042         3.99     1,696,979        19,099         4.51

Loans, non-taxable (B)

     24,653        178         2.90     14,525        97         2.68

Less: Allowance for loan losses

     (27,452          (26,533     

Other interest-earning assets

     64,063        481         3.01     29,523        124         1.69
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest earning assets

     5,017,972        45,092         3.60     3,233,653        31,673         3.93
    

 

 

        

 

 

    

Non-interest earning assets

     230,017             144,794        
  

 

 

        

 

 

      

Total assets

   $ 5,247,989           $ 3,378,447        
  

 

 

        

 

 

&nb