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Table of Contents

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

FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 001-35522
 
BANC OF CALIFORNIA, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
(State or other jurisdiction of
incorporation or organization)
04-3639825
(IRS Employer Identification No.)
3 MacArthur Place, Santa Ana, California
(Address of principal executive offices)
92707
(Zip Code)
(855) 361-2262
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yes ¨ No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
As of August 1, 2018, the registrant had outstanding 50,181,187 shares of voting common stock and 477,321 shares of Class B non-voting common stock.


Table of Contents

BANC OF CALIFORNIA, INC.
FORM 10-Q QUARTERLY REPORT
June 30, 2018
Table of Contents
 
 
Page
 
 
 
 
 
Item 1 –
 
 
 
Item 2 –
 
 
 
Item 3 –
 
 
 
Item 4 –
 
 
 
 
 
Item 1 –
 
 
 
Item 1A –
 
 
 
Item 2 –
 
 
 
Item 3 –
 
 
 
Item 4 –
 
 
 
Item 5 –
 
 
 
Item 6 –
 
 


2

Table of Contents

Forward-looking Statements
When used in this report and in public stockholder communications, in other documents of Banc of California, Inc. (the Company, we, us and our) filed with or furnished to the Securities and Exchange Commission (the SEC), or in oral statements made with the approval of an authorized executive officer, the words or phrases “believe,” “will,” “should,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “plans,” “guidance” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date made. These statements may relate to our future financial performance, strategic plans or objectives, revenue, expense or earnings projections, or other financial items. By their nature, these statements are subject to numerous uncertainties that could cause actual results to differ materially from those anticipated in the statements.
Factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following:
i.
an ongoing investigation by the SEC may result in adverse findings, reputational damage, the imposition of sanctions, increased costs and other negative consequences;
ii.
management time and resources may be diverted to address the ongoing SEC investigation as well as any related litigation, litigation initiated by stockholders and other litigation, as well as the threat of litigation;
iii.
the costs and effects of litigation, including settlements and judgments;
iv.
our performance may be adversely affected by the management transition we have undergone;
v.
risks that the Company’s merger and acquisition transactions may disrupt current plans and operations and lead to difficulties in customer and employee retention, risks that the costs, fees, expenses and charges related to these transactions could be significantly higher than anticipated and risks that the expected revenues, cost savings, synergies and other benefits of these transactions might not be realized to the extent anticipated, within the anticipated timetables, or at all;
vi.
risks that funds obtained from capital raising activities will not be utilized efficiently or effectively;
vii.
the risk that the savings we actually realize from our recently announced reduction in force and planned reduction in use of third party advisors will be less than anticipated and the risk that the costs associated with the reduction in force will be greater than anticipated;
viii.
a worsening of current economic conditions, as well as turmoil in the financial markets;
ix.
the credit risks of lending activities, which may be affected by deterioration in real estate markets and the financial condition of borrowers, and the operational risks of lending activities, including but not limited to the risk of fraud, any of which credit and operational risks may lead to increased loan and lease delinquencies, losses and non-performing assets in our loan and lease portfolio, and may result in our allowance for loan and lease losses not being adequate to cover actual losses and require us to materially increase our loan and lease loss reserves;
x.
the quality and composition of our securities portfolio;
xi.
changes in general economic conditions, either nationally or in our market areas, or in financial markets;
xii.
continuation of or changes in the historically low short-term interest rate environment, changes in the levels of general interest rates, volatility in the interest rate environment, the relative differences between short- and long-term interest rates, deposit interest rates, and our net interest margin and funding sources;
xiii.
fluctuations in the demand for loans and leases, the number of unsold homes and other properties and fluctuations in commercial and residential real estate values in our market area;
xiv.
our ability to develop and maintain a core deposit base or other low cost funding sources necessary to fund our activities;
xv.
results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, limit our business activities, require us to change our business mix, increase our allowance for loan and lease losses, write-down asset values, or increase our capital levels, or affect our ability to borrow funds or maintain or increase deposits, any of which could adversely affect our liquidity and earnings;
xvi.
legislative or regulatory changes that adversely affect our business, including, without limitation, changes in tax laws and policies and changes in regulatory capital or other rules, as well as additional regulatory burdens, including those that result from being larger than $10 billion in total assets;
xvii.
our ability to control operating costs and expenses;
xviii.
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges;
xix.
errors in estimates of the fair values of certain of our assets and liabilities, which may result in significant changes in valuation;
xx.
the network and computer systems on which we depend could fail or experience a security breach;
xxi.
our ability to attract and retain key members of our senior management team;
xxii.
increased competitive pressures among financial services companies;
xxiii.
changes in consumer spending, borrowing and saving habits;
xxiv.
adverse changes in the securities markets;
xxv.
earthquake, fire or other natural disasters affecting the condition of real estate collateral;
xxvi.
the availability of resources to address changes in laws, rules or regulations or to respond to regulatory actions;
xxvii.
the ability of key third party providers to perform their obligations to us;
xxviii.
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board (FASB) or their application to our business, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
xxix.
share price volatility and reputational risks related to, among other things, speculative trading and certain traders shorting our common shares and attempting to generate negative publicity about us;
xxx.
war or terrorist activities; and
xxxi.
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described in this report and from time to time in other documents that we file with or furnish to the SEC, including, without limitation, the risks described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017.
The Company undertakes no obligation to update any such statement to reflect circumstances or events that occur after the date, on which the forward-looking statement is made, except as required by law.

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Table of Contents

PART I – FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands, except share and per share data)
(Unaudited)

 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Cash and due from banks
$
23,961

 
$
20,117

Interest-earning deposits in financial institutions
361,730

 
367,582

Total cash and cash equivalents
385,691

 
387,699

Securities available-for-sale, at fair value
2,297,124

 
2,575,469

Loans held-for-sale, carried at fair value
12,334

 
66,603

Loans held-for-sale, carried at lower of cost or fair value
1,419

 
466

Loans and leases receivable, net of allowance for loan and lease losses of $56,678 and $49,333 at June 30, 2018 and December 31, 2017, respectively
6,979,326

 
6,610,074

Federal Home Loan Bank and other bank stock, at cost
75,737

 
75,654

Servicing rights, net ($2,062 and $31,852 measured at fair value at June 30, 2018 and December 31, 2017, respectively, and $70 and $29,793 measured at fair value were held-for-sale at June 30, 2018 and December 31, 2017, respectively)
3,869

 
33,708

Other real estate owned, net
710

 
1,796

Premises, equipment, and capital leases, net
135,478

 
135,699

Bank owned life insurance
105,917

 
104,851

Goodwill
37,144

 
37,144

Investments in alternative energy partnerships, net
44,806

 
48,826

Deferred income taxes, net
42,334

 
31,074

Income tax receivable
7,995

 
8,739

Other intangible assets, net
7,683

 
9,353

Other assets
155,298

 
161,797

Assets of discontinued operations
26,415

 
38,900

Total assets
$
10,319,280

 
$
10,327,852

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Noninterest-bearing deposits
$
1,005,032

 
$
1,071,608

Interest-bearing deposits
6,130,762

 
6,221,295

Total deposits
7,135,794

 
7,292,903

Advances from Federal Home Loan Bank
1,805,000

 
1,695,000

Long term debt, net
173,017

 
172,941

Reserve for loss on repurchased loans
3,149

 
6,306

Due on unsettled securities purchases
132,546

 

Accrued expenses and other liabilities
81,086

 
140,575

Liabilities of discontinued operations

 
7,819

Total liabilities
9,330,592

 
9,315,544

Commitments and contingent liabilities

 

Preferred stock
269,071

 
269,071

Common stock, $0.01 par value per share, 446,863,844 shares authorized; 51,726,335 shares issued and 50,142,955 shares outstanding at June 30, 2018; 51,666,725 shares issued and 50,083,345 shares outstanding at December 31, 2017
517

 
517

Class B non-voting non-convertible common stock, $0.01 par value per share, 3,136,156 shares authorized; 403,778 shares issued and outstanding at June 30, 2018 and 508,107 shares issued and outstanding at December 31, 2017
4

 
5

Additional paid-in capital
623,372

 
621,435

Retained earnings
143,880

 
144,839

Treasury stock, at cost (1,583,380 shares at June 30, 2018 and December 31, 2017)
(28,786
)
 
(28,786
)
Accumulated other comprehensive income (loss), net
(19,370
)
 
5,227

Total stockholders’ equity
988,688

 
1,012,308

Total liabilities and stockholders’ equity
$
10,319,280

 
$
10,327,852

See Accompanying Notes to Consolidated Financial Statements (Unaudited)


4

Table of Contents

BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Interest and dividend income
 
 
 
 
 
 
 
Loans and leases, including fees
$
81,307

 
$
69,661

 
$
156,219

 
$
139,168

Securities
21,455

 
24,996

 
43,086

 
52,235

Other interest-earning assets
2,423

 
1,783

 
4,587

 
3,879

Total interest and dividend income
105,185

 
96,440

 
203,892

 
195,282

Interest expense
 
 
 
 
 
 
 
Deposits
20,315

 
14,942

 
37,110

 
28,902

Federal Home Loan Bank advances
9,539

 
2,774

 
16,931

 
4,197

Securities sold under repurchase agreements
211

 
180

 
961

 
186

Long term debt and other interest-bearing liabilities
2,356

 
3,044

 
4,688

 
6,016

Total interest expense
32,421

 
20,940

 
59,690

 
39,301

Net interest income
72,764

 
75,500

 
144,202

 
155,981

Provision for loan and lease losses
2,653

 
2,503

 
22,152

 
5,086

Net interest income after provision for loan and lease losses
70,111

 
72,997

 
122,050

 
150,895

Noninterest income
 
 
 
 
 
 
 
Customer service fees
1,491

 
1,669

 
3,083

 
3,292

Loan servicing income
948

 
132

 
3,259

 
2,888

Income from bank owned life insurance
533

 
616

 
1,066

 
1,197

Net gain on sale of securities available-for-sale
278

 
1,099

 
5,519

 
4,455

Net gain on sale of loans
821

 
983

 
780

 
5,002

Net loss on sale of mortgage servicing rights
(155
)
 

 
(2,450
)
 

Other income
4,145

 
1,208

 
5,386

 
3,776

Total noninterest income
8,061

 
5,707

 
16,643

 
20,610

Noninterest expense
 
 
 
 
 
 
 
Salaries and employee benefits
29,440

 
33,348

 
60,555

 
65,791

Occupancy and equipment
7,883

 
9,776

 
15,570

 
20,444

Professional fees
6,303

 
11,794

 
15,480

 
26,867

Outside service fees
413

 
1,119

 
2,959

 
3,002

Data processing
1,678

 
2,246

 
3,334

 
4,425

Advertising and promotion
2,864

 
1,117

 
6,141

 
2,842

Regulatory assessments
2,196

 
1,140

 
4,288

 
3,581

Loss on investments in alternative energy partnerships
1,808

 
9,761

 
1,774

 
18,443

Reversal of provision for loan repurchases
(218
)
 
(403
)
 
(2,006
)
 
(728
)
Amortization of intangible assets
827

 
1,056

 
1,670

 
2,146

Impairment on intangible assets

 

 

 
336

Restructuring expense
3,983

 
82

 
3,983

 
5,369

All other expense
5,362

 
5,283

 
8,591

 
13,697

Total noninterest expense
62,539

 
76,319

 
122,339

 
166,215

Income from continuing operations before income taxes
15,633

 
2,385

 
16,354

 
5,290

Income tax expense (benefit)
1,779

 
(12,753
)
 
(4,574
)
 
(19,224
)
Income from continuing operations
13,854

 
15,138

 
20,928

 
24,514

Income from discontinued operations before income taxes (including net gain on disposal of $272 and $236, respectively, for the three months ended June 30, 2018 and 2017 and $1,275 and $13,538, respectively, for the six months ended June 30, 2018 and 2017)
1,281

 
(4,991
)
 
3,325

 
8,357

Income tax expense (benefit)
355

 
(2,110
)
 
915

 
3,413

Income (loss) from discontinued operations
926

 
(2,881
)
 
2,410

 
4,944

Net income
14,780

 
12,257

 
23,338

 
29,458

Preferred stock dividends
5,113

 
5,113

 
10,226

 
10,226

Net income available to common stockholders
$
9,667

 
$
7,144

 
$
13,112

 
$
19,232

Basic earnings per common share
 
 
 
 
 
 
 
Income from continuing operations
$
0.17

 
$
0.20

 
$
0.20

 
$
0.27

Income (loss) from discontinued operations
0.02

 
(0.06
)
 
0.05

 
0.10

Net income
$
0.19

 
$
0.14

 
$
0.25

 
$
0.37

Diluted earnings per common share
 
 
 
 
 
 
 
Income from continuing operations
$
0.16

 
$
0.20

 
$
0.20

 
$
0.27

Income (loss) from discontinued operations
0.02

 
(0.06
)
 
0.05

 
0.10

Net income
$
0.18

 
$
0.14

 
$
0.25

 
$
0.37

Basic earnings per class B common share
 
 
 
 
 
 
 
Income from continuing operations
$
0.17

 
$
0.20

 
$
0.20

 
$
0.27

Income (loss) from discontinued operations
0.02

 
(0.06
)
 
0.05

 
0.10

Net income
$
0.19

 
$
0.14

 
$
0.25

 
$
0.37

Diluted earnings per class B common share
 
 
 
 
 
 
 
Income from continuing operations
$
0.17

 
$
0.20

 
$
0.20

 
$
0.27

Income (loss) from discontinued operations
0.02

 
(0.06
)
 
0.05

 
0.10

Net income
$
0.19

 
$
0.14

 
$
0.25

 
$
0.37

See Accompanying Notes to Consolidated Financial Statements (Unaudited)


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Table of Contents

BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
14,780

 
$
12,257

 
$
23,338

 
$
29,458

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gain (loss) arising during the period
(7,631
)
 
6,380

 
(21,192
)
 
7,680

Unrealized gain arising from the reclassification of securities held-to-maturity to securities available-for-sale

 
12,845

 

 
12,845

Reclassification adjustment for gain included in net income
(197
)
 
(642
)
 
(3,901
)
 
(2,602
)
Total change in unrealized gain (loss) on available-for-sale securities
(7,828
)
 
18,583

 
(25,093
)
 
17,923

Total other comprehensive income (loss)
(7,828
)
 
18,583

 
(25,093
)
 
17,923

Comprehensive income (loss)
$
6,952

 
$
30,840

 
$
(1,755
)
 
$
47,381

See Accompanying Notes to Consolidated Financial Statements (Unaudited)


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Table of Contents

BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands)
(Unaudited)
 
Preferred Stock
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Treasury Stock
 
Accumulated Other Comprehensive Income (Loss)
 
Total Stockholders' Equity
 
 
Voting
 
Class B Non-Voting
 
 
 
 
 
Balance at December 31, 2016
$
269,071

 
$
537

 
$
2

 
$
614,226

 
$
134,515

 
$
(29,070
)
 
$
(9,042
)
 
$
980,239

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 
29,458

 

 

 
29,458

Other comprehensive loss, net

 

 

 

 

 

 
17,923

 
17,923

Issuance of common stock

 
5

 
2

 
(7
)
 

 

 

 

Exercise of stock options

 
1

 

 
(285
)
 

 
284

 

 

Share-based compensation expense

 

 

 
7,691

 

 

 

 
7,691

Restricted stock surrendered due to employee tax liability

 
(3
)
 

 
(5,374
)
 

 

 

 
(5,377
)
Stock appreciation right dividend equivalents

 

 

 

 
(405
)
 

 

 
(405
)
Dividends declared ($0.26 per common share)

 

 

 

 
(13,011
)
 

 

 
(13,011
)
Preferred stock dividends

 

 

 

 
(10,226
)
 

 

 
(10,226
)
Balance at June 30, 2017
$
269,071

 
$
540

 
$
4

 
$
616,251

 
$
140,331

 
$
(28,786
)
 
$
8,881

 
$
1,006,292

Balance at December 31, 2017
$
269,071

 
$
517

 
$
5

 
$
621,435

 
$
144,839

 
$
(28,786
)
 
$
5,227

 
$
1,012,308

Reclassification of stranded tax effects to retained earnings

 

 

 

 
(496
)
 

 
496

 

Adjusted Balance at December 31, 2017
269,071

 
517

 
5

 
621,435

 
144,343

 
(28,786
)
 
5,723

 
1,012,308

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 
23,338

 

 

 
23,338

Other comprehensive loss, net

 

 

 

 

 

 
(25,093
)
 
(25,093
)
Issuance of common stock

 
1

 
(1
)
 

 

 

 

 

Share-based compensation expense

 

 

 
3,875

 

 

 

 
3,875

Restricted stock surrendered due to employee tax liability

 
(1
)
 

 
(2,070
)
 

 

 

 
(2,071
)
Shares purchased under the Dividend Reinvestment Plan

 

 

 
132

 
(142
)
 

 

 
(10
)
Stock appreciation right dividend equivalents

 

 

 

 
(406
)
 

 

 
(406
)
Dividends declared ($0.26 per common share)

 

 

 

 
(13,027
)
 

 

 
(13,027
)
Preferred stock dividends

 

 

 

 
(10,226
)
 

 

 
(10,226
)
Balance at June 30, 2018
$
269,071

 
$
517

 
$
4

 
$
623,372

 
$
143,880

 
$
(28,786
)
 
$
(19,370
)
 
$
988,688

See Accompanying Notes to Consolidated Financial Statements (Unaudited)

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Table of Contents

BANC OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
23,338

 
$
29,458

Adjustments to reconcile net income to net cash provided by (used in) operating activities
 
 
 
Provision for loan and lease losses
22,152

 
5,086

Provision for unfunded loan commitments
315

 
1,629

Reversal of provision for loan repurchases
(2,006
)
 
(728
)
Depreciation on premises and equipment
5,212

 
6,420

Amortization of intangible assets
1,670

 
2,146

Amortization of debt issuance cost
76

 
96

Net amortization (accretion) of premium and discount on securities
530

 
(505
)
Net accretion of deferred loan cost and fees
(228
)
 
(161
)
Accretion of discounts on purchased loans
(562
)
 
(4,222
)
Deferred income tax benefit
(852
)
 
(12,271
)
Bank owned life insurance income
(1,066
)
 
(1,197
)
Share-based compensation expense
3,875

 
7,691

Loss in investments in alternative energy partnerships
1,774

 
18,443

Impairment on intangible assets

 
336

Impairment on capitalized software projects
498

 

Net revenue on mortgage banking activities
(288
)
 
(43,070
)
Net gain on sale of loans
(780
)
 
(5,002
)
Net gain on sale of securities available for sale
(5,519
)
 
(4,455
)
Loss from change of fair value on mortgage servicing rights
1,241

 
6,378

Loss on sale or disposal of property and equipment
61

 
1,035

Loss on sale of mortgage servicing rights
2,450

 

Net gain on disposal of discontinued operations
(1,275
)
 
(13,538
)
Repurchase of mortgage loans
(11,091
)
 
(53,290
)
Originations of loans held-for-sale from mortgage banking

 
(1,510,971
)
Originations of other loans held-for-sale
(6,274
)
 
(83,815
)
Proceeds from sales of and principal collected on loans held-for-sale from mortgage banking
15,417

 
1,848,535

Proceeds from sales of and principal collected on other loans held-for-sale
5,751

 
265,510

Change in accrued interest receivable and other assets
5,117

 
10,288

Change in accrued interest payable and other liabilities
(8,678
)
 
(86,711
)
Net cash provided by operating activities
50,858

 
383,115

Cash flows from investing activities:
 
 
 
Proceeds from sales of securities available-for-sale
392,556

 
810,786

Proceeds from maturities and calls of securities available-for-sale
220,400

 
75,804

Proceeds from principal repayments of securities available-for-sale
20,451

 
22,958

Proceeds from maturities and calls of securities held-to-maturity

 
143,505

Purchases of securities available-for-sale
(247,530
)
 
(550,700
)
Net cash provided by disposal of discontinued operations

 
55,865

Loan and lease originations and principal collections, net
(602,103
)
 
(467,539
)
Redemption of Federal Home Loan Bank stock
13,642

 
5,300

Purchase of Federal Home Loan Bank and other bank stock
(13,725
)
 
(896
)
Proceeds from sale of loans
211,459

 
409,134

Proceeds from sale of other real estate owned
1,484

 
1,066

Proceeds from sale of mortgage servicing rights
30,056

 

Proceeds from sale of premises and equipment
19

 
512

Additions to premises and equipment
(5,569
)
 
(12,089
)
Payments of capital lease obligations
(253
)
 
(516
)
Funding of equity investment
(1,864
)
 
(10,332
)
Net (increase) decrease in investments in alternative energy partnerships
1,027

 
(30,940
)
Net cash provided by investing activities
20,050

 
451,918

Cash flows from financing activities:
 
 
 
Net decrease in deposits
(157,109
)
 
(1,097,239
)
Net increase (decrease) in short-term Federal Home Loan Bank advances
(270,000
)
 
330,000

Repayment of long-term Federal Home Loan Bank advances

 
(50,000
)
Proceeds from long-term Federal Home Loan Bank advances
380,000

 
100,000

Net increase in securities sold under repurchase agreements

 
53,242

Net (decrease) increase in other borrowings

 
(68,000
)
Payment of junior subordinated amortizing notes

 
(2,684
)
Restricted stock surrendered due to employee tax liability
(2,071
)
 
(5,377
)
Dividend equivalents paid on stock appreciation rights
(404
)
 
(404
)
Dividends paid on preferred stock
(10,226
)
 
(10,226
)
Dividends paid on common stock
(13,106
)
 
(12,665
)
Net cash used by financing activities
(72,916
)
 
(763,353
)
Net change in cash and cash equivalents
(2,008
)
 
71,680

Cash and cash equivalents at beginning of period
387,699

 
439,510

Cash and cash equivalents at end of period
$
385,691

 
$
511,190

Supplemental cash flow information
 
 
 
Interest paid on deposits and borrowed funds
$
58,727

 
$
38,673

Income taxes paid
2,337

 
8,864

Income taxes refunds received
24

 
14,070

Supplemental disclosure of non-cash activities
 
 
 
Transfer from loans to other real estate owned, net
$
434

 
$
1,803

Transfer of loans held-for-investment to loans held-for-sale
211,824

 
547,099

Equipment acquired under capital leases
21

 
70

Reclassification of stranded tax effects to retained earnings
496

 

Due on unsettled securities purchases
132,546

 
116,090

Loans sold to Ginnie Mae that are subject to a repurchase option

 
29,825

See Accompanying Notes to Consolidated Financial Statements (Unaudited)

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BANC OF CALIFORNIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2018
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations: Banc of California, Inc. (collectively, with its consolidated subsidiaries, the Company, we, us and our) is a financial holding company under the Bank Holding Company Act of 1956, as amended, headquartered in Santa Ana, California and incorporated under the laws of Maryland. Banc of California, Inc. is subject to regulation by the Board of Governors of the Federal Reserve System (FRB) and its wholly owned subsidiary, Banc of California, National Association (the Bank), operates under a national bank charter issued by the Office of the Comptroller of the Currency (OCC), the Bank's primary regulator. The Bank is a member of the Federal Home Loan Bank (FHLB) system, and maintains insurance on deposit accounts with the Federal Deposit Insurance Corporation (FDIC).
As of June 30, 2018, the Bank had 34 banking offices, serving Orange, Los Angeles, San Diego, and Santa Barbara counties in California.
Basis of Presentation: The accompanying unaudited interim consolidated financial statements have been prepared pursuant to Article 10 of SEC Regulation S-X and other SEC rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by U.S. generally accepted accounting principles (GAAP) are not included herein. These interim statements should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the year ended December 31, 2017 filed by the Company with the SEC. The December 31, 2017 statement of financial condition presented herein has been derived from the audited financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC, but does not include all of the disclosures required by GAAP for complete financial statements.
In the opinion of management of the Company, the accompanying unaudited interim consolidated financial statements reflect all of the adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the consolidated financial condition and consolidated results of operations as of the dates and for the periods presented. Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation. The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.
Principles of Consolidation: The accompanying unaudited consolidated financial statements include the accounts of the Company as of June 30, 2018 and December 31, 2017 and for the three and six months ended June 30, 2018 and 2017. Significant intercompany accounts and transactions have been eliminated in consolidation. Unless the context requires otherwise, all references to the Company include its then wholly owned subsidiaries.
Significant Accounting Policies: The accounting and reporting policies of the Company are based upon GAAP and conform to predominant practices within the banking industry. The Company has not made any significant changes in its critical accounting policies from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC. Refer to Accounting Pronouncements below for discussion of accounting pronouncements adopted in 2018.
Use of Estimates in the Preparation of Financial Statements: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ. The allowance for loan and lease losses (ALLL), reserve for loss on repurchased loans, reserve for unfunded loan commitments, servicing rights, realization of deferred tax assets, the valuation of goodwill and other intangible assets, purchased credit impaired (PCI) loan discount accretion, Hypothetical Liquidation at Book Value (HLBV) of investments in alternative energy partnerships, fair value of assets and liabilities acquired in business combinations, and the fair value measurement of financial instruments are particularly subject to change and such change could have a material effect on the consolidated financial statements.
Incentive Compensation: At December 31, 2017 and 2016 the Company accrued a liability for estimated discretionary incentive compensation payments to certain employees. In each case, the amount paid was less than the accrued liability. Consequently, the Company reversed each excess accrual and recorded a pre-tax credit to salaries and employee benefits on the consolidated statements of operations of $937 thousand and $7.8 million, respectively, during the three months ended March 31, 2018 and 2017. Each reversal, based on new information driven by changes to certain facts and circumstances subsequent to December 31, 2017 and 2016, was determined to be a change in estimate.

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Discontinued Operations: During the three months ended March 31, 2017, the Company completed the sale of its Banc Home Loans division, which largely represented the Company's Mortgage Banking segment. In accordance with Accounting Standards Codification (ASC) 205-20, the Company determined that the sale of the Banc Home Loans division and certain other mortgage banking related assets and liabilities that would be sold or settled separately within one year met the criteria to be classified as a discontinued operation and the related operating results and financial condition have been presented as discontinued operations on the consolidated financial statements. See Note 2 for additional information. Unless otherwise indicated, information included in these notes to the consolidated financial statements is presented on a consolidated operations basis, which includes results from both continuing and discontinued operations, for all periods presented.
Adopted Accounting Pronouncements: During the six months ended June 30, 2018, the following pronouncements applicable to the Company were adopted:
In May 2014, the FASB issued Accounting Standard Update (ASU) 2014-09, “Revenue from Contracts with Customers (Topic 606). This Update outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The model is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This Update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. The Update, as amended by ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-12, ASU 2016-20, ASU 2017-13, and ASU 2017-14, is effective for interim and annual periods beginning after December 15, 2017, and entities have the option of using either a modified retrospective or full retrospective approach for the adoption. The Company’s revenue streams primarily consist of net interest income and noninterest income. The scope of this Update explicitly excludes net interest income, as well as other revenues from transactions involving financial instruments, such as loans, leases, and securities. Certain noninterest income items such as service charges on deposits accounts, gain and loss on other real estate owned sales, and other income items are in the scope of this Update. The Company evaluated the accounting impact of adopting this guidance based on the following “Five-step Model” prescribed in ASC 606:
(i)
identify the contract;
(ii)
identify the performance obligation in the contract;
(iii)
determine the transaction price;
(iv)
allocate the transaction price to the performance obligations; and
(v)
recognize revenue when (or as) the performance obligation is satisfied.
The Company identified and reviewed the revenue streams within the scope of the Update, including escrow fees, trust and fiduciary fees, deposit service fees, debit card fees, investment commissions, gains on sales of OREO, referral fees, and income from joint marketing with a certain credit card company. The Company determined that the new guidance will not require significant changes to the manner in which income from those revenue streams is currently recognized. Adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. However, the Company has enhanced its processes to identify contracts within the scope of Topic 606 and apply the Five-step Model to determine how revenue should be recognized. The Company adopted this Update and its related amendments effective January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. See Note 21 for additional information.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This Update amends certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The ASU requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; simplifies the impairment assessment of equity investments by requiring a qualitative assessment; eliminates the requirement for public business entities to disclose methods and assumptions for financial instruments measured at amortized cost on the statement of financial position; requires the exit price notion to be used when measuring the fair value of financial instruments for disclosure purposes; requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability; requires separate presentation of financial assets and liabilities by measurement category; and certain other requirements. This ASU and ASU 2018-04 became effective for interim and annual periods beginning on or after December 15, 2017. Adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. With regard to the aforementioned exit price notion, the Company measured the fair value of its loans and leases portfolio for disclosure purposes starting March 31, 2018 using an exit price notion. See Note 3 for additional information.

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In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230)." The amendments in this Update provide guidance on classification of certain cash receipts and cash payments. For public business entities that are SEC filers, this Update was effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. While permitted, the Company did not elect to adopt the guidance early. Adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230).” The amendments in this Update are intended to reduce diversity in practice regarding classification of changes in restricted cash, requiring an entity to provide changes in restricted cash and restricted cash equivalents during the period in a statement of cash flows. This Update is effective for public business entities with fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Adoption of the new guidance had no impact on the Company's consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805). This Update provides guidance on evaluating whether transactions should be accounted for as an acquisition (or disposal) of assets or a businesses. This Update provides a more robust framework to use when determining whether a set of assets and activities represents a business. Public business entities must prospectively apply the amendment in this Update to annual periods beginning after December 15, 2017, including interim periods. Adoption of the new guidance had no impact on the Company's consolidated financial statements.
In February 2017, the FASB issued ASU 2017-05, “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.” This Update clarifies the scope and application of ASC 610-20 on the sale or transfer of nonfinancial assets, including real estate, and in substance nonfinancial assets to noncustomers, including partial sales. An entity should identify each distinct nonfinancial asset or in substance nonfinancial asset promised to a counterparty and derecognize each asset when the counterparty obtains control of it. In addition, the amendment requires an entity to derecognize a distinct nonfinancial asset, or an in-substance nonfinancial asset, in a partial sale transaction when the entity does not retain a controlling financial interest in the legal entity that holds the asset and transfers control of the asset. Once control is transferred, any non-controlling interest received is required to be measured at fair value. The new guidance was effective for public business entities in annual and interim reporting periods beginning after December 15, 2017. Adoption of the new guidance had no impact on the Company's consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, “Stock Compensation - Scope of Modification Accounting (Topic 718): Scope of Modification Accounting.” This Update provides guidance on when changes to the terms or conditions of a share-based payment award are to be accounted for as modifications. Under the new guidance, entities are not required to apply modification accounting to a share-based payment award when the award’s fair value, vesting conditions, and classification as an entity or a liability instrument remain the same after the change. The new guidance was effective for all entities beginning after December 15, 2017, including interim periods within the fiscal year. Upon adoption, the guidance will be applied prospectively to awards modified on or after the adoption date. Adoption of the new guidance had no impact on the Company's consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02. "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This Update allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amendments in this Update also require certain disclosures about stranded tax effects. The amendments in this Update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments in this Update is permitted, including adoption in any interim period for public business entities for reporting periods for which financial statements have not yet been issued. The Company early adopted this Update during the three months ended March 31, 2018 and reclassified its stranded tax effect of $496 thousand in accumulated other comprehensive income that resulted from the change in the U.S. federal corporate tax rate to retained earnings.



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NOTE 2 – SALE OF BUSINESS UNIT (DISCONTINUED OPERATIONS)
Banc Home Loans Sale
On March 30, 2017, the Company completed the sale of specific assets and activities related to its Banc Home Loans division to Caliber Home Loans, Inc. (Caliber). The Banc Home Loans division largely represented the Company's Mortgage Banking segment, the activities of which related to originating, servicing, underwriting, funding and selling single family residential (SFR) mortgage loans. Assets sold to Caliber included mortgage servicing rights (MSRs) on certain conventional agency SFR mortgage loans. The Banc Home Loans division, along with certain other mortgage banking related assets and liabilities that were sold or settled separately within one year, is classified as discontinued operations in the accompanying Consolidated Statements of Financial Condition and Consolidated Statements of Operations. Certain components of the Company’s Mortgage Banking segment, including MSRs on certain conventional agency SFR mortgage loans that were not sold as part of the Banc Home Loans sale and repurchase reserves related to previously sold loans, have been classified as continuing operations in the financial statements as they remain part of the Company’s ongoing operations.
The specific assets acquired by Caliber include, among other things, the leases relating to the Company’s dedicated mortgage loan origination offices and rights to certain portions of the Company’s unlocked pipeline of residential mortgage loan applications. Caliber has assumed certain obligations and liabilities of the Company under the acquired leases, and with respect to the employment of transferred employees. The Company received a $25.0 million cash premium payment, in addition to the net book value of certain assets acquired by Caliber, totaling $2.5 million, upon the closing of the transaction. Additionally, the Company could receive an earn-out, payable quarterly, based on future performance over the 38 months following completion of the transaction. During the three and six months ended June 30, 2018, the Company recognized an earn-out of $777 thousand and $1.4 million, respectively. The Company did not recognize any earn-out during the three months ended June 30, 2017. Since the completion of the transaction, the Company has recognized a total earn-out of $2.5 million in Income from Discontinued Operations on the Consolidated Statements of Operations. Caliber retains an option to buy out the future earn-out payable to the Company for cash consideration of $35.0 million, less the aggregate amount of all earn-out payments made prior to the date on which Caliber pays the buyout amount.
Caliber also purchased MSRs of $37.8 million on approximately $3.86 billion in unpaid balances of conventional agency mortgage loans, subject to adjustment under certain circumstances. During the three and six months ended June 30, 2018, the Company recorded $272 thousand and $1.3 million, respectively, to net gain on disposal of discontinued operations. Net gain on disposal of discontinued operations recognized in the first half of 2018 was primarily the result of the release of $1.0 million in liability for estimated discretionary incentive compensation payments to certain employees transferred to Caliber as the amount paid was less than the accrued liability. To date, the entire transaction has resulted in a net gain on disposal of $15.1 million.
The following table summarizes the calculation of the net gain on disposal of discontinued operations:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
Total Net Gain on Disposal After Completion of Sale
($ in thousands)
 
2018
 
2017
 
2018
 
2017
 
Proceeds from the transaction
 
$

 
$
(264
)
 
$

 
$
63,068

 
$
63,054

Compensation expense related to the transaction
 

 
500

 
1,003

 
(3,500
)
 
(2,497
)
Other transaction costs
 
272

 

 
272

 
(3,703
)
 
(3,159
)
Net cash proceeds
 
272

 
236

 
1,275

 
55,865

 
57,398

Book value of certain assets sold
 

 

 

 
(2,455
)
 
(2,455
)
Book value of MSRs sold
 

 

 

 
(37,772
)
 
(37,772
)
Goodwill
 

 

 

 
(2,100
)
 
(2,100
)
Net gain on disposal
 
$
272

 
$
236

 
$
1,275

 
$
13,538

 
$
15,071

The Banc Home Loans division originated conforming SFR mortgage loans and sold these loans in the secondary market. The amount of net revenue on mortgage banking activities was a function of mortgage loans originated for sale and the fair values of these loans and related derivatives. Net revenue on mortgage banking activities included mark to market pricing adjustments on loan commitments and forward sales contracts, and initial capitalized value of MSRs.

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The following tables present the financial information of discontinued operations as of the dates or for the periods indicated:
Statements of Financial Condition of Discontinued Operations
($ in thousands)
 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
 
Loans held-for-sale, carried at fair value (1) (2)
 
$
26,415

 
$
38,696

Other assets
 

 
204

Assets of discontinued operations
 
$
26,415

 
$
38,900

LIABILITIES
 
 
 
 
Accrued expenses and other liabilities (1)
 
$

 
$
7,819

Liabilities of discontinued operations
 
$

 
$
7,819

(1)
Includes $0 and $7.1 million of loans sold to Government National Mortgage Association (GNMA) that were delinquent more than 90 days and subject to a repurchase option by the Company at June 30, 2018 and December 31, 2017, respectively. As such, the Company was deemed to have regained control over those previously transferred assets and has re-recognized them with an offsetting liability in Accrued Expenses and Other Liabilities in the Statements of Financial Condition of Discontinued Operations, as a secured borrowing. Because the Company intends to exercise its option to repurchase and sell them within one year, they have been classified as part of discontinued operations.
(2)
Includes $10.7 million and $24.1 million of non-performing loans at June 30, 2018 and December 31, 2017.

Statements of Operations of Discontinued Operations
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Interest income
 
 
 
 
 
 
 
 
Loans, including fees
 
$
189

 
$
2,796

 
$
375

 
$
6,062

Total interest income
 
189

 
2,796

 
375

 
6,062

Noninterest income
 
 
 
 
 
 
 
 
Net gain on disposal
 
272

 
236

 
1,275

 
13,538

Loan servicing income
 

 

 

 
1,551

Net revenue on mortgage banking activities
 
56

 
13,636

 
288

 
43,070

All other income
 
779

 
238

 
1,414

 
752

Total noninterest income
 
1,107

 
14,110

 
2,977

 
58,911

Noninterest expense
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
6

 
13,593

 
15

 
37,968

Occupancy and equipment
 

 
1,038

 

 
3,395

Professional fees
 

 
2,090

 

 
2,192

Outside Service Fees
 

 
3,249

 

 
5,613

Data processing
 

 
63

 

 
527

Advertising
 

 
449

 

 
1,282

Restructuring expense
 

 
297

 

 
3,515

All other expenses
 
9

 
1,118

 
12

 
2,124

Total noninterest expense
 
15

 
21,897

 
27

 
56,616

Income (loss) from discontinued operations before income taxes
 
1,281

 
(4,991
)
 
3,325

 
8,357

Income tax expense
 
355

 
(2,110
)
 
915

 
3,413

Income (loss) from discontinued operations
 
$
926

 
$
(2,881
)
 
$
2,410

 
$
4,944


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Table of Contents

Statements of Cash Flows of Discontinued Operations
 
 
Six Months Ended June 30,
($ in thousands)
 
2018
 
2017
Net cash provided by operating activities
 
$
7,076

 
$
250,170

Net cash provided by investing activities
 

 
55,865

Net cash provided by discontinued operations
 
$
7,076

 
$
306,035


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NOTE 3 – FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Value Hierarchy
ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The topic describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Assets and Liabilities Measured on a Recurring Basis
Securities Available-for-Sale: The fair values of securities available-for-sale are generally determined by quoted market prices in active markets, if available (Level 1). If quoted market prices are not available, the Company primarily employs independent pricing services that utilize pricing models to calculate fair value. Such fair value measurements consider observable data such as dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and respective terms and conditions for debt instruments. The Company employs procedures to monitor the pricing service's assumptions and establishes processes to challenge the pricing service's valuations that appear unusual or unexpected. Level 2 securities include U.S. Small Business Administration (SBA) loan pool securities, U.S. government agency and U.S. government sponsored enterprise (GSE) residential mortgage-backed securities, non-agency residential mortgage-backed securities, non-agency commercial mortgage-backed securities, collateralized loan obligations, and corporate debt securities. When a market is illiquid or there is a lack of transparency around the inputs to valuation, including at least one unobservable input, the securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. The Company had no securities available-for-sale classified as Level 3 at June 30, 2018 or December 31, 2017.
Loans Held-for-Sale, Carried at Fair Value: The fair value of loans held-for-sale is based on commitments outstanding from investors as well as what secondary market investors are currently offering for portfolios with similar characteristics, except for loans that are repurchased out of GNMA loan pools that become severely delinquent which are valued based on an internal model that estimates the expected loss the Company will incur on these loans. Loans previously sold to GNMA that are delinquent more than 90 days are subject to a repurchase option when that condition exists. These loans were re-recognized at fair value and offset by a secured borrowing, as the loans were still legally owned by GNMA. Loans held-for-sale subject to recurring fair value adjustments are classified as Level 2 or, in the case of loans repurchased, Level 3. The fair value includes the servicing value of the loans as well as any accrued interest. As of June 30, 2018, there were no loans that were delinquent more than 90 days and eligible to be repurchased out of GNMA loan pools. As of December 31, 2017, loans eligible to be repurchased out of GNMA loan pools of $66.0 million were classified as Level 3.
Derivative Assets and Liabilities: The Company offers interest rate swaps and caps products to certain loan customers to allow them to hedge the risk of rising interest rates on their variable rate loans. The Company originates a variable rate loan and enters into a variable-to-fixed interest rate swap with the customer. The Company also enters into an offsetting swap with a correspondent bank. These back-to-back agreements are intended to offset each other and allow the Company to originate a variable rate loan, while providing a contract for fixed interest payments for the customer. The net cash flow for the Company is equal to the interest income received from a variable rate loan originated with the customer. The fair value of these derivatives is based on a discounted cash flow approach. Due to the observable nature of the inputs used in deriving the fair value of these derivative contracts, the valuation of interest rate swaps is classified as Level 2.
Mortgage Servicing Rights: The Company retains servicing on some of its mortgage loans sold and elected the fair value option for these MSRs. Generally, the value is estimated based on a valuation from a third party provider that calculates the present value of the expected net servicing income from the portfolio based on key factors that include interest rates, prepayment assumptions, discount rate and estimated cash flows. Because of the significance of unobservable inputs, these servicing rights are classified as Level 3. At June 30, 2018 and December 31, 2017, MSRs held-for-sale of $70 thousand and $29.8 million, respectively, were valued based on a market bid adjusted for value associated with early payoffs and paydowns and included as Level 3.

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Table of Contents

The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis as of the dates indicated:
 
 
 
 
Fair Value Measurement Level
($ in thousands)
 
Carrying Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
June 30, 2018
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
SBA loan pools securities
 
$
967

 
$

 
$
967

 
$

U.S. government agency and U.S. government sponsored enterprise residential mortgage-backed securities
 
456,790

 

 
456,790

 

Non-agency residential mortgage-backed securities
 
496

 

 
496

 

Non-agency commercial mortgage-backed securities
 
158,358

 

 
158,358

 

Collateralized loan obligations
 
1,680,513

 

 
1,680,513

 

Loans held-for-sale, carried at fair value (1)
 
38,749

 

 
5,515

 
33,234

Mortgage servicing rights (2)
 
2,062

 

 

 
2,062

Derivative assets:
 
 
 
 
 
 
 
 
Interest rate swaps and caps (3)
 
1,686

 

 
1,686

 

Liabilities
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
Interest rate swaps and caps (4)
 
1,650

 

 
1,650

 

December 31, 2017
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
SBA loan pools securities
 
$
1,058

 
$

 
$
1,058

 
$

U.S. government agency and U.S. government sponsored enterprise residential mortgage-backed securities
 
476,929

 

 
476,929

 

Non-agency residential mortgage-backed securities
 
756

 

 
756

 

Non-agency commercial mortgage-backed securities
 
310,511

 

 
310,511

 

Collateralized loan obligations
 
1,702,318

 

 
1,702,318

 

Corporate debt securities
 
83,897

 

 
83,897

 

Loans held-for-sale, carried at fair value (5)
 
105,299

 

 
6,359

 
98,940

Mortgage servicing rights (2)
 
31,852

 

 

 
31,852

Derivative assets:
 
 
 
 
 
 
 
 
Interest rate swaps and caps (3)
 
1,005

 

 
1,005

 

Liabilities
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
Interest rate swaps and caps (4)
 
1,033

 

 
1,033

 

(1)
Includes loans held-for-sale carried at fair value of $26.4 million ($5.5 million at Level 2 and $20.9 million at Level 3) of discontinued operations, which are included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition.
(2)
Included in Servicing Rights, Net in the Consolidated Statements of Financial Condition.
(3)
Included in Other Assets in the Consolidated Statements of Financial Condition.
(4)
Included in Accrued Expenses and Other Liabilities in the Consolidated Statements of Financial Condition.
(5)
Includes loans held-for-sale carried at fair value of $38.7 million ($6.4 million at Level 2 and $32.3 million at Level 3) of discontinued operations, which are included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition.


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Table of Contents

The following table presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), on a consolidated operations basis, for the periods indicated:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Mortgage servicing rights
 
 
 
 
 
 
 
 
Balance at beginning of period (1)
 
$
4,953

 
$
42,833

 
$
31,852

 
$
76,121

Transfers in and (out) of Level 3 (2)
 

 

 

 

Total gains or losses (realized/unrealized):
 
 
 
 
 
 
 
 
Included in earnings—fair value adjustment
 
(216
)
 
(3,035
)
 
(1,090
)
 
(3,079
)
Additions
 

 
3,751

 

 
11,552

Sales, paydowns, and other (3)
 
(2,675
)
 
(1,440
)
 
(28,700
)
 
(42,485
)
Balance at end of period
 
$
2,062

 
$
42,109

 
$
2,062

 
$
42,109

Loans repurchased or subject to repurchase option from GNMA Loan Pools (4)
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
42,962

 
$
66,701

 
$
98,940

 
$
58,260

Transfers in and (out) of Level 3 (2)
 

 

 

 

Total gains or losses (realized/unrealized):
 
 
 
 
 
 
 
 
Included in earnings—fair value adjustment
 
(248
)
 
6

 
(254
)
 
15

Additions
 
2,765

 
17,935

 
27,385

 
35,231

Sales, settlements, and other
 
(12,245
)
 
(11,097
)
 
(92,837
)
 
(19,961
)
Balance at end of period
 
$
33,234

 
$
73,545

 
$
33,234

 
$
73,545

(1)
Includes MSRs of discontinued operations, which is included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition, of $37.7 million for the six months ended June 30, 2017 in balance at beginning of period.
(2)
The Company’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that causes the transfer.
(3)
Includes $37.8 million of MSRs sold as a part of discontinued operations for the six months ended June 30, 2017.
(4)
Includes loans repurchased from GNMA Loan Pools of discontinued operations, which is included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition, of $24.0 million and $66.7 million, respectively, for the three months ended June 30, 2018 and 2017 and $32.3 million and $58.3 million, respectively, for the six months ended June 30, 2018 and 2017 in balance at beginning of period, and $20.9 million and $52.1 million, respectively, for the three and six months ended June 30, 2018 and 2017 in balance at end of period.
Loans repurchased from GNMA loan pools and loans previously sold to GNMA that are delinquent more than 90 days and subject to a repurchase option held by the Company had aggregate unpaid principal balances of $34.2 million and $99.7 million at June 30, 2018 and December 31, 2017, respectively.
The following table presents, as of the dates indicated, quantitative information about Level 3 fair value measurements on a recurring basis, other than loans that become severely delinquent and are repurchased out of GNMA loan pools that were valued based on an estimate of the expected loss the Company will incur on these loans, which was included as Level 3 at June 30, 2018 and December 31, 2017:
($ in thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
June 30, 2018
 
 
 
 
 
 
 
 
Mortgage servicing rights
 
$
1,992

 
Discounted cash flow
 
Discount rate
 
13.00% to 13.00% (13.00%)
 
 
 
 
 
 
Prepayment rate
 
12.39% to 44.76% (16.44%)
December 31, 2017
 
 
 
 
 
 
 
 
Mortgage servicing rights (1)
 
$
2,059

 
Discounted cash flow
 
Discount rate
 
13.00% to 13.00% (13.00%)
 
 
 
 
 
 
Prepayment rate
 
10.04% to 49.97% (16.54%)
(1)
Excludes MSRs held-for-sale of $70 thousand and $29.8 million, respectively, which were valued based on a market bid adjusted for expected obligations arising from standard representations and warranties at June 30, 2018 and December 31, 2017.

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Table of Contents

The significant unobservable inputs used in the fair value measurement of the Company’s servicing rights include the discount rate and prepayment rate. The significant unobservable inputs used in the fair value measurement of the Company's loans repurchased from GNMA loan pools at June 30, 2018 and December 31, 2017 included an expected loss rate of 1.55 percent for insured loans and 20.00 percent for uninsured loans. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results.
Fair Value Option
Loans Held-for-Sale, Carried at Fair Value: The Company elected to measure certain SFR mortgage loans held-for-sale under the fair value option. Electing to measure SFR mortgage loans held-for-sale at fair value reduces certain timing differences and better matches changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets. The Company also elected to record loans repurchased from GNMA at fair value, as the Company intends to sell them after curing any defects and, accordingly, they are classified as held-for-sale. Loans previously sold to GNMA that are delinquent more than 90 days are subject to a repurchase option when that condition exists. These loans were re-recognized at fair value and offset by a secured borrowing, as the loans were still legally owned by GNMA.
The following table presents the fair value and aggregate principal balance of certain assets, on a consolidated operations basis, under the fair value option:
 
 
June 30, 2018
 
December 31, 2017
($ in thousands)
 
Fair Value
 
Unpaid Principal Balance
 
Difference
 
Fair Value
 
Unpaid Principal Balance
 
Difference
Loans held-for-sale, carried at fair value in continuing operations:
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
 
$
12,334

 
$
13,021

 
$
(687
)
 
$
66,603

 
$
67,415

 
$
(812
)
Non-accrual loans (1)
 
919

 
938

 
(19
)
 
60,999

 
61,900

 
(901
)
Loans held-for-sale, carried at fair value in discontinued operations:
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
 
$
26,415

 
$
27,510

 
$
(1,095
)
 
$
38,696

 
$
39,541

 
$
(845
)
Non-accrual loans (2)
 
10,732

 
10,887

 
(155
)
 
24,073

 
24,297

 
(224
)
(1)
Includes loans guaranteed by the U.S. government of $753 thousand and $54.2 million, respectively, at June 30, 2018 and December 31, 2017.
(2)
Includes loans guaranteed by the U.S. government of $8.6 million and $20.7 million, respectively, at June 30, 2018 and December 31, 2017.
There were no loans held-for-sale that were 90 days or more past due and still accruing as of June 30, 2018 and December 31, 2017.
The assets and liabilities accounted for under the fair value option are initially measured at fair value. Gains and losses from initial measurement and subsequent changes in fair value are recognized in earnings. The following table presents changes in fair value related to initial measurement and subsequent changes in fair value included in earnings for these assets and liabilities measured at fair value for the periods indicated:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net gains (losses) from fair value changes
 
 
 
 
 
 
 
 
Net gain (loss) on sale of loans (continuing operations)
 
$
6

 
$
2

 
$
(20
)
 
$
8

Net revenue on mortgage banking activities (discontinued operations)
 
(247
)
 
2,459

 
(245
)
 
2,373

Changes in fair value due to instrument-specific credit risk were insignificant for the three and six months ended June 30, 2018 and 2017. Interest income on loans held-for-sale under the fair value option is measured based on the contractual interest rate and reported in Loans and Leases, including Fees under Interest and Dividend Income and Income from Discontinued Operations in the Consolidated Statements of Operations.

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Table of Contents

Assets and Liabilities Measured on a Non-Recurring Basis
Impaired Loans and Leases: Impairment of collateral dependent loans and leases with specific allocations of the ALLL are generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically deemed significant unobservable inputs used for determining fair value and result in a Level 3 classification.
Loans Held-for-Sale, Carried at Lower of Cost or Fair Value: The Company records non-conforming jumbo mortgage loans held-for-sale and certain non-residential mortgage loans held-of-sale at the lower of cost or fair value, on an aggregate basis. The Company obtains fair values from a third party independent valuation service provider. Loans held-for-sale accounted for at the lower of cost or fair value are considered to be recognized at fair value when they are recorded at below cost, on an aggregate basis, and are classified as Level 2.
SBA Servicing Assets: SBA servicing assets represent the value associated with servicing SBA loans that have been sold. SBA servicing assets are accounted for at the lower of cost or market value and considered to be recognized at fair value when they are recorded at below cost and are classified as Level 3. The fair value for SBA servicing assets is determined through a discounted cash flow analysis that utilizes estimated market yield and projected prepayment speeds as inputs. All of these assumptions require a significant degree of management estimation and judgment. The fair market valuation is performed on a quarterly basis for SBA servicing assets.
Other Real Estate Owned Assets: Other Real Estate Owned (OREO) assets initially are recorded at fair value at the time of foreclosure. Thereafter, they are recorded at the lower of cost or fair value. The fair value of other real estate owned assets is generally based on recent real estate appraisals adjusted for estimated selling costs. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and result in a Level 3 classification due to the unobservable inputs used for determining fair value. Only OREO assets with a valuation allowance are considered to be carried at fair value. There was no valuation allowance expense for OREO assets for the three months ended June 30, 2018 and 2017. The Company recorded valuation allowance expense for OREO assets of $53 thousand and $9 thousand for the six months ended June 30, 2018 and 2017 in All Other Expense in the Consolidated Statements of Operations.

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Table of Contents

The following table presents the Company’s financial assets and liabilities measured at fair value on a non-recurring basis as of the dates indicated:
 
 
 
 
Fair Value Measurement Level
($ in thousands)
 
Carrying Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
June 30, 2018
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
 
Other consumer
 
$
4

 

 

 
$
4

Other real estate owned:
 
 
 
 
 
 
 
 
Single family residential
 
276

 

 

 
276

December 31, 2017
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
 
SBA
 
$
174

 

 

 
$
174

Other real estate owned:
 
 
 
 
 
 
 
 
Single family residential