Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2013

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.)

18500 Von Karman Ave, Suite 1100, Irvine, California

(Address of principal executive offices)

92612

(Zip Code)

(949) 236-5211

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (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  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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

As of October 31, 2013 the registrant had outstanding 18,021,789 shares of voting common stock and 584,674 shares of Class B non-voting common stock.

 

 

 


Table of Contents

BANC OF CALIFORNIA, INC.

Form 10-Q Quarterly Report

Index

 

          Page  

Part I - Financial Information

  

Item 1

  

Financial Statements

     4   

Item 2

  

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

     52   

Item 3

  

Quantitative and Qualitative Disclosure About Market Risk

     84   

Item 4

  

Controls and Procedures

     85   

Part II - Other Information

  

Item 1

  

Legal Proceedings

     87   

Item 1A

  

Risk Factors

     87   

Item 2

  

Unregistered Sales of Equity Securities and Use of Proceeds

     87   

Item 3

  

Defaults Upon Senior Securities

     88   

Item 4

  

Mine Safety Disclosures

     88   

Item 5

  

Other Information

     88   

Item 6

  

Exhibits

     89   

Signatures

     94   

 

2


Table of Contents

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

When used in this report and in public shareholder 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) risks that the Company’s recently completed acquisition of The Private Bank of California (“PBOC”) may disrupt current plans and operations, the potential difficulties in customer and employee retention as a result of the transaction and the amount of the costs, fees, expenses and charges related to the transaction; (ii) a worsening of current economic conditions, as well as turmoil in the financial markets; (iii) the credit risks of lending activities, which may be affected by deterioration in real estate markets and the financial condition of borrowers, may lead to increased loan and lease delinquencies, losses and nonperforming 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; (iv) the quality and composition of our securities portfolio; (v) changes in general economic conditions, either nationally or in our market areas; (vi) continuation of the historically low short-term interest rate environment, changes in the levels of general interest rates, and the relative differences between short- and long-term interest rates, deposit interest rates, our net interest margin and funding sources; (vii) 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; (viii) results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan and lease losses, write-down asset values, increase our capital levels, or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; (ix) legislative or regulatory changes that adversely affect our business, including changes in regulatory capital or other rules; (x) our ability to control operating costs and expenses; (xi) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; (xii) errors in our estimates in determining fair value of certain of our assets, which may result in significant declines in valuation; (xiii) the network and computer systems on which we depend could fail or experience a security breach; (xiv) our ability to attract and retain key members of our senior management team; (xv) costs and effects of litigation, including settlements and judgments; (xvi) increased competitive pressures among financial services companies; (xvii) changes in consumer spending, borrowing and saving habits; (xviii) adverse changes in the securities markets; (xix) earthquake, fire or other natural disasters affecting the condition of real estate collateral; (xx) the availability of resources to address changes in laws, rules or regulations or to respond to regulatory actions; (xxi) inability of key third-party providers to perform their obligations to us; (xxii) changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board or their application to our business, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; (xxiii) war or terrorist activities; and (xxiv) 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, 2012. You should not place undue reliance on forward-looking statements, and we undertake no obligation to update any such statements to reflect circumstances or events that occur after the date on which the forward-looking statement is made.

 

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Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

Banc of California, Inc.

Consolidated Statements of Financial Condition

(In thousands of dollars except share and per share data)

(Unaudited)

 

     September 30,     December 31,  
     2013     2012  
ASSETS     

Cash and due from banks

   $ 7,951      $ 8,254   

Interest-bearing deposits

     408,059        100,389   
  

 

 

   

 

 

 

Total cash and cash equivalents

     416,010        108,643   

Time deposits in financial institutions

     2,938        5,027   

Securities available for sale, at fair value

     167,998        121,419   

Loans held for sale, carried at fair value except for $105,126 and $0 at lower of cost or fair value at September 30, 2013 and December 31, 2012, respectively

     367,111        113,158   

Loans and leases receivable, net of allowance of $19,130 at September 30, 2013 and $14,448 at December 31, 2012

     2,577,058        1,234,023   

Federal Home Loan Bank and other bank stock, at cost

     14,789        8,842   

Servicing rights, net ($7,220 measured at fair value at September 30, 2013 and $1,739 at December 31, 2012)

     7,603        2,278   

Accrued interest receivable

     10,425        5,002   

Other real estate owned, net

     1,383        4,527   

Premises, equipment, and capital leases, net

     61,443        16,147   

Premises and equipment held-for-sale

     3,080        —     

Bank-owned life insurance

     18,834        18,704   

Deferred income tax, net

     5,515        7,572   

Goodwill

     22,086        7,048   

Affordable housing fund investment

     5,787        6,197   

Income tax receivable

     4,077        5,545   

Other intangible assets, net

     13,191        5,474   

Other assets

     19,045        13,096   
  

 

 

   

 

 

 

Total assets

   $ 3,718,373      $ 1,682,702   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Deposits:

    

Noninterest-bearing deposits

   $ 418,759      $ 194,662   

Interest-bearing deposits

     2,377,847        1,111,680   

Deposits held for sale

     462,768        —     
  

 

 

   

 

 

 

Total deposits

     3,259,374        1,306,342   

Advances from Federal Home Loan Bank

     25,000        75,000   

Notes payable, net

     82,224        81,935   

Reserve for loss on repurchased loans

     4,282        3,485   

Accrued expenses and other liabilities

     44,913        27,183   
  

 

 

   

 

 

 

Total liabilities

     3,415,793        1,493,945   

Commitments and contingent liabilities

    
SHAREHOLDERS’ EQUITY     

Preferred stock, $0.01 par value per share, 50,000,000 shares authorized:

    

Series A, non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 32,000 shares authorized, 32,000 shares issued and outstanding at September 30, 2013 and December 31, 2012

     31,934        31,934   

Series B, non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 10,000 shares authorized, 10,000 shares issued and outstanding at September 30, 2013 and 0 shares issued and outstanding at December 31, 2012

     10,000        —     

Series C, 8.00% non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 40,250 shares authorized, 40,250 shares issued and outstanding at September 30, 2013 and 0 shares issued and outstanding at December 31, 2012

     37,943        —     

Common stock, $.01 par value per share, 196,863,844 shares authorized; 18,693,092 shares issued and 17,439,562 shares outstanding at September 30, 2013; 12,013,717 shares issued and 10,780,427 shares outstanding at December 31, 2012

     188        120   

Class B non-voting non-convertible Common stock, $.01 par value per share, 3,136,156 shares authorized; 579,490 shares issued and outstanding at September 30, 2013 and 1,112,188 shares issued and outstanding at December 31, 2012

     5        11   

Additional paid-in capital

     230,804        154,563   

Retained earnings

     17,027        26,550   

Treasury stock, at cost (1,253,530 shares at September 30, 2013 and 1,233,290 shares at December 31, 2012)

     (25,455     (25,818

Accumulated other comprehensive income, net

     134        1,397   
  

 

 

   

 

 

 

Total shareholders’ equity

     302,580        188,757   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,718,373      $ 1,682,702   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements (Unaudited)

 

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Table of Contents

Banc of California, Inc.

Consolidated Statements of Operations

(In thousands of dollars except share and per share data)

(Unaudited)

 

     Three months ended     Nine months ended  
     September 30,     September 30,  
     2013     2012     2013     2012  

Interest and dividend income

        

Loans, including fees

   $ 32,061      $ 15,928      $ 76,751      $ 35,060   

Securities

     1,292        708        2,159        2,139   

Dividends and other interest-earning assets

     493        86        845        226   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and dividend income

     33,846        16,722        79,755        37,425   

Interest expense

        

Deposits

     5,084        1,578        10,386        4,285   

Federal Home Loan Bank advances

     56        74        177        266   

Capital leases

     27        2        59        4   

Notes payable

     1,736        660        5,206        1,155   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     6,903        2,314        15,828        5,710   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     26,943        14,408        63,927        31,715   

Provision for loan and lease losses

     2,109        1,031        6,195        2,001   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan and lease losses

     24,834        13,377        57,732        29,714   

Noninterest income

        

Customer service fees

     621        543        1,676        1,282   

Loan servicing income

     293        146        939        146   

Income from bank owned life insurance

     42        69        130        198   

Net gain (loss) on sales of securities available for sale

     10        (12     319        (83

Net gain on sale of loans

     484        59        4,520        204   

Net gain on mortgage banking activities

     16,231        5,546        52,862        5,546   

Bargain purchase gain

     —          12,055        —          12,055   

Other income

     545        1,106        1,780        1,306   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     18,226        19,512        62,226        20,654   

Noninterest expense

        

Salaries and employee benefits

     30,179        13,613        74,570        23,657   

Occupancy and equipment

     5,247        2,473        12,070        4,793   

Professional fees

     4,560        3,788        9,804        5,318   

Data processing

     1,552        1,037        3,827        1,946   

Advertising

     1,664        395        3,076        848   

Regulatory assessments

     986        291        1,578        971   

Loan servicing and foreclosure expense

     276        83        628        788   

Operating loss on equity investment

     120        76        410        229   

Valuation allowance for OREO

     18        36        97        205   

Net gain (loss) on sales of other real estate owned

     (73     42        (224     (466

Provision for loan repurchases

     375        172        1,363        172   

Amortization of intangible assets

     973        329        1,707        329   

Impairment on intangible assets

     976        —          976        —     

All other expense

     5,451        2,121        11,574        3,827   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     52,304        24,456        121,456        42,617   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (9,244     8,433        (1,498     7,751   

Income tax expense (benefit)

     (710     (1,110     1,744        (1,430
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (8,534   $ 9,543      $ (3,242   $ 9,181   

Preferred stock dividends

     946        328        1,234        1,042   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ (9,480   $ 9,215      $ (4,476   $ 8,139   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per common share

   $ (0.53   $ 0.79      $ (0.32   $ 0.70   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings (loss) per common share

   $ (0.53   $ 0.79      $ (0.32   $ 0.70   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per class B common share

   $ (0.53   $ 0.79      $ (0.32   $ 0.70   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings (loss) per class B common share

   $ (0.53   $ 0.79      $ (0.32   $ 0.70   
  

 

 

   

 

 

   

 

 

   

 

 

 

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)

(In thousands of dollars, except share and per share data)

(Unaudited)

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2013     2012      2013     2012  

Net income (loss)

   $ (8,534   $ 9,543       $ (3,242   $ 9,181   

Other comprehensive income (loss), before tax:

         

Change in net unrealized gains (losses) on securities:

         

Unrealized holding gains (losses) arising during the period, net of tax expense of none and $336 for the three months ended and none and $887 for the nine months ended September 30, 2013 and 2012, respectively

     (644     481         (944     1,268   

Less: reclassification adjustment for (gains) losses included in net income, net of tax expense of none and $5 for the three months ended and none and $34 for the nine months ended September 30, 2013 and 2012, respectively

     (10     7         (319     49   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other comprehensive (loss) income, net of tax

     (654     488         (1,263     1,317   
  

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss)

   $ (9,188   $ 10,031       $ (4,505   $ 10,498   
  

 

 

   

 

 

    

 

 

   

 

 

 

See accompanying notes to consolidated financial statements (Unaudited)

 

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Table of Contents

Banc of California, Inc.

Consolidated Statements of Shareholders’ Equity

(In thousands of dollars, except share and per share data)

(Unaudited)

 

    Series A
Preferred
Stock
    Series B
Preferred
Stock
    Series C
Preferred
Stock
    Common
Stock
    Class B
Non-voting
Non-convertible
Common Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Treasury
Stock
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  

Balance at January 1, 2012

  $ 31,934      $ —        $ —        $ 117      $ 11      $ 150,786      $ 27,623      $ (25,037   $ (939   $ 184,495   

Comprehensive income (loss):

                   

Net loss

    —          —          —          —          —          —          9,181        —          —          9,181   

Other comprehensive income, net

    —          —          —          —          —          —          —          —          1,317        1,317   

Forfeiture and retirement of 200 shares of common stock

    —          —          —          —          —          3        —          (120     —          (117

Forfeiture of stock option

    —          —          —          —          —          (387     —          —          —          (387

Stock option compensation expense

    —          —          —          —          —          774        —          —          —          774   

Restricted stock compensation expense

    —          —          —          —          —          161        —          —          —          161   

Stock awards earned

    —          —          —          —          —          644        —          —          —          644   

Severance payment

    —          —          —          —          —          (129     —          —          —          (129

Issuance of common stock

    —          —          —          2        —          (2     —          —          —          —     

Purchase of 42,693 shares of treasury stock

    —          —          —          —          —          —          —          (481     —          (481

Dividends declared ($0.36 per common share)

    —          —          —          —          —          632        (4,285     —          —          (3,653

Preferred stock issuance cost

    (9     —          —          —          —          —          —          —          —          (9

Preferred stock dividends

    —          —          —          —          —          —          (1,042     —          —          (1,042

Tax loss of restricted share awards vesting

    —          —          —          —          —          (17     —          —          —          (17

Warrants issued with Beach Business Bank purchase

    —          —          —          —          —          1,009        —          —          —          1,009   

Capital raising expenses

    —          —          —          —          —          (7     —          —          —          (7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

  $ 31,925      $ —        $ —        $ 119      $ 11      $ 153,467      $ 31,477      $ (25,638   $ 378      $ 191,739   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2013

  $ 31,934      $ —        $ —        $ 120      $ 11      $ 154,563      $ 26,550      $ (25,818   $ 1,397      $ 188,757   

Net income

    —          —          —          —          —          —          (3,242     —          —          (3,242

Other comprehensive income, net

    —          —          —          —          —          —          —          —          (1,263     (1,263

Issuance of common stock

    —          —          —          68        (6     76,173        —          —          —          76,235   

Issuance of preferred stock

    —          —          37,943        —          —          —          —          —          —          37,943   

Preferred stock assumed through business acquisition

    —          10,000        —          —          —          —          —          —          —          10,000   

Stock options converted through business acquisition

    —          —          —          —          —          9        —          —          —          9   

Forefeiture and retirement of common stock

    —          —          —          —          —          34        —          (34     —          —     

Purchase of 104,740 shares of treasury stock

    —          —          —          —          —          —          —          (1,402     —          (1,402

Issuance of stock awards from treasury stock

    —          —          —          —          —          (1,799     —          1,799        —          —     

Shares purchased under the Dividend Reinvestment Plan

    —          —          —          —          —          519        (519     —          —          —     

Stock option compensation expense

    —          —          —          —          —          336        —          —          —          336   

Restricted stock compensation expense

    —          —          —          —          —          969        —          —          —          969   

Dividends declared ($0.36 per common share)

    —          —          —          —          —          —          (4,528     —          —          (4,528

Preferred stock dividends

    —          —          —          —          —          —          (1,234     —          —          (1,234
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2013

  $ 31,934      $ 10,000      $ 37,943      $ 188      $ 5      $ 230,804      $ 17,027      $ (25,455   $ 134      $ 302,580   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements (Unaudited)

 

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Banc of California, Inc.

Consolidated Statements of Cash Flows

(In thousands of dollars)

(Unaudited)

 

     Nine months ended  
     September 30,  
     2013     2012  

Cash flows from operating activities:

    

Net income (loss)

   $ (3,242   $ 9,181   

Adjustments to reconcile net income (loss) to net cash from operating activities

    

Provision for loan losses

     6,195        2,001   

Bargain purchase gain

     —          (12,055

Provision for loan repurchases

     1,363        172   

Net gain on mortgage banking activities

     (52,862     (5,836

Gain on sale of loans

     (4,520     (204

Net amortization (accretion) of securities

     953        861   

Depreciation

     2,785        1,035   

Amortization of intangibles

     1,707        329   

Amortization of debt

     289        76   

Stock option compensation expense

     336        805   

Restricted stock compensation expense

     969        —     

Change in fair value of converted stock options related to business acquisition

     9        —     

Stock appreciation right expense

     1,130        —     

Bank owned life insurance income

     (130     (198

Operating loss on equity investment

     410        229   

Impairment of intangible assets

     976        —     

Net (gain) loss on sale of securities available for sale

     (319     83   

Gain on sale of other real estate owned

     (224     (466

Gain on sale of property and equipment

     (1     —     

Deferred income tax expense

     —          1,113   

Decrease (increase) in valuation allowances on other real estate owned

     97        (851

Originations of loans held for sale

     (1,388,622     (166,250

Proceeds from sales of loans held for sale

     1,276,104        128,804   

Deferred loan (costs) fees

     (414     377   

Premiums and discounts on purchased loans

     (13,714     (1,231

Accrued interest receivable

     (5,423     (3,951

Other assets

     14,209        9,630   

Accrued interest payable and other liabilities

     13,496        3,979   
  

 

 

   

 

 

 

Net cash used in operating activities

     (148,443     (32,367
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Proceeds from sales of securities available-for-sale

     127,286        7,712   

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

     95,081        34,512   

Net cash acquired through acquisitions

     5,786        43,670   

Purchases of securities available-for-sale

     (51,526     (56,088

Loan originations and principal collections, net

     (415,272     (107,421

Purchase of loans

     (852,913     (66,528

Redemption of Federal Home Loan Bank stock

     25        702   

Purchase of Federal Home Loan Bank and Other Bank Stocks

     (5,972     (543

Net change in other interest-bearing deposits

     2,089        —     

Proceeds from sale of other real estate owned

     3,600        11,672   

Proceeds from sale of loans held for investment

     219,211        27,713   

Additions to premises and equipment

     (49,609     (4,492

Payment of capital lease obligations

     (218     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (922,432     (109,091
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in deposits

     1,391,343        126,625   

Repayments of Federal Home Loan Bank advances

     (116,833     (30,053

Proceeds from Federal Home Loan Bank advances

     25,000        96,000   

Purchase of preferred stock

     —          (7

Net proceeds from issuance of common stock

     47,953        —     

Net proceeds from issuance of preferred stock

     37,943        —     

Net proceeds from issuance of long term debt

     —          31,680   

Purchase of treasury stock

     (1,402     (490

Tax benefit (expense) from restricted stock vesting

     —          (17

Dividends paid on preferred stock

     (1,234     (1,042

Dividends paid on common stock

     (4,528     (3,653
  

 

 

   

 

 

 

Net cash provided by financing activities

     1,378,242        219,043   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     307,367        77,585   

Cash and cash equivalents at beginning of period

     108,643        44,475   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 416,010      $ 122,060   
  

 

 

   

 

 

 

Supplemental cash flow information

    

Interest paid on deposits and borrowed funds

   $ 15,722      $ 5,636   

Income taxes paid

     —          —     

Supplemental disclosure of noncash activities

    

Transfer from loans to other real estate owned, net

     —          3,750   

Transfer of loans receivable to loans held for sale

     105,126        —     

Transfer of deposits to deposits held for sale

     462,768        —     

Equipment acquired under capital leases

     1,239        365   

See accompanying notes to consolidated financial statements (Unaudited)

 

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BANC OF CALIFORNIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2013

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The accompanying unaudited consolidated financial statements include the accounts of Banc of California, Inc. (the Company, we, us and our) and its wholly owned subsidiaries, Banc of California, National Association (the Bank), the Palisades Group, LLC (the Palisades Group), and PTB Property Holdings, LLC, as of September 30, 2013 and December 31, 2012 and for the nine months ended September 30, 2013 and 2012, except that the accounts of the Palisades Group were not included for amounts prior to September 10, 2013 and The Private Bank of California were not included for amounts prior to July 1, 2013. Significant intercompany accounts and transactions have been eliminated in consolidation. Unless the context requires otherwise, all references to the Company include its wholly owned subsidiaries. As discussed in Note 19, Subsequent Events, on October 11, 2013, the Company completed the merger of the Company’s two banking subsidiaries, Pacific Trust Bank (sometimes referred to herein as PacTrust Bank) and The Private Bank of California, to form the Bank. Unless the context indicates otherwise, references to the “Bank” prior to October 11, 2013 means Pacific Trust Bank and The Private Bank of California (Beach Business Bank prior to July 1, 2013), collectively, and references to the “Bank” on or after October 11, 2013 refer to Banc of California, National Association.

Nature of Operations: The principal business of the Company is the ownership of the Bank. The Bank operates under a national bank charter issued by the Office of the Comptroller of the Currency (the OCC), its 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). PTB Property Holdings, LLC manages and disposes of other real estate owned properties and the Palisades Group, LLC provides financial advisory and asset management services.

The Bank is engaged in the business of retail banking, with operations conducted through 23 banking offices as of September 30, 2013, serving San Diego, Los Angeles, Orange and Riverside counties, California and 50 producing loan production offices in California, Arizona, Oregon, Washington and Montana as of September 30, 2013. Upon the completion of branch sales to AmericanWest Bank on October 4, 2013, the number of the Company’s banking offices decreased to fifteen. As of September 30, 2013, single family residential (SFR) loans and Green loans (SFR mortgage lines of credit) accounted for approximately 53.6 percent and 6.4 percent, respectively, of the Company’s loan and lease portfolio, with a high percentage of such loans concentrated in Southern California. The customer’s ability to repay their loans or leases is dependent on the real estate market and general economic conditions in the area.

The accounting and reporting polices of the Company are based upon U.S. generally accepted accounting principles (GAAP) and conform to predominant practices within the banking industry. The Company has not made any significant changes in its critical accounting policies or in its estimates and assumptions from those disclosed in its 2012 Annual Report on Form 10-K other than the adoption of new accounting pronouncements and other authoritative guidance that became effective for the Company on or after January 1, 2013. Refer to Accounting Pronouncements for discussion of accounting pronouncements adopted in 2013.

Basis of Presentation: The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by 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, 2012 filed by the Company with the Securities and Exchange Commission. The December 31, 2012 balance sheet 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, 2012 filed with the Securities and Exchange Commission, but does not include all of the disclosures required by GAAP.

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 position and consolidated results of operations 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 nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the full year.

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, reserve for loss reimbursements on sold loans, servicing rights, other real estate owned, realization of deferred tax assets, goodwill, other intangible assets, mortgage banking derivatives, fair value of assets and liabilities acquired in business combinations, fair value estimate of private label residential mortgage-backed securities, and the fair value of financial instruments are particularly subject to change and such change could have a material effect on the consolidated financial statements.

 

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Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance is established when necessary to reduce deferred tax assets when it is more-likely-than-not that a portion or all of the net deferred tax assets will not be realized. The Company had $12.3 million and $8.4 million of valuation allowance related to its deferred tax assets at September 30, 2013 and December 31, 2012 (See further discussion in Note 11, Income Taxes).

Accounting Pronouncements: During the nine months ended September 30, 2013, the following pronouncements applicable to the Company were issued or became effective:

In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210), Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01” ). ASU 2013-01 clarifies that ordinary trade receivables and other receivables are not in the scope of ASU 2011-11, Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities (“2011- 11”). Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the ASC or subject to a master netting arrangement or similar agreement. The amendments in ASU 2013-01 are effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, Other Comprehensive Income (Topic 220), Reporting of Amounts Reclassified out of Other Comprehensive Income (“ASU 2013-02”). The provisions in the ASU supersede and replace the presentation requirements for reclassifications out of accumulated other comprehensive income (“AOCI”) in ASUs 2011-05 and 2011-12. ASU 2013-02 requires entities to disclose additional information about reclassification adjustments, including (1) changes in AOCI balances by component and (2) significant items reclassified out of AOCI. The new disclosure requirements are effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

NOTE 2 – BUSINESS COMBINATIONS AND BRANCH SALES

Beach Business Bank Merger

Effective July 1, 2012, the Company acquired Beach Business Bank pursuant to the terms of the Agreement and Plan of Merger (the Merger Agreement) dated August 30, 2011, as amended October 31, 2011. At the effective time of the transaction, a newly formed and wholly owned subsidiary of the Company (Merger Sub) merged with and into Beach (the Merger), with Beach continuing as the surviving entity in the Merger and a wholly owned subsidiary of the Company. Pursuant and subject to the terms of the Merger Agreement, each outstanding share of Beach common stock (other than specified shares owned by the Company, Merger Sub or Beach, and other than in the case of shares in respect of, or underlying, certain Beach options and other equity awards, which were treated as set forth in the Merger Agreement) was converted into the right to receive $9.21415 in cash and one warrant. Each warrant entitled the holder to purchase 0.33 of a share of Company common stock at an exercise price of $14.00 per share for a period of one year. All of the warrants expired on June 30, 2013 without being exercised. The aggregate cash consideration paid to Beach shareholders in the Merger was approximately $39.1 million. In addition, Beach shareholders received in aggregate warrants to purchase the equivalent of 1,401,959 shares of the Company’s common stock with an estimated fair value of $1.0 million.

Beach (re-named The Private Bank of California effective July 1, 2013 and merged with Pacific Trust Bank on October 11, 2013 to form the Bank) operated branches in Manhattan Beach, Long Beach, and Costa Mesa, California. Beach also has a division named The Doctors Bank®, which serves physicians and dentists nationwide. Additionally, Beach provides loans to small businesses based on Small Business Administration (SBA) lending programs. Beach’s consolidated assets and equity (unaudited) as of June 30, 2012 totaled $311.9 million and $33.3 million, respectively. The acquired assets and liabilities were recorded at fair value at the date of acquisition and were reflected in the Company’s consolidated September 30, 2013 and December 31, 2012 financial statements as such.

In accordance with GAAP guidance for business combinations, the Company recorded $7.0 million of goodwill and $4.5 million of other intangible assets during the year ended December 31, 2012. The other intangible assets are primarily related to core deposits and are being amortized on an accelerated basis over 2—7 years. For tax purposes purchase accounting adjustments, including goodwill are all non-taxable and/or non-deductible.

The unique market opportunity that was created with the acquisition is that it creates for our Company the opportunity to leverage Beach’s branch network, SBA lending platform, the Doctors Bank product offerings and other programs that can be deployed throughout our market which we expect will help augment our customer base. This acquisition was consistent with the Company’s strategy to build a regional presence in Southern California. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as acquire new customers in the expanded region.

 

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Gateway Bancorp Acquisition

Effective August 18, 2012, the Company acquired Gateway Bancorp, the holding company of Gateway Business Bank (Gateway) pursuant to the terms of the Stock Purchase Agreement (the Purchase Agreement) dated June 3, 2011, as amended on November 28, 2011, February 24, 2012, June 30, 2012, and July 31, 2012. The acquisition was accomplished by the Company’s purchase of all of the outstanding stock of Gateway Bancorp, followed by the merger of Gateway into PacTrust Bank. Under the terms of the Purchase Agreement, the Company purchased all of the issued and outstanding shares of Gateway Bancorp for $15.4 million in cash.

Gateway operated branches in Lakewood and Laguna Hills, California. As part of the acquisition, Mission Hills Mortgage Bankers (MHMB, a division of Gateway), including its 22 loan production offices in California, Arizona, Oregon and Washington, became a division of the Bank. Gateway’s consolidated assets and equity (unaudited) as of August 17, 2012 totaled $175.5 million and $25.8 million, respectively. The acquired assets and liabilities were recorded at fair value at the date of acquisition and were reflected in the September 30, 2013 and December 31, 2012 consolidated financial statements as such.

In accordance with GAAP guidance for business combinations, the Company recorded $11.6 million of bargain purchase gain and $1.7 million of other intangible assets during the year ended December 31, 2012. The other intangible assets are related to $720 thousand of core deposits, which are being amortized on an accelerated basis over 4 - 6 years, and $955 thousand of trade name intangible which is being amortized over 20 years. For tax purposes the purchase accounting adjustments and bargain purchase gain are non-taxable and/or non-deductible. Due to circumstances that Gateway faced at the time the acquisition was negotiated, which include regulatory orders and operating losses, the terms negotiated included a purchase price that was $5 million lower than Gateway Bancorp’s equity book value. The discount was further increased to $6.5 million in exchange for the elimination of any contingent liability to the shareholder of Gateway Bancorp related to mortgage repurchase risk. Due to delays in obtaining regulatory approval, the deal closed nine months later than originally planned. This passage of time allowed Gateway to eliminate all regulatory orders, return to profitability, improve asset quality, and increase the book value of equity by reducing the expected discount on assets. As a result, a bargain purchase gain of $11.6 million resulted at the time of purchase.

This acquisition was consistent with the Company’s strategy to build a regional presence in Southern California. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region.

Private Bank of California Acquisition

On July 1, 2013, the Company completed its acquisition of The Private Bank of California, (PBOC) pursuant to the terms of the Agreement and Plan of Merger, dated as of August 21, 2012, as amended (the Merger Agreement), by and between the Company, Beach and PBOC. PBOC merged with and into Beach, with Beach continuing as the surviving entity in the merger and a wholly owned subsidiary of the Company, and changing its name to “The Private Bank of California.” On October 11, 2013, The Private Bank of California merged with the Company’s other wholly owned banking subsidiary, Pacific Trust Bank, to form the Bank.

Pursuant and subject to the terms of the Merger Agreement, each outstanding share of PBOC common stock (other than specified shares owned by the Company. On July 1, 2013, merger between PBOC and Beach was completed. Based on the merger agreement, all of the issued and outstanding common stocks were converted into, in the aggregate, (1) 2,082,654 shares of BANC common shares par value $0.01 per share, $28.3 million at $13.58 per share closing price on July 1, 2013, and (2) $25.3 million in cash. Additionally, the Company paid out $2.7 million for all outstanding options to acquire PBOC common stock in accordance with the merger agreement and converted outstanding PBOC stock options to the Company’s stock options with an assumed fair value of approximately $30 thousand. On the basis of the number of shares of PBOC Common Stock issued and outstanding immediately prior to the completion of the Merger, each outstanding share of PBOC Common Stock was converted into the right to receive $6.52 in cash and 0.5379 shares of the Company Common Stock.

In addition, upon completion of the acquisition, each share of preferred stock issued by PBOC as part of the Small Business Lending Fund (“SBLF”) program of the United States Department of Treasury (10,000 shares in the aggregate with a liquidation preference amount of $1,000 per share) was converted automatically into one substantially identical share of preferred stock of the Company. The terms of the preferred stock issued by the Company in exchange for the PBOC preferred stock are substantially identical to the preferred stock previously issued by the Company as part of its own participation in the SBLF program (32,000 shares in aggregate with a liquidation preference amount of $1,000 per share).

PBOC provided a range of financial services, including credit and deposit products as well as cash management services, from its headquarters located in the Century City area of Los Angeles, California as well as a full-service branch in Hollywood and

 

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loan production offices in downtown Los Angeles and Irvine. PBOC’s target clients included high-net worth and high income individuals, business professionals and their professional service firms, business owners, entertainment service businesses and non-profit organizations.

In accordance with GAAP guidance for business combinations, the Company has expensed approximately $2.6 million of direct acquisition costs and recorded $15.0 million of goodwill and $10.4 million of other intangible assets. The other intangible assets are primarily related to core deposits and are being amortized on an accelerated basis over 2-7 years. Loans that were acquired from PBOC that were considered credit impaired were written down at the acquisition date in accordance with purchase accounting to fair value. In addition, the allowance for loan losses for all PBOC loans was not carried over to the Company’s allowance for loan and lease losses. A full valuation allowance for the deferred tax asset was recorded as well. For tax purposes purchase accounting adjustments, including goodwill are all nontaxable and/or non-deductible. The Company does not expect material variances from these estimates and expects that final valuation estimates of the acquisition will be completed during the fourth quarter of 2013. The following table summarizes the fair value of the total consideration transferred as a part of the PBOC merger as well as the fair value of identifiable assets acquired and liabilities assumed as of the effective date of the transaction.

The following table summarizes the fair value marks to the Company’s balance sheet as of close of the PBOC transaction, and the resulting goodwill derived.

 

Consideration paid

            

Cash

     $ 25,252   

Options payout

       2,663   

Pre-merger options fair market value

       30   

Shares issued (1)

       28,282   
    

 

 

 

Total consideration

       56,227   

SBLF preferred stock assumed

       10,000   

Net assets pre-acquisition

       51,278   

Fair value marks

            

Loans receivable

     (10,856  

Allowance for loan losses

     7,380     

Investment securities

     (2,495  

Fixed assets

     5     

Trade name

     70     

Core deposit intangible

     10,330     

Deferred taxes assets, net

     (4,207  

Prepaid rent

     (64  

Lease liability

     (56  

Certificate of deposits purchase premium

     (196  
  

 

 

   

 

 

 

Total fair value marks

       (89

Fair value of net assets acquired

       51,189   
    

 

 

 

Excess of consideration paid over fair value of net assets acquired (goodwill)

     $ 15,038   
    

 

 

 

 

(1) @$13.58/share

 

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The following balance sheet of PBOC is presented at estimated fair value as of the acquisition date:

 

     July 1,  
     2013  

Assets acquired:

  

Cash and due from banks

   $ 33,752   

Securities available for sale, at fair value

     219,298   

Loans and leases receivable

     385,256   

Premises, equipment, and capital leases

     1,501   

Deferred income tax, net

     —     

Income tax receivable

     682   

Goodwill

     15,038   

Other intangible assets

     10,400   

Other assets

     6,578   
  

 

 

 

Total assets acquired

   $ 672,505   
  

 

 

 

Liabilities assumed:

  

Noninterest-bearing deposits

   $ 273,929   

Interest-bearing deposits

     287,760   

Advances from Federal Home Loan Bank

     41,833   

Other liabilities

     2,756   
  

 

 

 

Total liabilities assumed

   $ 606,278   
  

 

 

 

SBLF preferred stock assumed

   $ 10,000   
  

 

 

 

Total consideration paid

   $ 56,227   
  

 

 

 

Summary of considerations

  

Cash paid

   $ 27,915   

Common stock issued

   $ 28,282   

Convertion of stock options

   $ 30   

The Palisades Group, LLC, Acquisition

Effective September 10, 2013, the Company acquired The Palisades Group, LLC (“Palisades”), a Delaware limited liability company and a registered investment adviser under the Investment Advisers Act of 1940, pursuant to the terms of the Amended and Restated Units Purchase Agreement dated as of November 30, 2012, amended and restated as of August 12, 2013, for $50 thousand. Palisades provides financial advisory and asset management services to third parties, including the Bank, with respect to the purchase, sale and management of portfolios of residential mortgage loans.

In accordance with GAAP guidance for business combinations, the Company recorded no intangible assets related to Palisades. The following balance sheet of Palisades is presented at estimated fair value as of the acquisition date:

 

     September 10,  
     2013  

Assets acquired:

  

Cash and due from banks

   $ 900   

Interest-bearing deposits

     5   

Other assets

     364   
  

 

 

 

Total assets acquired

   $ 1,269   
  

 

 

 

Liabilities assumed:

  

Other liabilities

     1,219   
  

 

 

 

Total liabilities assumed

   $ 1,219   
  

 

 

 

SBLF preferred stock assumed

   $ —     
  

 

 

 

Total consideration paid

   $ 50   
  

 

 

 

Summary of considerations

  

Cash paid

   $ 50   

Other assets include account receivables of $265 thousand between Palisades and the Company, which is eliminated in the consolidated financials.

 

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Pro Forma Information

The following table presents unaudited pro forma information as if the acquisitions of Beach, Gateway, PBOC and Palisades had occurred on January 1, 2012 after giving effect to certain adjustments. The unaudited pro forma information for the three and nine months ended September 30, 2013 and 2012 includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, interest expense on deposits and borrowings acquired, and the related income tax effects. The unaudited pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transaction been effected on the assumed date.

 

    Pro Forma  
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2013     2012     2013     2012  
    (In thousands, except per share data)  

SUMMARIZED INCOME STATEMENT DATA (unaudited):

       

Net interest income

  $ 26,943      $ 20,685      $ 74,385      $ 58,185   

Provision for loan and lease losses

    2,109        1,350        6,987        3,647   

Non-interest income

    18,262        16,854        65,062        40,140   

Non-interest expense

    53,093        35,644        131,703        90,704   

Income (loss) before income taxes

    (9,997     545        757        3,974   

Income tax expense (benefit)

    (710     640        2,713        2,047   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (9,287   $ (95   $ (1,956   $ 1,927   
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per share

  $ (0.57   $ (0.04   $ (0.23   $ 0.07   

Diluted earnings (loss) per share

  $ (0.57   $ (0.04   $ (0.23   $ 0.07   

The above unaudited pro forma financial information for 2012 and 2013 includes the pre-acquisition periods for Beach, Gateway, PBOC and Palisades. Excluded from the above pro forma financial information for the three and nine months ended September 30, 2012 is revenue of $12.1 million related to the bargain purchase gain recorded in connection with the Gateway acquisition. The above unaudited pro forma financial information includes pre-acquisition provision for loan and lease losses of $319 thousand during the three months ended September 30, 2012 for PBOC, $850 thousand and $796 thousand for the nine months ended September 30, 2012 for Beach and PBOC, respectively, and $792 thousand for the nine months ended September 30, 2013 for PBOC.

Branch Sales

On May 31, 2013, the Bank entered into a definitive agreement with AmericanWest Bank, a Washington state chartered bank (“AWB”), pursuant to which the Bank has agreed to sell eight branches and related assets and deposit liabilities to AWB. The transaction provides for the transfer of deposits to AWB in exchange for a deposit premium of 2.3 percent applied to certain deposit balances transferred at closing. Such deposits totaled approximately $462.8 million as of September 30, 2013. Certain other assets related to the branches include the real estate for three of the branch locations and certain overdraft and other credit facilities related to the deposit accounts. These deposits and retail branch assets were classified as held-for-sale in the Consolidated Statements of Financial Condition as of September 30, 2013. As discussed in Note 19, Subsequent Events, this transaction was completed on October 4, 2013.

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 other 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.

 

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Securities Available for Sale. The fair values of securities available for sale are generally determined by quoted market prices, if available (Level 1), or by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). The fair values of the Company’s Level 3 securities are determined by the Company and an independent third-party provider using a discounted cash flow methodology. The methodology uses discount rates that are based upon observed market yields for similar securities. Prepayment speeds are estimated based upon the prepayment history of each bond and a detailed analysis of the underlying collateral. Gross weighted average coupon, geographic concentrations, loan to value, FICO and seasoning are among the different loan attributes that are factored into our prepayment curve. Default rates and severity are estimated based upon geography of the collateral, delinquency, modifications, loan to value ratios, FICO scores, and past performance.

Impaired Loans and Leases. The fair value of impaired loans and leases with specific allocations of the allowance for loan and lease losses based on collateral values is generally based on recent real estate appraisals (Level 2). These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. The impaired loans categorized as Level 3 also include unsecured and other secured loans whose fair value is based on significantly unobservable inputs such as strength of guarantees, cash flows discounted at the effective loan rate, and management’s judgment.

Loans Held for Sale. The fair value of loans held for sale is based on commitments outstanding from investors as well as what secondary markets are currently offering for portfolios with similar characteristics. Therefore, loans held for sale subjected to recurring fair value adjustments are classified as Level 2.

Derivative Assets and Liabilities. The Company’s derivative assets and liabilities are carried at fair value as required by GAAP and are accounted for as freestanding derivatives. The Company has entered into pay-fixed, receive-variable interest rate swap contracts with institutional counterparties to hedge against variability in cash flow attributable to interest rate risk caused by changes in the LIBOR benchmark interest rate on the Company’s ongoing LIBOR based variable rate deposits. The Company is accounting for the swaps as cash flow hedges under ASC 815. The other derivative assets are interest rate lock commitments (IRLCs) with prospective residential mortgage borrowers whereby the interest rate on the loan is locked by borrower prior to funding. These IRLCs are determined to be derivative instruments in accordance with GAAP. The derivative liabilities are hedging instruments typically mortgage-backed to-be-announced (TBA securities) used to hedge the risk of fair value changes affected by interest rates changes relating to the Company’s mortgage banking operations. The Company hedges the period from the interest rate lock (assuming a fall-out factor) to the date of the loan sale. The estimated fair value is based on current market prices for similar instruments. Given the meaningful level of secondary market activity for derivative contracts, active pricing is available for similar assets and accordingly, the Company classifies its derivative assets and liabilities as Level 2.

Servicing Rights – Mortgage. The Company retains servicing on some of its mortgage loans sold and has elected the fair value option for valuation of these mortgage servicing rights. The value is based on a third party model 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.

I/O Strips Receivable. The fair value is determined by discounting future cash flows using discount rates and prepayment assumptions that market participants would use for similar financial instruments. Because of the significance of unobservable inputs, the I/O strips receivable are classified as Level 3.

Other Real Estate Owned Assets (OREO). OREO are recorded at the fair value less estimated costs to sell at the time of foreclosure. 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 are typically significant and result in a Level 3 classification of the inputs for determining fair value. Only OREO with a valuation allowance are considered to be carried at fair value. For the nine months ended September 30, 2013 and 2012, the Company experienced $97 thousand and $205 thousand in valuation allowance expense for those assets, respectively.

 

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Assets and Liabilities Measured on a Recurring and Non-Recurring Basis

Available-for-sale securities, loans held for sale, derivative assets and liabilities, and mortgage servicing rights are measured at fair value on a recurring basis, whereas impaired loans and leases and other real estate owned are measured at fair value on a non-recurring basis.

The following table sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis as of the dates indicated:

 

          Fair Value Measurements Level  
          Quoted Prices in     Significant        
          Active Markets     Other     Significant  
          for Identical     Observable     Unobservable  
    Carrying     Assets     Inputs     Inputs  
    Value     (Level One)     (Level Two)     (Level Three)  
    (In thousands)  

September 30, 2013:

       

Assets

       

Available-for-sale securities:

       

U.S. Treasury note

  $ 110      $ 110      $ —        $ —     

SBA loan pools securities

    1,771        —          1,771        —     

U.S. government-sponsored entities and agency securities

    1,942        —          1,942        —     

Private label residential mortgage-backed securities

    17,334        —          17,334        —     

Agency mortgage-backed securities

    146,841        —          146,841        —     

Loans held for sale

    367,111        —          367,111        —     

Derivative assets (1)

    7,634        —          7,634        —     

Mortgage servicing rights (2)

    7,220        —          —          7,220   

Liabilities

       

Derivative liabilities (3)

    5,872        —          5,872        —     

December 31, 2012:

       

Assets

 

Available-for-sale securities:

       

U.S. government-sponsored entities and agency securities

  $ 2,710      $ —        $ 2,710      $ —     

State and Municipal securities

    9,944        —          9,944        —     

Private label residential mortgage-backed securities

    41,846        —          39,632        2,214   

Agency mortgage-backed securities

    66,919        —          66,919        —     

Loans held for sale

    113,158        —          113,158        —     

Derivative assets (1)

    2,890        —          2,890        —     

Mortgage servicing rights (2)

    1,739        —          —          1,739   

Liabilities

       

Derivative liabilities (3)

    988        —          988        —     

 

(1)

Included in other assets on the consolidated statements of financial condition

(2)

Included in servicing rights, net on the consolidated statements of financial condition

(3)

Included in accrued expenses and other liabilities on the consolidated statements of financial condition

 

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The following table sets forth the Company’s financial assets and liabilities measured at fair value on a non-recurring basis as of the dates indicated:

 

            Fair Value Measurements Level  
            Quoted Prices in      Significant         
            Active Markets      Other      Significant  
            for Identical      Observable      Unobservable  
     Carrying      Assets      Inputs      Inputs  
     Value      (Level One)      (Level Two)      (Level Three)  
     (In thousands)  

September 30, 2013:

           

Assets

           

Impaired loans:

           

Real estate 1-4 family first mortgage

   $ 13,202       $ —         $ 1,104       $ 12,098   

Real estate mortgage

     5,896         —           —           5,896   

HELOC’s, home equity loans, and other consumer installment credit

     1,055         —           —           1,055   

Commercial and industrial

     70         —           —           70   

SBA

     11         —           —           11   

Other real estate owned assets:

           

Land

     1,383         —           —           1,383   

December 31, 2012:

           

Assets

           

Impaired loans:

           

Real estate 1-4 family first mortgage

   $ 21,778       $ —         $ 3,041       $ 18,737   

Multi-family

     5,442         —           —           5,442   

Real estate mortgage

     2,531         —           829         1,702   

HELOC’s, home equity loans, and other consumer installment credit

     3         —           —           3   

Other real estate owned assets:

           

Real estate 1-4 family first mortgage

     118         —           —           118   

Land

     3,889         —           —           3,889   

There were impaired loans of $1.1 million and none with specific allowances tested for impairment using the fair value of the collateral for collateral dependent loans at September 30, 2013 and December 31, 2012.

Other real estate owned measured at fair value less costs to sell, had a net carrying value of $1.4 million, which was comprised of the outstanding balance of $1.4 million, net of a valuation allowance of $42 thousand at September 30, 2013. At December 31, 2012, real estate owned had a net carrying value of $4.5 million, which is made up of the outstanding balance of $6.6 million, net of a valuation allowance of $2.1 million.

The table below presents the gains and (losses) recognized on assets measured at fair value on a non-recurring basis as of the dates indicated:

 

     Three months
ended
September 30, 2013
    Nine months
ended
September 30, 2013
 
     (In thousands)  

Impaired loans:

    

Real estate 1-4 family first mortgage

   $ (884   $ (1,195

Real estate mortgage

     (117     (238

SBA

     (1     (29

HELOC’s, home equity loans, and other consumer installment credit

     —          (19

Commercial and industrial

     (2     (2

Other real estate owned assets:

    

Multi-family

     83        84   

Land

     (21     83   

Real estate 1-4 family first mortgage

     (7     (40

 

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The tables below present a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2013:

 

     Private label
residential
mortgage-backed
securities
    Mortgage
Servicing
Rights
    Total  
     (In thousands)  

Balance of recurring Level 3 securities at January 1, 2013

   $ 2,214      $ 1,739      $ 3,953   

Transfers out of Level 3

     —          —          —     

Total gains or losses (realized/unrealized):

      

Included in earnings—realized

     —          —          —     

Included in earnings—fair value adjustment

     —          251        251   

Included in other comprehensive income

     —          —          —     

Amortization of premium (discount)

     —          —          —     

Additions

     —          5,598        5,598   

Sales, issuances and settlements

     (2,214     (368     (2,582
  

 

 

   

 

 

   

 

 

 

Balance of recurring Level 3 securities at September 30, 2013

   $ —        $ 7,220      $ 7,220   
  

 

 

   

 

 

   

 

 

 

The table below presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2012:

 

     Private label
residential
mortgage-backed
securities
    Mortgage
Servicing
Rights
    Total  
     (In thousands)  

Balance of recurring Level 3 securities at January 1, 2012

   $ 76,203      $ —        $ 76,203   

Transfers out of Level 3

     —          —          —     

Total gains or losses (realized/unrealized):

      

Included in earnings—realized

     (83     —          (83

Included in earnings—fair value adjustment

     —          (107     (107

Included in other comprehensive income

     (9     —          (9

Amortization of premium (discount)

     (160     —          (160

Additions

     —          1,778        1,778   

Sales, issuances and settlements

     (25,671     (62     (25,733
  

 

 

   

 

 

   

 

 

 

Balance of recurring Level 3 securities at September 30, 2012

   $ 50,280      $ 1,609      $ 51,889   
  

 

 

   

 

 

   

 

 

 

The following table presents quantitative information about Level 3 fair value measurements on a recurring basis as of the dates indicated:

 

     Fair Value      Valuation Technique(s)    Unobservable Input(s)    Range (Weighted Average)
     ($ in thousands)

September 30, 2013:

           

Mortgage servicing rights

   $ 7,220       Discounted cash flow    Discount rate    10.00% to 17.46% (10.33%)
         Prepayment rate    3.29% to 38.70% (10.89%)

December 31, 2012:

           

Private label residential mortgage backed securities

   $ 2,214       Discounted cash flow    Voluntary prepayment rate
Collateral default rate
   3.15% to 8.00% (5.80%)

8.46% to 8.56% (8.5%)

         Loss severity at default    55%

Mortgage servicing rights

     1,739       Discounted cash flow    Discount rate    10.5% to 11.5% (10.5%)
         Prepayment rate    4.3% to 35.3% (13.8%)

 

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The significant unobservable inputs used in the fair value measurement of the Company’s private label and agency residential mortgage backed securities are prepayment rates, collateral default rates, and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the collateral default rates is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights include the discount rate and estimated cash flows. 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.

The carrying amounts and estimated fair values of financial instruments as of September 30, 2013 and December 31, 2012 were as follows:

 

            Fair Value Measurements Level  
     Carrying
Amount
     Level 1      Level 2      Level 3      Total  
     (In thousands)  

September 30, 2013:

  

Financial assets

              

Cash and cash equivalents

   $ 416,010       $ 416,010       $ —         $ —         $ 416,010   

Time deposits in financial institutions

     2,938         2,938         —           —           2,938   

Securities available-for-sale

     167,998         110         167,888         —           167,998   

FHLB stock

     14,789         —           14,789         —           14,789   

Loans and leases receivable, net of allowance

     2,577,058         —           —           2,608,253         2,608,253   

Loans held for sale

     367,111         —           367,111         —           367,111   

Accrued interest receivable

     10,425         10,425         —           —           10,425   

Derivative assets

     7,634         —           7,634         —           7,634   

Servicing rights

     7,603         —           —           7,603         7,603   

Financial liabilities

              

Deposits

     3,259,374         —           3,236,018         —           3,236,018   

Advances from the FHLB

     25,000         —           25,088         —           25,088   

Notes payable

     82,224         86,038         —           —           86,038   

Derivative liabilities

     5,872         —           5,872         —           5,872   

Accrued interest payable

     1,745         1,745         —           —           1,745   

December 31, 2012:

              

Financial assets

              

Cash and cash equivalents

   $ 108,643       $ 108,643       $ —         $ —         $ 108,643   

Time deposits in financial institutions

     5,027         5,027         —           —           5,027   

Securities available-for-sale

     121,419         —           119,205         2,214         121,419   

FHLB stock

     8,842         —           8,842         —           8,842   

Loans and leases receivable, net of allowance

     1,234,023         —           —           1,267,292         1,267,292   

Loans held for sale

     113,158         —           113,158         —           113,158   

Accrued interest receivable

     5,002         7         50         4,945         5,002   

Derivative assets

     2,890         —           2,890         —           2,890   

Servicing rights

     2,278         —           —           2,278         2,278   

Financial liabilities

              

Deposits

     1,306,342         —           1,305,884         —           1,305,884   

Advances from the FHLB

     75,000         —           75,166         —           75,166   

Notes payable

     81,935         86,106         —           —           86,106   

Derivative liabilities

     988         —           988         —           988   

Accrued interest payable

     1,639         1,335         304         —           1,639   

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and cash equivalents, FHLB stock, and accrued interest receivable and payable. The methods for determining the fair values for securities available for sale, derivatives assets and liabilities, and I/O strips are described above. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of long-term debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance-sheet items is not considered material (or is based on the current fees or costs that would be charged to enter into or terminate such arrangements) and is not presented.

 

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NOTE 4 – SECURITIES AVAILABLE FOR SALE

The following tables summarize the amortized cost and fair value of the available-for-sale investment securities portfolio at September 30, 2013 and December 31, 2012, respectively, and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss):

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (In thousands)  

September 30, 2013:

          

Available-for-sale

          

U.S. Treasury note

   $ 110       $ —         $ —        $ 110   

SBA loan pools securities

     1,794         —           (23     1,771   

U.S. government-sponsored entities and agency securities

     1,925         17         —          1,942   

Private label residential mortgage-backed securities

     17,208         169         (43     17,334   

Agency mortgage-backed securities

     147,469         593         (1,221     146,841   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 168,506       $ 779       $ (1,287   $ 167,998   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2012:

          

Available-for-sale

          

U.S. government-sponsored entities and agency securities

   $ 2,706       $ 4       $ —        $ 2,710   

State and Municipal securities

     9,660         284         —          9,944   

Private label residential mortgage-backed securities

     41,499         475         (128     41,846   

Agency mortgage-backed securities

     66,818         335         (234     66,919   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 120,683       $ 1,098       $ (362   $ 121,419   
  

 

 

    

 

 

    

 

 

   

 

 

 

The Company recorded no other-than-temporary impairment (OTTI) for securities available for sale at September 30, 2013 or December 31, 2012.

The amortized cost and fair value of the available-for-sale securities portfolio are shown below by expected maturity. In the case of residential mortgage-backed securities and SBA loan pool securities, expected maturities may differ from contractual maturities because borrowers generally have the right to call or prepay obligations with or without call or prepayment penalties. For that reason, mortgage-backed securities and SBA loan pool securities are not included in the maturity categories.

 

     September 30, 2013  
     Amortized
Cost
     Fair
Value
 
     (In thousands)  

Maturity

     

Available-for-sale

     

Within one year

   $ 2,035       $ 2,052   

One to five years

     —           —     

Five to ten years

     —           —     

Greater than ten years

     —           —     

SBA loan pools, private label residential mortgage backed and agency mortgage-backed securities

     166,471         165,946   
  

 

 

    

 

 

 
   $ 168,506       $ 167,998   
  

 

 

    

 

 

 

At September 30, 2013 and December 31, 2012, there were no holdings of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10 percent of shareholders’ equity.

 

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The following table summarizes the investment securities with unrealized losses at September 30, 2013 and December 31, 2012, respectively, by aggregated major security type and length of time in a continuous unrealized loss position:

 

     Less Than 12 Months     12 Months or Longer     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
     Value      Losses     Value      Losses     Value      Losses  
     (In thousands)  

September 30, 2013:

               

Available-for-sale

               

SBA loan pools securities

   $ 1,771       $ (23   $ —         $ —        $ 1,771       $ (23

Private label residential mortgage-backed securities

     5,739         (41     516         (2     6,255         (43

Agency residential mortgage-backed securities

     60,763         (1,221     —           —          60,763         (1,221
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale

   $ 68,273       $ (1,285   $ 516       $ (2   $ 68,789       $ (1,287
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2012:

               

Available-for-sale

               

Private label residential mortgage-backed securities

   $ 2,194       $ (13   $ 10,061       $ (115   $ 12,255       $ (128

Agency residential mortgage-backed securities

     37,388         (234     —           —          37,388         (234
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale

   $ 39,582       $ (247   $ 10,061       $ (115   $ 49,643       $ (362
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

As of September 30, 2013, the Company’s securities available for sale portfolio consisted of 122 securities, 56 of which were in an unrealized loss position. The unrealized losses are related to interest rate increases of the agency mortgage-backed securities as discussed below.

The Company’s private label residential mortgage-backed securities that are in an unrealized loss position had a fair value of $6.3 million with unrealized losses of $43 thousand at September 30, 2013. The Company’s agency residential mortgage-backed securities that are in an unrealized loss position had a fair value of $60.8 million with unrealized losses of $1.2 million at September 30, 2013.

The Company monitors its securities portfolio to ensure it has adequate credit support. With respect to its securities in an unrealized loss position as of September 30, 2013, the Company believes there is no OTTI and it does not have the intent to sell these securities and believes it is not likely that it will be required to sell the securities before their anticipated recovery. Of the Company’s $168.0 million securities portfolio, $163.2 million of the securities were rated A or above, and $4.8 million were rated BBB based on the most recent credit rating as of September 30, 2013. The Company considers the lowest credit rating for identification of potential OTTI.

 

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NOTE 5 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES

As of September 30, 2013 and December 31, 2012 the Company had the following balances in its loan and lease portfolio:

 

    Non-Traditional
Mortgages (NTM)
    Traditional
Loans
    Total NTM and
Traditional Loans
    Purchased Credit
Impaired
    Total Loans and
Leases Receivable
 
    ($ in thousands)  

September 30, 2013:

         

Commercial

         

Commercial and industrial

  $ —        $ 247,323      $ 247,323      $ 3,600      $ 250,923   

Real estate mortgage

    —          464,211        464,211        18,987        483,198   

Multi-family

    —          129,351        129,351        831        130,182   

SBA

    —          23,923        23,923        3,801        27,724   

Construction

    —          22,827        22,827        —          22,827   

Lease financing

    —          21,325        21,325        —          21,325   

Consumer:

         

Real estate 1-4 family first mortgage

    209,324        859,097        1,068,421        321,078        1,389,499   

Green Loans (HELOC)—First Liens

    158,517        —          158,517        —          158,517   

Green Loans (HELOC)—Second Liens

    6,309        —          6,309        —          6,309   

Other HELOC’s, home equity loans, and other consumer installment credit

    113        102,694        102,807        831        103,638   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Gross Loans

    374,263        1,870,751        2,245,014        349,128        2,594,142   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage to total gross loans

    14.4     72.1     86.5     13.5     100.0

Net deferred loan costs

          $ 842   

Unamortized purchase premium

            1,204   

Allowance for loan losses

            (19,130
         

 

 

 

Loans and leases receivable, net

          $ 2,577,058   
         

 

 

 

December 31, 2012:

         

Commercial

         

Commercial and industrial

  $ —        $ 73,585      $ 73,585      $ 6,808      $ 80,393   

Real estate mortgage

    —          318,051        318,051        21,837        339,888   

Multi-family

    —          112,829        112,829        845        113,674   

SBA

    —          30,512        30,512        5,608        36,120   

Construction

    —          6,648        6,648        —          6,648   

Lease financing

    —          11,203        11,203        —          11,203   

Consumer:

         

Real estate 1-4 family first mortgage

    162,127        211,527        373,654        65,066        438,720   

Green Loans (HELOC)—First Liens

    198,351        —          198,351        —          198,351   

Green Loans (HELOC)—Second Liens

    7,653        —          7,653        —          7,653   

Other HELOC’s, home equity loans, and other consumer installment credit

    113        13,740        13,853        56        13,909   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Gross Loans

  $ 368,244      $ 778,095      $ 1,146,339      $ 100,220      $ 1,246,559   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage to total gross loans

    29.5     62.5     92.0     8.0     100.0

Net deferred loan costs

          $ 447   

Unamortized purchase premium

            1,465   

Allowance for loan losses

            (14,448
         

 

 

 

Loans and leases receivable, net

          $ 1,234,023   
         

 

 

 

 

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Non Traditional Mortgage Loans

The Company’s non-traditional mortgage (“NTM”) portfolio is comprised of three interest only products: the Green Account Loans (Green Loans), the hybrid interest only fixed or adjustable rate mortgage (Interest Only) and a small number of loans with the potential for negative amortization. As of September 30, 2013 and December 31, 2012, the non-traditional mortgage loans totaled $374.3 million or 14.4 percent of the total gross loan portfolio and $368.2 million or 29.5 percent of the total gross loan portfolio, respectively. Despite the decrease in percentage to total gross loan portfolio, total NTM loans increased $6.0 million or 1.6 percent. The following table represents the composition of the NTM portfolio at the dates indicated:

 

     September 30, 2013     December 31, 2012  
     Count      Amount     Percent     Count      Amount     Percent  
     ($ in thousands)  

Green

     203       $ 164,826        44.0     239       $ 206,004        56.0

Interest-only

     292         192,363        51.4        191         142,978        38.8   

Negative amortization

     38         17,074        4.6        40         19,262        5.2   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total NTM loans

     533       $ 374,263        100.0     470       $ 368,244        100.0
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total gross loan portfolio

      $ 2,594,142           $ 1,246,559     

% of NTM to total gross loan portfolio

        14.4          29.5  

Green Loans

Green Loans are single family residence first and second mortgage lines of credit with a linked checking account that allows all types of deposits and withdrawals to be performed. The loans are generally interest only with a 15 year balloon payment due at maturity. At September 30, 2013, Green Loans totaled $164.8 million, a decrease of $41.2 million or 20.0 percent from $206.0 million at December 31, 2012, primarily due to reductions in principal balance and payoffs of $9.2 million and $39.7 million, respectively, partially offset by advances of $7.7 million. As of September 30, 2013 and December 31, 2012, $4.5 million and $5.7 million, respectively, of the Company’s Green Loans were non-performing. As a result of their unique payment feature, Green Loans possess higher credit risk due to the potential of negative amortization; however, management believes the risk is mitigated through the Company’s loan terms and underwriting standards, including its policies on loan-to-value ratios. The Company discontinued origination of the Green Loan products in 2011.

Interest Only Loans

Interest only loans are primarily single family residence first mortgage loans with payment features that allow interest only payment in initial periods before converting to fully amortizing payments. As of September 30, 2013, our interest only loans increased by $49.4 million or 34.5 percent to $192.4 million from $143.0 million at December 31, 2012, primarily due to purchases of $55.7 million and originations of $174.0 million, partially offset by sales of $64.0 million, payoffs and principal reductions of $87.8 million, and reclassification of $28.4 million from NTM interest only to traditional loans due to the expiration of the initial interest only period and conversion to a fully amortizing basis. As of September 30, 2013 and December 31, 2012, $297 thousand and $6.2 million, respectively, of the Company’s interest only loans were non-performing.

Loans with the Potential for Negative Amortization

Negative amortization loans decreased by $2.2 million or 11.4 percent to $17.1 million as of September 30, 2013 from $19.3 million as of December 31, 2012. The Company discontinued origination of negative amortization loans in 2007. As of September 30, 2013 and December 31, 2012, $158 thousand and none, respectively, of the Company’s loans that had the potential for negative amortization were non-performing. These loans pose a potentially higher credit risk because of the lack of principal amortization and potential for negative amortization; however, management believes the risk is mitigated through the Company’s loan terms and underwriting standards, including its policies on loan-to-value ratios.

Risk Management of Non-Traditional Mortgages

The Company has assessed that the most significant performance indicators for non-traditional mortgages (NTMs) are loan-to-value (LTV) and FICO scores. Accordingly, the Company manages credit risk in the NTM portfolio through semi-annual review of the loan portfolio that includes refreshing FICO scores on the Green Loans and home equity lines of credit, typically in November and April or as needed in conjunction with portfolio management, and ordering third party automated valuation models. The loan review is designed to provide a method of identifying borrowers who may be experiencing financial difficulty before they actually fail to make a loan payment. Upon receipt of the updated FICO scores, an exception report is run to identify loans with a decrease in

 

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FICO of 10 percent or more and a resulting FICO of 620 or less. The loans are then further analyzed to determine if the risk rating should be downgraded which will increase the reserves the Company will establish for potential losses. A report of the semi-annual loan review is published and regularly monitored.

As these loans are revolving lines of credit, the Company, based on the loan agreement and loan covenants of the particular loan, as well as applicable rules and regulations, could suspend the borrowing privileges or reduce the credit limit at any time the Company reasonably believes that the borrower will be unable to fulfill their repayment obligations under the agreement or certain other conditions are met. In many cases, the decrease in FICO is the first red flag that the borrower may have difficulty in making their future payment obligations.

As a result, the Company proactively manages the portfolio by performing detailed analysis on its portfolio with emphasis on the non-traditional mortgage portfolio. The Company’s Internal Asset Review Committee (IARC) conducts monthly meetings to review the loans classified as special mention, substandard, or doubtful and determines whether suspension or reduction in credit limit is warranted. If the line has been suspended and the borrower would like to have their credit privileges reinstated, they would need to provide updated financials showing their ability to meet their payment obligations.

On the interest only loans, the Company projects future payment changes to determine if there will be an increase in payment of 3.50 percent or greater and then monitors the loans for possible delinquency. The individual loans are monitored for possible downgrading of risk rating, and trends within the portfolio are identified that could affect other interest only loans scheduled for payment changes in the near future.

Non Traditional Mortgage Performance Indicators

The tables below represent the Company’s non-traditional one-to-four SFR mortgage Green Loans first lien portfolio at September 30, 2013 by FICO scores that were obtained during the second quarter of 2013, comparing to the FICO scores that were obtained during the fourth quarter of 2012:

 

     September 30, 2013     December 31, 2012     Changes in count and amounts  
     Count      Amount      Percent     Count      Amount      Percent     Count change     Amount change     Percent change  
     ($ in thousands)  

800+

     13       $ 3,925         2.5     8       $ 6,991         4.4     5      $ (3,066     (1.9 )% 

700-799

     96         87,340         55.1        102         81,021         51.1        (6     6,319        4.0   

600-699

     45         38,198         24.1        44         43,226         27.3        1        (5,028     (3.2

<600

     14         13,952         8.8        14         12,177         7.7        —          1,775        1.1   

No FICO

     10         15,102         9.5        10         15,102         9.5        —          —          —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Totals

     178       $ 158,517         100.0     178       $ 158,517         100.0     —        $ —          —  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The 700-799 FICO score category increased by 4.0 percent to 55.1 percent of total non-traditional one-to-four SFR mortgage Green Loans first lien at September 30, 2013 from 51.1 percent at December 31, 2012 from FICO scores obtained during the fourth quarter of 2012.

 

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Table of Contents

Loan to Value

The table below represents the Company’s one-to-four SFR non-traditional mortgage first lien portfolio by LTV as of the dates indicated:

 

    Green     I/O     Neg Am     Total  
    Count     Amount     Percentage     Count     Amount     Percentage     Count     Amount     Percentage     Count     Amount     Percentage  
    ($ in thousands)  

September 30, 2013:

                       

LTV’s (1)

                       

< 61

    60      $ 56,734        35.7     71      $ 66,070        34.4     13      $ 5,114        30.0     144      $ 127,918        34.8

61-80

    55        55,295        34.9        85        72,620        37.8        7        4,613        27.0        147        132,528        36.0   

81-100

    36        28,639        18.1        57        27,526        14.3        12        5,735        33.6        105        61,900        16.8   

> 100

    27        17,849        11.3        78        26,034        13.5        6        1,612        9.4        111        45,495        12.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals

    178        158,517        100.0     291        192,250        100.0     38        17,074        100.0     507        367,841        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2012:

                       

LTV’s (1)

                       

< 61

    51      $ 59,546        30.0     60      $ 47,295        33.1     11      $ 2,442        12.6     122      $ 109,283        30.3

61-80

    63        51,934        26.2        72        59,025        41.3        4        1,225        6.4        139        112,184        31.1   

81-100

    61        62,518        31.5        27        17,578        12.3        11        8,120        42.2        99        88,216        24.5   

> 100

    37        24,353        12.3        31        18,967        13.3        14        7,475        38.8        82        50,795        14.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals

    212      $ 198,351        100.0     190      $ 142,865        100.0     40      $ 19,262        100.0     442      $ 360,478        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) LTV represents estimated current loan to value ratio, determined by dividing current unpaid principal balance by latest estimated property value received per the Company’s policy

At September 30, 2013, the increase in interest only loans primarily related to purchases of 153 loans with a carrying value of $55.7 million and originations of $174.0 million, partially offset by sales, payoffs, principal reductions, and conversions to traditional loans of $180.1 million.

Allowance for Loan and Lease Losses

The Company has an established credit risk management process that includes regular management review of the loan and lease portfolio to identify problem loans and leases. During the ordinary course of business, management becomes aware of borrowers and lessees that may not be able to meet the contractual requirements of the loan and lease agreements. Such loans and leases are subject to increased monitoring. Consideration is given to placing the loan or lease on non-accrual status, assessing the need for additional allowance for loan and lease losses, and partial or full charge-off. The Company maintains the allowance for loan and lease losses at a level that is considered adequate to cover the estimated and known inherent risks in the loan portfolio and off-balance sheet unfunded credit commitments. The allowance for loan and lease losses includes allowances for loan, lease, and off-balance sheet unfunded credit commitment losses.

The credit risk monitoring system is designed to identify impaired and potential problem loans, and to permit periodic evaluation of impairment and the adequacy level of the allowance for credit losses in a timely manner. In addition, the Board of Directors of the Bank has adopted a credit policy that includes a credit review and control system which it believes should be effective in ensuring that the Company maintains an adequate allowance for credit losses. The Board of Directors provides oversight and guidance for management’s allowance evaluation process, including quarterly valuations, and consideration of management’s determination of whether the allowance is adequate to absorb losses in the loan and lease portfolio. The determination of the amount of the allowance for loan and lease losses and the provision for loan and lease losses is based on management’s current judgment about the credit quality of the loan and lease portfolio and takes into consideration known relevant internal and external factors that affect collectability when determining the appropriate level for the allowance for loan and lease losses. The nature of the process by which the Company determines the appropriate allowance for loan and lease losses requires the exercise of considerable judgment. Additions to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses. Identified credit exposures that are determined to be uncollectible are charged against the allowance for loan and lease losses. Recoveries of previously charged off amounts, if any, are credited to the allowance for loan and lease losses.

 

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Table of Contents

The following is a summary of activity in the allowance for loan and lease losses and ending balances of loans evaluated for impairment for the three and nine months ended September 30, 2013 and 2012, respectively:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2013     2012     2013     2012  
     (In thousands)  

Balance at beginning of period

   $ 16,979      $ 11,448      $ 14,448      $ 12,780   

Loans and leases charged off

     (211     (226     (2,145     (2,547

Recoveries of loans and leases previously charged off

     253        126        632        145   

Provision for loan and lease losses

     2,109        1,031        6,195        2,001   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 19,130      $ 12,379      $ 19,130      $ 12,379   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following table presents the activity and balance in the allowance for loan and lease losses and the recorded investment in loans and leases by portfolio segment and is based on the impairment method as of and for the three and nine months ended September 30, 2013:

 

    Commercial
and
Industrial
    Commercial
Real Estate
Mortgage
    Multi-
Family
    SBA     Construction     Lease
Financing
    Real Estate
1-4  family
First
Mortgage
    HELOC’s,
Home Equity
Loans, and
Other
Consumer
Credit
    Unallocated     TOTAL  
    (In thousands)  

Allowance for loan and lease losses:

                   

Balance as of June 30, 2013

  $ 816      $ 4,508      $ 1,449      $ 179      $ 503      $ 244      $ 8,751      $ 225      $ 304      $ 16,979   

Charge-offs

    —          (12     —          (199     —          —          —          —          —          (211

Recoveries

    —          153        —          97        —          2        1        —          —          253   

Provision

    636        1,047        266        373        (194     66        12        102        (199     2,109   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2013

  $ 1,452      $ 5,696      $ 1,715      $ 450        309      $ 312      $ 8,764      $ 327      $ 105      $ 19,130   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of December 31, 2012

  $ 263      $ 3,178      $ 1,478      $ 118      $ 21      $ 261      $ 8,855      $ 274      $ —        $ 14,448   

Charge-offs

    —          (372     (553     (592     —          (23     (591     (14     —          (2,145

Recoveries

    —          173        88        264        —          8        92        7        —          632   

Provision

    1,189        2,717        702        660        288        66        408        60        105        6,195   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2013

  $ 1,452      $ 5,696      $ 1,715      $ 450        309      $ 312      $ 8,764      $ 327      $ 105      $ 19,130   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Individually evaluated for impairment

  $ 2      $ 276      $ —        $ —        $ —        $ —        $ 1,089      $ 32      $ —        $ 1,399   

Collectively evaluated for impairment

    1,450        5,420        1,715        450        309        312        7,363        295        105        17,419   

Acquired with deteriorated credit quality

    —          —          —          —          —          —          312        —          —          312   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

  $ 1,452      $ 5,696      $ 1,715      $ 450        309      $ 312      $ 8,764      $ 327      $ 105      $ 19,130   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

                   

Individually evaluated for impairment

  $ 70      $ 5,896      $ —        $ 11      $ —        $ —        $ 13,202      $ 1,055      $ —        $ 20,234   

Collectively evaluated for impairment

    247,079        457,377        130,449        23,857        22,838        21,340        1,215,788        108,098