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CATHAY GENERAL BANCORP - Quarter Report: 2014 March (Form 10-Q)

caty20140331_10q.htm

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

                               March 31, 2014

 

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

0-18630

 

CATHAY GENERAL BANCORP

(Exact name of registrant as specified in its charter)

 

Delaware 

 

95-4274680 

(State of other jurisdiction of incorporation

or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

777 North Broadway, Los Angeles, California

 

90012

(Address of principal executive offices)

 

(Zip Code)

 

Registrant's telephone number, including area code:

(213) 625-4700



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

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

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

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

Large accelerated filer    

 

Accelerated filer  

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 

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

 

Common stock, $.01 par value, 79,619,641 shares outstanding as of April 30, 2014.

 

 
1

 

 

CATHAY GENERAL BANCORP AND SUBSIDIARies

1ST quarter 2014 REPORT ON FORM 10-Q

table of contents

 

PART I – FINANCIAL INFORMATION

  5
   

Item 1.   FINANCIAL STATEMENTS (Unaudited).

  5

   NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited).

  8

Item 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

  35

Item 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  58

Item 4.   CONTROLS AND PROCEDURES.

  59
   

PART II - OTHER INFORMATION

  60
   

Item 1.   LEGAL PROCEEDINGS.

60

Item 1A RISK FACTORS.

  60

Item 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

60

Item 3.   DEFAULTS UPON SENIOR SECURITIES.

61

Item 4.   MINE SAFETY DISCLOSURES.

61

Item 5.   OTHER INFORMATION.

61

Item 6.   EXHIBITS.

61

   
   
   
   

SIGNATURES

62

 

 
2

 

 

Forward-Looking Statements

 

In this Quarterly Report on Form 10-Q, the term “Bancorp” refers to Cathay General Bancorp and the term “Bank” refers to Cathay Bank. The terms “Company,” “we,” “us,” and “our” refer to Bancorp and the Bank collectively.

 

The statements in this report include forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 regarding management’s beliefs, projections, and assumptions concerning future results and events. We intend such forward-looking statements to be covered by the safe harbor provision for forward-looking statements in these provisions. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including statements about anticipated future operating and financial performance, financial position and liquidity, growth opportunities and growth rates, growth plans, acquisition and divestiture opportunities, business prospects, strategic alternatives, business strategies, financial expectations, regulatory and competitive outlook, investment and expenditure plans, financing needs and availability, and other similar forecasts and statements of expectation and statements of assumptions underlying any of the foregoing. Words such as “aims,” “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “hopes,” “intends,” “may,” “optimistic,” “plans,” “potential,” “possible,” “predicts,” “projects,” “seeks,” “shall,” “should,” “will,” and variations of these words and similar expressions are intended to identify these forward-looking statements. Forward-looking statements by us are based on estimates, beliefs, projections, and assumptions of management and are not guarantees of future performance. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Such risks and uncertainties and other factors include, but are not limited to, adverse developments or conditions related to or arising from:

 

 

U.S. and international business and economic conditions;

 

 

possible additional provisions for loan losses and charge-offs;

 

 

credit risks of lending activities and deterioration in asset or credit quality;

 

 

extensive laws and regulations and supervision that we are subject to, including potential supervisory action by bank supervisory authorities;

 

 

increased costs of compliance and other risks associated with changes in regulation, including the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);

 

 

higher capital requirements from the implementation of the Basel III capital standards;

 

 

compliance with the Bank Secrecy Act and other money laundering statutes and regulations;

 

 

potential goodwill impairment;

 

 

liquidity risk;

 

 

fluctuations in interest rates;

 

 

risks associated with acquisitions and the expansion of our business into new markets;

 

 

inflation and deflation;

 

 

real estate market conditions and the value of real estate collateral;

 

 

environmental liabilities;

 

 
3

 

 

 

our ability to compete with larger competitors;

 

 

our ability to retain key personnel;

 

 

successful management of reputational risk;

 

 

natural disasters and geopolitical events;

 

 

general economic or business conditions in Asia, and other regions where the Bank has operations;

 

 

failures, interruptions, or security breaches of our information systems;

 

 

our ability to adapt our systems to technological changes;

 

 

risk management processes and strategies;

 

 

adverse results in legal proceedings;

 

 

certain provisions in our charter and bylaws that may affect acquisition of the Company;

 

 

changes in accounting standards or tax laws and regulations;

 

 

market disruption and volatility;

 

 

restrictions on dividends and other distributions by laws and regulations and by our regulators and our capital structure;

 

 

issuance of preferred stock;

 

 

successfully raising additional capital, if needed, and the resulting dilution of interests of holders of our common stock; and

 

 

the soundness of other financial institutions.

 

These and other factors are further described in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2013 (Item 1A in particular), other reports and registration statements filed with the Securities and Exchange Commission (“SEC”), and other filings it makes with the SEC from time to time. Actual results in any future period may also vary from the past results discussed in this report. Given these risks and uncertainties, readers are cautioned not to place undue reliance on any forward-looking statements, which speak to the date of this report. We have no intention and undertake no obligation to update any forward-looking statement or to publicly announce any revision of any forward-looking statement to reflect future developments or events, except as required by law.

 

Bancorp’s filings with the SEC are available at the website maintained by the SEC at http://www.sec.gov, or by request directed to Cathay General Bancorp, 9650 Flair Drive, El Monte, California 91731, Attention: Investor Relations (626) 279-3286.

 

 
4

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

 

CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(In thousands, except share and per share data)

 

March 31, 2014

   

December 31, 2013

 
                 

Assets

               

Cash and due from banks

  $ 161,657     $ 153,747  

Short-term investments and interest bearing deposits

    620,306       516,938  

Securities available-for-sale (amortized cost of $1,617,014 in 2014 and $1,637,965 in 2013)

    1,578,897       1,586,668  

Trading securities

    -       4,936  

Loans

    8,302,282       8,084,563  

Less: Allowance for loan losses

    (169,138 )     (173,889 )

   Unamortized deferred loan fees, net

    (12,936 )     (13,487 )

   Loans, net

    8,120,208       7,897,187  

Federal Home Loan Bank stock

    29,901       25,000  

Other real estate owned, net

    44,853       52,985  

Affordable housing investments, net

    89,303       84,108  

Premises and equipment, net

    102,340       102,045  

Customers’ liability on acceptances

    23,677       32,194  

Accrued interest receivable

    25,237       24,274  

Goodwill

    316,340       316,340  

Other intangible assets, net

    2,051       2,230  

Other assets

    176,418       190,634  

Total assets

  $ 11,291,188     $ 10,989,286  

Liabilities and Stockholders’ Equity

               

Deposits

               

Non-interest-bearing demand deposits

  $ 1,488,720     $ 1,441,858  

Interest-bearing deposits:

               

NOW deposits

    692,925       683,873  

Money market deposits

    1,261,419       1,286,338  

Savings deposits

    523,950       499,520  

Time deposits under $100,000

    1,076,329       931,204  

Time deposits of $100,000 or more

    3,189,282       3,138,512  

Total deposits

    8,232,625       7,981,305  
                 

Securities sold under agreements to repurchase

    700,000       800,000  

Advances from the Federal Home Loan Bank

    636,200       521,200  

Other borrowings for affordable housing investments

    19,025       19,062  

Long-term debt

    121,136       121,136  

Acceptances outstanding

    23,677       32,194  

Other liabilities

    64,124       55,418  

Total liabilities

    9,796,787       9,530,315  

Commitments and contingencies

    -       -  

Stockholders’ Equity

               

Common stock, $0.01 par value, 100,000,000 shares authorized, 83,827,123 issued and 79,619,558 outstanding at March 31, 2014, and 83,797,434 issued and 79,589,869 outstanding at December 31, 2013

    838       838  

Additional paid-in-capital

    785,001       784,489  

Accumulated other comprehensive loss, net

    (22,090 )     (29,729 )

Retained earnings

    856,388       829,109  

Treasury stock, at cost (4,207,565 shares at March 31, 2014, and at December 31, 2013)

    (125,736 )     (125,736 )

Total equity

    1,494,401       1,458,971  

Total liabilities and equity

  $ 11,291,188     $ 10,989,286  

 

See accompanying notes to unaudited condensed consolidated financial statements 

 

 
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CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE INCOME

(Unaudited)

 

   

Three months ended March 31,

 
   

2014

   

2013

 
   

(In thousands, except share and per share data)

 

Interest and Dividend Income

               

Loans receivable, including loan fees

  $ 92,732     $ 88,840  

Investment securities- taxable

    7,576       11,786  

Investment securities- nontaxable

    -       967  

Federal Home Loan Bank stock

    450       250  

Deposits with banks

    449       208  

Total interest and dividend income

    101,207       102,051  
                 

Interest Expense

               

Time deposits of $100,000 or more

    6,664       6,757  

Other deposits

    4,028       2,766  

Securities sold under agreements to repurchase

    6,930       11,392  

Advances from Federal Home Loan Bank

    199       80  

Long-term debt

    728       924  

Total interest expense

    18,549       21,919  

Net interest income before provision for credit losses

    82,658       80,132  

Provision for loan losses

    -       -  

Net interest income after provision for loan losses

    82,658       80,132  
                 

Non-Interest Income

               

Securities gains, net

    5,960       6,292  

Letters of credit commissions

    1,468       1,461  

Depository service fees

    1,363       1,474  

Other operating income

    5,768       5,654  

Total non-interest income

    14,559       14,881  
                 

Non-interest Expense

               

Salaries and employee benefits

    23,451       22,853  

Occupancy expense

    3,862       3,644  

Computer and equipment expense

    2,302       2,676  

Professional services expense

    5,156       5,817  

FDIC and State assessments

    2,154       1,738  

Marketing expense

    564       437  

Other real estate owned expense

    759       623  

Operations of affordable housing investments, net

    2,436       1,695  

Amortization of core deposit intangibles

    172       1,396  

Costs associated with debt redemption

    3,376       5,645  

Other operating expense

    3,836       2,604  

Total non-interest expense

    48,068       49,128  

Income before income tax expense

    49,149       45,885  

Income tax expense

    17,890       16,887  

Net income

    31,259       28,998  

Less: net income attributable to noncontrolling interest

    -       151  

Net income attributable to Cathay General Bancorp

    31,259       28,847  

Dividends on preferred stock and noncash charge from repayment

    -       (5,184 )

Net income attributable to common stockholders

    31,259       23,663  

Other comprehensive income, net of tax

               

Unrealized holding gain arising during the period

    11,094       26,659  

Less: reclassification adjustments included in net income

    3,455       3,647  

Total other comprehensive gain, net of tax

    7,639       23,012  

Total comprehensive income

  $ 38,898     $ 51,859  

Net income per common share:

               

Basic

  $ 0.39     $ 0.30  

Diluted

  $ 0.39     $ 0.30  

Cash dividends paid per common share

  $ 0.05     $ 0.01  

Average common shares outstanding

               

Basic

    79,595,757       78,795,564  

Diluted

    80,039,382       78,815,141  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
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CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   

Three months ended March 31

 
   

2014

   

2013

 
   

(In thousands)

         

Cash Flows from Operating Activities

               

Net income

  $ 31,259     $ 28,998  

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

               

Provision/(credit) for losses on other real estate owned

    617       (37 )

Deferred tax liabilities

    6,012       6,227  

Depreciation

    1,742       1,527  

Net (gains)/losses on sale and transfer of other real estate owned

    (559 )     44  

Net gains on sale of loans

    (128 )     (567 )

Proceeds from sales of loans

    4,525       23,672  

Originations of loans held-for-sale

    (4,397 )     (23,105 )

Net change in trading securities

    4,936       (55 )

Write-downs on venture capital investments

    75       92  

Gain on sales and calls of securities

    (5,960 )     (6,292 )

Amortization/accretion of security premiums/discounts, net

    867       1,114  

Amortization of other intangible assets

    196       1,428  

Excess tax short-fall from share-based payment arrangements

    1,227       69  

Stock based compensation and stock issued to officers as compensation

    1,353       1,037  

Net change in accrued interest receivable and other assets

    3,285       4,081  

Net change in other liabilities

    1,374       1,612  

Net cash provided by operating activities

    46,424       39,845  

Cash Flows from Investing Activities

               

(Increase)/decrease in short-term investments

    (103,368 )     196,189  

Purchase of investment securities available-for-sale

    (246,498 )     (508,865 )

Proceeds from sale of investment securities available-for-sale

    139,671       320,234  

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

    133,369       57,495  

Proceeds from repayments, maturities and calls of investment securities held-to-maturity

    -       50,973  

(Purchase)/redemption of Federal Home Loan Bank stock

    (4,901 )     4,142  

Net (increase)/decrease in loans

    (220,402 )     61,833  

Purchase of premises and equipment

    (2,081 )     (1,014 )

Proceeds from sale of other real estate owned

    6,379       1,351  

Net increase in investment in affordable housing

    (1,894 )     (1,614 )

Net cash (used in)/provided by investing activities

    (299,725 )     180,724  

Cash Flows from Financing Activities

               

Net increase in deposits

    251,032       42,362  

Net decrease in federal funds purchased and securities sold under agreements to repurchase

    (100,000 )     (100,000 )

Advances from Federal Home Loan Bank

    5,127,400       298,020  

Repayment of Federal Home Loan Bank borrowings

    (5,012,400 )     (317,500 )

Cash dividends paid

    (3,980 )     (3,828 )

Redemption of series B preferred stock

    -       (129,000 )

Proceeds from shares issued under Dividend Reinvestment Plan

    386       62  

Excess tax short-fall from share-based payment arrangements

    (1,227 )     (69 )

Net cash provided by/(used in) financing activities

    261,211       (209,953 )

Increase in cash and cash equivalents

    7,910       10,616  

Cash and cash equivalents, beginning of the period

    153,747       144,909  

Cash and cash equivalents, end of the period

  $ 161,657     $ 155,525  
                 

Supplemental disclosure of cash flow information

               

Cash paid during the period:

               

Interest

  $ 19,533     $ 22,827  

Income tax

  $ 12,444     $ 8,562  

Non-cash investing and financing activities:

               

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

  $ 7,639     $ 23,012  

Transfers investment securities to available-for-sale from held-to-maturity

  $ -     $ 722,466  

Transfers to other real estate owned from loans held for investment

  $ -     $ 366  

Loans to facilitate the sale of other real estate owned

  $ -     $ 75  

 

 See accompanying notes to unaudited condensed consolidated financial statements.

 

 
7

 

 

CATHAY GENERAL BANCORP AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1. Business

 

Cathay General Bancorp (“Bancorp”) is the holding company for Cathay Bank (the “Bank” and, together, the “Company”), six limited partnerships investing in affordable housing investments in which the Bank is the sole limited partner, and GBC Venture Capital, Inc. The Bancorp also owns 100% of the common stock of five statutory business trusts created for the purpose of issuing capital securities. The Bank was founded in 1962 and offers a wide range of financial services. As of March 31, 2014, the Bank operated 21 branches in Southern California, 11 branches in Northern California, nine branches in New York State, three branches in Illinois, three branches in Washington State, two branches in Texas, one branch in Massachusetts, one branch in New Jersey, one branch in Nevada, one branch in Hong Kong, and a representative office in Shanghai and in Taipei. Deposit accounts at the Hong Kong branch are not insured by the Federal Deposit Insurance Corporation (the “FDIC”).

 

2. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. For further information, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

The preparation of the condensed consolidated financial statements in accordance with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The most significant estimates subject to change are the allowance for loan losses, goodwill impairment, and other-than-temporary impairment.

 

3. Recent Accounting Pronouncements

 

In January 2014, the FASB issued ASU 2014-01, “InvestmentsEquity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects.” ASU No. 2014-01 permits a reporting entity to make an accounting policy election to account for their investments in affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the amount of tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense or benefit. ASU 2014-01 becomes effective for interim and annual periods beginning on or after December 15, 2014. The Company is evaluating whether to adopt ASU 2014-01 or to continue to apply the equity method of accounting for investments in affordable housing projects.

 

 
8

 

 

In January 2014, the FASB issued ASU 2014-04, “Receivables Trouble Debt Restructurings by Creditors.” ASU No. 2014-04 clarifies that upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement, a creditor is considered to have physical possession of residential real estate property collateralizing a consumer mortgage loan. A reporting entity is required to have interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in process of foreclosure. ASU 2014-04 becomes effective for interim and annual periods beginning on or after December 15, 2014. Adoption of ASU 2014-04 is not expected to have a significant impact on the Company’s consolidated financial statements.

 

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements and Property, Plant, and Equipment.” ASU No. 2014-08 defines a discontinued operation as disposal of components of an entity that represent a strategic shift that has or will have a major effect on an entity’s operations. ASU No. 2014-08 also requires a reporting entity to present the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections, respectively, of the statement of financial position for each comparative period. ASU 2014-08 becomes effective for interim and annual periods beginning on or after December 15, 2014. Adoption of ASU 2014-08 is not expected to have a significant impact on the Company’s consolidated financial statements.

 

4. Earnings per Share

 

Basic earnings per share exclude dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock that then shared in earnings.

 

 
9

 

 

Outstanding stock options with anti-dilutive effect were not included in the computation of diluted earnings per share. The following table sets forth earnings per common share calculations:

 

   

Three months ended March 31,

 

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

 

2014

   

2013

 

Net income attributable to Cathay General Bancorp

  $ 31,259     $ 28,847  

Dividends on preferred stock and noncash charge from repayment

    -       (5,184 )

Net income available to common stockholders

  $ 31,259     $ 23,663  
                 

Weighted-average shares:

               

Basic weighted-average number of common shares outstanding

    79,595,757       78,795,564  

Dilutive effect of weighted-average outstanding common share equivalents

               

Warrants

    298,535       -  

Options

    101,698       -  

Restricted stock units

    43,392       19,577  

Diluted weighted-average number of common shares outstanding

    80,039,382       78,815,141  
                 

Average stock options and warrants with anti-dilutive effect

    1,985,848       5,630,813  

Earnings per common share:

               

Basic

  $ 0.39     $ 0.30  

Diluted

  $ 0.39     $ 0.30  

  

5. Stock-Based Compensation

 

Under the Company’s equity incentive plans, directors and eligible employees may be granted incentive or non-statutory stock options and/or restricted stock units, or awarded non-vested stock. As of March 31, 2014, the only options granted by the Company were non-statutory stock options to selected Bank officers and non-employee directors at exercise prices equal to the fair market value of a share of the Company’s common stock on the date of grant. Such options have a maximum ten-year term and vest in 20% annual increments (subject to early termination in certain events) except certain options granted to the Chief Executive Officer of the Company in 2005 and 2008. If such options expire or terminate without having been exercised, any shares not purchased will again be available for future grants or awards. There were no options granted during the first quarter of 2014 or the year ended December 31, 2013.

 

Option compensation expense was zero for the three months ended March 31, 2014, and $129,000 for the three months ended March 31, 2013. Stock-based compensation is recognized ratably over the requisite service period for all awards.

 

No stock options were exercised in the first quarter of 2014 or in the first quarter of 2013. The table below summarizes stock option activity for the periods indicated:

 

 

           

Weighted-average

   

Weighted-

average remaining contractual

   

Aggregate

intrinsic value

 
   

Shares

   

exercise price

   

life (in years)

   

 (in thousands)

 
                                 
                                 

Balance, December 31, 2013

    2,812,874     $ 31.81       1.9     $ 2,119  

Forfeited

    (438,000 )     28.70                  

Balance, March 31, 2014

    2,374,874     $ 32.38       2.0     $ 1,148  

Exercisable, March 31, 2014

    2,374,874     $ 32.38       2.0     $ 1,148  

  

 
10

 

 

At March 31, 2014, 3,073,452 shares were available under the Company’s 2005 Incentive Plan for future grants.

 

The Company granted restricted stock units for 4,812 shares at an average closing price of $25.55 per share on March 13, 2014, and 25,037 shares at an average closing price of $20.68 per share in 2013. The restricted stock units granted in 2014 and 2013 are scheduled to vest two years from grant date.

 

The following table presents information relating to the restricted stock units as of March 31, 2014:

 

   

Units

 

Balance at December 31, 2013

    143,433  

Granted

    4,812  

Balance at March 31, 2014

    148,245  

 

The compensation expense related to the restricted stock units was $1.0 million for the three months ended March 31, 2014, compared to $609,000 for the three months ended March 31, 2013. Unrecognized stock-based compensation expense related to restricted stock units was $6.3 million at March 31, 2014, and is expected to be recognized over the next 2.5 years. In the first quarter of 2014, the Company granted 13,690 shares to directors of the Company and recorded compensation expenses of $350,000.

 

In December 2013, the Company granted performance share units in which the number of units earned is calculated based on the relative total shareholder return (“TSR”) of the Company’s common stock as compared to the TSR of the KBW Regional Banking Index. In addition, the Company granted performance share units in which the number of units earned is determined by comparison to the targeted earnings per share (“EPS share”) for the three years ending December 31, 2016. Performance TSR restricted stock units for 119,840 shares and performance EPS restricted stock units for 116,186 shares were granted to eight executive officers. Both the performance TSR and performance EPS share units are scheduled to vest at December 31, 2016. In the first quarter of 2014, the Company did not grant any performance share units.

 

The following table summarizes the tax short-fall from share-based payment arrangements:

 

 

   

Three months ended March 31,

 

(Dollars in thousands)

 

2014

   

2013

 

Short-fall of tax deductions in excess of grant-date fair value

  $ (1,227 )   $ (69 )

Benefit of tax deductions on grant-date fair value

    1,227       596  

Total benefit of tax deductions

  $ -     $ 527  

 

 
11

 

 

6. Investment Securities

 

Investment securities were $1.58 billion at March 31, 2014, compared to $1.59 billion at December 31, 2013. During the first quarter of 2013, due to the ongoing discussions regarding corporate income tax rates which could have a negative impact on the after-tax yields and fair values of the Company’s portfolio of municipal securities, the Company determined it may sell such securities in response to market conditions. As a result, the Company reclassified its municipal securities from securities held-to-maturity to securities available-for-sale. Concurrent with this reclassification, the Company also reclassified all other securities held-to-maturity, which together with the municipal securities had an amortized cost on the date of transfer of $722.5 million, to securities available-for-sale. At the reclassification date, a net unrealized gain was recorded in other comprehensive income for these securities totaling $40.5 million.

 

The following tables reflect the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of investment securities as of March 31, 2014, and December 31, 2013:

 

   

March 31, 2014

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 
                                 

Securities Available-for-Sale

                               

U.S. treasury securities

  $ 475,139     $ 120     $ -     $ 475,259  

Mortgage-backed securities

    969,042       1,860       49,749       921,153  

Collateralized mortgage obligations

    82       -       39       43  

Corporate debt securities

    165,716       423       3,458       162,681  

Mutual funds

    6,000       -       243       5,757  

Preferred stock of government sponsored entities

    535       12,909       -       13,444  

Other equity securities

    500       60       -       560  

Total securities available-for-sale

  $ 1,617,014     $ 15,372     $ 53,489     $ 1,578,897  

Total investment securities

  $ 1,617,014     $ 15,372     $ 53,489     $ 1,578,897  

 

  

   

December 31, 2013

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. treasury securities

  $ 460,095     $ 99     $ 1     $ 460,193  

Mortgage-backed securities

    1,010,294       7,049       64,529       952,814  

Collateralized mortgage obligations

    5,929       231       54       6,106  

Asset-backed securities

    123       -       -       123  

Corporate debt securities

    154,955       298       4,949       150,304  

Mutual funds

    6,000       -       275       5,725  

Preferred stock of government sponsored entities

    569       10,834       -       11,403  

Total securities available-for-sale

  $ 1,637,965     $ 18,511     $ 69,808     $ 1,586,668  

Total investment securities

  $ 1,637,965     $ 18,511     $ 69,808     $ 1,586,668  

  

The amortized cost and fair value of investment securities at March 31, 2014, by contractual maturities, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or repayment penalties.  

 

 
12

 

 

   

Securities available-for-sale

 
   

Amortized cost

   

Fair value

 
   

(In thousands)

         

Due in one year or less

  $ 385,848     $ 385,941  

Due after one year through five years

    178,382       179,513  

Due after five years through ten years

    100,805       98,143  

Due after ten years (1)

    951,979       915,300  

Total

  $ 1,617,014     $ 1,578,897  

 

(1) Equity securities are reported in this category

               

 

Proceeds from sales of mortgage-backed securities were $123.7 million and from repayments, maturities and calls of mortgage-backed securities were $20.5 million during the first quarter of 2014 compared to no proceeds from sales and proceeds of $98.4 million from repayments, maturities, and calls during the same period a year ago. Proceeds from sales of other investment securities were $16.0 million during the first quarter of 2014 compared to $320.2 million during the same period a year ago. Proceeds from maturities and calls of other investment securities were $112.9 million during the first quarter of 2014 compared to $10.1 million during the same period a year ago. Gains of $6.0 million and losses of $67,000 were realized on sales and calls of investment securities during the first quarter of 2014 compared to gains of $6.3 million and no losses realized during the same period a year ago.

 

At March 31, 2014, all of the Company’s mortgage-backed securities were rated as investment grade except for one non-agency issue. Total unrealized losses of $49.7 million from all mortgage-backed securities resulted from increases in interest rates subsequent to the date that these securities were purchased. The Company’s unrealized loss on investments in corporate bonds relates to nine issues of investments in bonds of financial institutions, all of which were investment grade at the date of acquisition and as of March 31, 2014. The unrealized losses were primarily caused by the widening of credit and liquidity spreads since the dates of acquisition. The contractual terms of those investments do not permit the issuers to settle the security at a price less than the amortized cost of the investment. The Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investments. Therefore, it is expected that these mortgage-backed securities and corporate bonds would not be settled at a price less than the amortized cost of the investment. Because the Company does not intend to sell and would not be required to sell these investments until a recovery of fair value, which may be maturity, it does not consider its investments in these mortgaged-backed securities and corporate bonds to be other-than-temporarily impaired at March 31, 2014.

 

The temporarily impaired securities represent 64.4% of the fair value of investment securities as of March 31, 2014. Unrealized losses for securities with unrealized losses for less than twelve months represent 5.2%, and securities with unrealized losses for twelve months or more represent 3.5%, of the historical cost of these securities. Unrealized losses on these securities generally resulted from increases in interest rates or spreads subsequent to the date that these securities were purchased.

 

At March 31, 2014, management believed the impairment was temporary and, accordingly, no impairment loss has been recognized in our condensed consolidated statements of operations. The Company expects to recover the amortized cost basis of its debt securities, and has no intent to sell and will not be required to sell available-for-sale debt securities that have declined below their cost before their anticipated recovery.

 

 
13

 

 

The tables below show the fair value and unrealized losses of the temporarily impaired securities in our investment securities portfolio as of March 31, 2014, and December 31, 2013:

 

   

March 31, 2014

 
   

Temporarily impaired securities

 
   

Less than 12 months

   

12 months or longer

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
   

(Dollars in thousands)

 
                                                 

Securities Available-for-Sale

                                               

Mortgage-backed securities

  $ 888,606     $ 49,748     $ 151     $ 1     $ 888,757     $ 49,749  

Collateralized mortgage obligations

    -       -       43       39       43       39  

Corporate debt securities

    25,778       2       96,544       3,456       122,322       3,458  

Mutual funds

    -       -       5,757       243       5,757       243  

Total securities available-for-sale

  $ 914,384     $ 49,750     $ 102,495     $ 3,739     $ 1,016,879     $ 53,489  

Total investment securities

  $ 914,384     $ 49,750     $ 102,495     $ 3,739     $ 1,016,879     $ 53,489  

 

 

   

December 31, 2013

 
   

Temporarily impaired securities

 
   

Less than 12 months

   

12 months or longer

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
   

(Dollars in thousands)

 
                                                 

Securities Available-for-Sale

                                               

U.S. treasury securities

  $ 75,064     $ 1     $ -     $ -     $ 75,064     $ 1  

Mortgage-backed securities

    792,012       64,526       272       2       792,284       64,528  

Mortgage-backed securities-Non-agency

    94       1       -       -       94       1  

Collateralized mortgage obligations

    68       4       301       50       369       54  

Corporate debt securities

    9,970       30       100,081       4,919       110,051       4,949  

Mutual funds

    -       -       5,724       275       5,724       275  

Total securities available-for-sale

  $ 877,208     $ 64,562     $ 106,378     $ 5,246     $ 983,586     $ 69,808  

Total investment securities

  $ 877,208     $ 64,562     $ 106,378     $ 5,246     $ 983,586     $ 69,808  

 

Investment securities having a carrying value of $853.6 million at March 31, 2014, and $926.5 million at December 31, 2013, were pledged to secure public deposits, other borrowings, treasury tax and loan, Federal Home Loan Bank advances, securities sold under agreements to repurchase, interest rate swaps, and foreign exchange transactions. 

 

 
14

 

 

7. Loans 

 

Most of the Company’s business activity is with Asian customers located in Southern and Northern California; New York City, New York; Houston and Dallas, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; Edison, New Jersey; Las Vegas, Nevada, and Hong Kong. The Company has no specific industry concentration, and generally its loans are secured by real property or other collateral of the borrowers. Loans are generally expected to be paid off from the operating profits of the borrowers, from refinancing by other lenders, or through sale by the borrowers of the secured collateral.

 

The components of loans in the condensed consolidated balance sheets as of March 31, 2014, and December 31, 2013, were as follows:

 

   

March 31, 2014

   

December 31, 2013

 
   

(In thousands)

 

Type of Loans:

               

Commercial loans

  $ 2,229,880     $ 2,298,724  

Residential mortgage loans

    1,441,230       1,355,255  

Commercial mortgage loans

    4,192,987       4,023,051  

Equity lines

    172,395       171,277  

Real estate construction loans

    253,832       221,701  

Installment and other loans

    11,958       14,555  

Gross loans

    8,302,282       8,084,563  

Less:

               

Allowance for loan losses

    (169,138 )     (173,889 )

Unamortized deferred loan fees

    (12,936 )     (13,487 )

Total loans, net

  $ 8,120,208     $ 7,897,187  

 

At March 31, 2014, recorded investment in impaired loans totaled $189.3 million and was comprised of non-accrual loans of $70.4 million and accruing troubled debt restructured (“TDR”) loans of $118.9 million. At December 31, 2013, recorded investment in impaired loans totaled $200.8 million and was comprised of non-accrual loans of $83.2 million and accruing TDRs of $117.6 million. For impaired loans, the amounts previously charged off represent 15.0% at March 31, 2014, and 23.9% at December 31, 2013, of the contractual balances for impaired loans. The following table presents the average balance and interest income recognized related to impaired loans for the periods indicated:

 

   

Impaired Loans

 
   

Average Recorded Investment

   

Interest Income Recognized

 
   

Three months ended

   

Three months ended

 
   

March 31,

   

March 31,

 
   

2014

   

2013

   

2014

   

2013

 
    (In thousands)  

Commercial loans

  $ 30,844     $ 22,126     $ 226     $ 183  

Real estate construction loans

    34,060       42,068       65       66  

Commercial mortgage loans

    111,305       162,257       1,134       1,562  

Residential mortgage and equity lines

    19,156       17,797       95       84  

Total

  $ 195,365     $ 244,248     $ 1,520     $ 1,895  

 

 
15

 

 

The following table presents impaired loans and the related allowance for credit losses as of the dates indicated:

 

   

Impaired Loans

 
   

March 31, 2014

   

December 31, 2013

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Allowance

   

Unpaid Principal Balance

   

Recorded Investment

   

Allowance

 
   

(In thousands)

 
                                                 

With no allocated allowance

                                               

Commercial loans

  $ 14,001     $ 11,914     $ -     $ 20,992     $ 18,905     $ -  

Real estate construction loans

    25,157       14,854       -       25,401       15,097       -  

Commercial mortgage loans

    73,274       71,934       -       105,593       78,930       -  

Residential mortgage loans and equity lines

    4,876       4,876       -       4,892       4,892       -  

Subtotal

  $ 117,308     $ 103,578     $ -     $ 156,878     $ 117,824     $ -  

With allocated allowance

                                               

Commercial loans

  $ 27,772     $ 18,099     $ 4,663     $ 22,737     $ 13,063     $ 2,519  

Real estate construction loans

    28,158       19,005       3,129       28,475       19,323       3,460  

Commercial mortgage loans

    35,363       34,979       6,165       39,223       35,613       6,584  

Residential mortgage loans and equity lines

    14,083       13,650       538       16,535       14,957       721  

Subtotal

  $ 105,376     $ 85,733     $ 14,495     $ 106,970     $ 82,956     $ 13,284  

Total impaired loans

  $ 222,684     $ 189,311     $ 14,495     $ 263,848     $ 200,780     $ 13,284  

 

The following table presents the aging of the loan portfolio by type as of March 31, 2014, and as of December 31, 2013:

 

   

March 31, 2014

 
   

30-59 Days Past Due

   

60-89 Days Past Due

   

90 Days or More Past Due

   

Non-accrual Loans

   

Total Past Due

   

Loans Not Past Due

   

Total

 

Type of Loans:

 

(In thousands)

 

Commercial loans

  $ 11,386     $ 610     $ -     $ 13,806     $ 25,802     $ 2,204,078     $ 2,229,880  

Real estate construction loans

    3,140       -       -       28,042       31,182       222,650       253,832  

Commercial mortgage loans

    62,014       -       974       17,042       80,030       4,112,957       4,192,987  

Residential mortgage loans and equity lines

    5,881       -       -       11,498       17,379       1,596,246       1,613,625  

Installment and other loans

    -       -       -       -       -       11,958       11,958  

Total loans

  $ 82,421     $ 610     $ 974     $ 70,388     $ 154,393     $ 8,147,889     $ 8,302,282  

 

   

December 31, 2013

 
   

30-59 Days Past Due

   

60-89 Days Past Due

   

90 Days or More Past Due

   

Non-accrual Loans

   

Total Past Due

   

Loans Not Past Due

   

Total

 

Type of Loans:

 

(In thousands)

 

Commercial loans

  $ 7,170     $ 16,562     $ -     $ 21,232     $ 44,964     $ 2,253,760     $ 2,298,724  

Real estate construction loans

    -       -       -       28,586       28,586       193,115       221,701  

Commercial mortgage loans

    20,043       7,862       982       19,621       48,508       3,974,543       4,023,051  

Residential mortgage loans and equity lines

    3,508       832       -       13,744       18,084       1,508,448       1,526,532  

Installment and other loans

    100       -       -       -       100       14,455       14,555  

Total loans

  $ 30,821     $ 25,256     $ 982     $ 83,183     $ 140,242     $ 7,944,321     $ 8,084,563  

 

The determination of the amount of the allowance for credit losses for impaired loans is based on management’s current judgment about the credit quality of the loan portfolio and takes into consideration known relevant internal and external factors that affect collectability when determining the appropriate level for the allowance for credit losses. The nature of the process by which the Bank determines the appropriate allowance for credit losses requires the exercise of considerable judgment. This allowance evaluation process is also applied to troubled debt restructurings since they are considered to be impaired loans.

 

 
16

 

 

A troubled debt restructuring is a formal modification of the terms of a loan when the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower. The concessions may be granted in various forms, including a change in the stated interest rate, a reduction in the loan balance or accrued interest, or an extension of the maturity date that causes significant delay in payment.

 

TDRs on accrual status are comprised of the loans that have, pursuant to the Bank’s policy, performed under the restructured terms and have demonstrated sustained performance under the modified terms for nine months before being returned to accrual status. The sustained performance considered by management pursuant to its policy includes the periods prior to the modification if the prior performance met or exceeded the modified terms. This would include cash paid by the borrower prior to the restructure to set up interest reserves.

 

At March 31, 2014, accruing TDRs were $118.9 million and non-accrual TDRs were $37.8 million compared to accruing TDRs of $117.6 million and non-accrual TDRs of $38.8 million at December 31, 2013. The Company allocated specific reserves of $7.3 million to accruing TDRs and $1.8 million to non-accrual TDRs at March 31, 2014, and $6.9 million to accruing TDRs and $2.2 million to non-accrual TDRs at December 31, 2013. The following tables present TDRs that were modified during the first quarter of 2014 and 2013, their specific reserve at March 31, 2014, and charge-offs during the first quarter of 2014 and 2013:

 

   

Three months ended March 31, 2014

   

March 31, 2014

 
   

No. of Contracts

   

Pre-Modification Outstanding Recorded Investment

   

Post-Modification Outstanding Recorded Investment

   

Charge-offs

   

Specific Reserve

 
   

(Dollars in thousands)

         
                                         

Commercial loans

    2     $ 8,243     $ 8,243     $ -     $ 1,035  

Residential mortgage loans and equity lines

    2       671       671       -       36  

Total

    4     $ 8,914     $ 8,914     $ -     $ 1,071  

 

   

Three months ended March 31, 2013

   

March 31, 2013

 
   

No. of Contracts

   

Pre-Modification Outstanding Recorded Investment

   

Post-Modification Outstanding Recorded Investment

   

Charge-offs

   

Specific Reserve

 
   

(Dollars in thousands)

         
                                         

Commercial loans

    4     $ 4,007     $ 4,007     $ -     $ 61  

Commercial mortgage loans

    2       1,175       1,175       -       10  

Residential mortgage loans and equity lines

    6       1,696       1,696       -       265  

Total

    12     $ 6,878     $ 6,878     $ -     $ 336  

 

Modifications of the loan terms during the first quarter of 2014 were in the form of changes in the stated interest rate, and in payment terms to interest only from principal and interest or reduction in monthly payment amount, multiple note structure, and waiver of late charges and collection fees.  The length of time for which modifications involving a reduction of the stated interest rate or changes in payment terms that were documented ranged from twelve months to three years from the modification date. 

 

 
17

 

 

We expect that the TDR loans on accruing status as of March 31, 2014, which were all performing in accordance with their restructured terms, will continue to comply with the restructured terms because of the reduced principal or interest payments on these loans. A summary of TDRs by type of concession and by type of loan, as of March 31, 2014, and December 31, 2013, is shown below:

 

    March 31, 2014  

Accruing TDRs

 

Principal Deferral

   

Rate Reduction

   

Rate Reduction and Payment Deferral

   

Total

 
    (In thousands)  

Commercial loans

  $ 12,047     $ 1,594     $ 2,566     $ 16,207  

Real estate construction loans

    -       -       5,817       5,817  

Commercial mortgage loans

    11,708       8,330       69,832       89,870  

Residential mortgage loans

    2,513       1,021       3,494       7,028  

Total accruing TDRs

  $ 26,268     $ 10,945     $ 81,709     $ 118,922  

 

   

March 31, 2014

 

Non-accrual TDRs

 

Interest Deferral

   

Principal Deferral

   

Rate Reduction and Forgiveness of Principal

   

Rate Reduction and Payment Deferral

   

Total

 
   

(In thousands)

 

Commercial loans

  $ -     $ 2,867     $ 1,307     $ -     $ 4,174  

Real estate construction loans

    -       15,692       -       9,037       24,729  

Commercial mortgage loans

    1,407       2,153       -       1,843       5,403  

Residential mortgage loans

    231       1,681       219       1,360       3,491  

Total non-accrual TDRs

  $ 1,638     $ 22,393     $ 1,526     $ 12,240     $ 37,797  

 

   

December 31, 2013

 

Accruing TDRs

 

Principal Deferral

   

Rate Reduction

   

Rate Reduction and Payment Deferral

   

Total

 
    (In thousands)  

Commercial loans

  $ 9,112     $ 2,916     $ 2,708     $ 14,736  

Real estate construction loans

    -       -       5,834       5,834  

Commercial mortgage loans

    11,333       9,389       70,200       90,922  

Residential mortgage loans

    1,564       1,024       3,517       6,105  

Total accruing TDRs

  $ 22,009     $ 13,329     $ 82,259     $ 117,597  

 

 
18

 

 

   

December 31, 2013

 

Non-accrual TDRs

 

Interest Deferral

   

Principal Deferral

   

Rate Reduction and Forgiveness of Principal

   

Rate Reduction and Payment Deferral

   

Total

 
   

(In thousands)

 

Commercial loans

  $ -     $ 2,866     $ 1,352     $ -     $ 4,218  

Real estate construction loans

    -       16,009       -       9,263       25,272  

Commercial mortgage loans

    1,443       2,168       -       1,843       5,454  

Residential mortgage loans

    241       2,206       -       1,378       3,825  

Total non-accrual TDRs

  $ 1,684     $ 23,249     $ 1,352     $ 12,484     $ 38,769  

 

The activity within our TDR loans for the periods indicated are shown below:

 

   

Three months ended March 31,

 

Accruing TDRs

 

2014

   

2013

 
   

(In thousands)

 

Beginning balance

  $ 117,597     $ 144,695  

New restructurings

    7,375       4,816  

Restructured loans restored to accrual status

    962       630  

Payments

    (7,012 )     (17,892 )

Restructured loans placed on nonaccrual

    -       (2,034 )

Ending balance

  $ 118,922     $ 130,215  

 

   

Three months ended March 31,

 

Non-accrual TDRs

 

2014

   

2013

 
   

(In thousands)

 

Beginning balance

  $ 38,769     $ 47,731  

New restructurings

    1,539       2,062  

Restructured loans placed on nonaccrual

    -       2,034  

Charge-offs

    (4 )     (679 )

Payments

    (1,545 )     (640 )

Restructured loans restored to accrual status

    (962 )     (630 )

Ending balance

  $ 37,797     $ 49,878  

 

A loan is considered to be in payment default once it is 60 to 90 days contractually past due under the modified terms.  The Company did not have any loans that were modified as TDRs during the previous twelve months and which subsequently defaulted as of March 31, 2014. 

 

Under the Company’s internal underwriting policy, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification in order to determine whether a borrower is experiencing financial difficulty.

 

As of March 31, 2014, there were no commitments to lend additional funds to those borrowers whose loans have been restructured, were considered impaired, or were on non-accrual status.

 

 
19

 

 

As part of the on-going monitoring of the credit quality of our loan portfolio, the Company utilizes a risk grading matrix to assign a risk grade to each loan. The risk rating categories can be generally described by the following grouping for non-homogeneous loans: 

 

 

Pass/Watch – These loans range from minimal credit risk to lower than average, but still acceptable, credit risk.

     
 

Special Mention – Borrower is fundamentally sound and loan is currently protected but adverse trends are apparent that, if not corrected, may affect ability to repay. Primary source of loan repayment remains viable but there is increasing reliance on collateral or guarantor support.

     
 

Substandard – These loans are inadequately protected by current sound net worth, paying capacity, or pledged collateral. Well-defined weaknesses exist that could jeopardize repayment of debt. Loss may not be imminent, but if weaknesses are not corrected, there is a good possibility of some loss.

     
  Doubtful – The possibility of loss is extremely high, but due to identifiable and important pending events (which may strengthen the loan), a loss classification is deferred until the situation is better defined.
     
  Loss – These loans are considered uncollectible and of such little value that to continue to carry the loan as an active asset is no longer warranted.

 

The following tables present loan portfolio by risk rating as of March 31, 2014, and as of December 31, 2013:

 

   

March 31, 2014

 
   

Pass/Watch

   

Special Mention

   

Substandard

   

Doubtful

   

Total

 
    (in thousands)  

Commercial loans

  $ 2,022,525     $ 111,451     $ 89,713     $ 6,191     $ 2,229,880  

Real estate construction loans

    213,529       4,062       32,928       3,313       253,832  

Commercial mortgage loans

    3,858,117       128,977       205,893       -       4,192,987  

Residential mortgage loans and equity lines

    1,599,979       244       13,402       -       1,613,625  

Installment and other loans

    11,958       -       -       -       11,958  

Total gross loans

  $ 7,706,108     $ 244,734     $ 341,936     $ 9,504     $ 8,302,282  

 

   

December 31, 2013

 
   

Pass/Watch

   

Special Mention

   

Substandard

   

Doubtful

   

Total

 
    (in thousands)  

Commercial loans

  $ 2,108,191     $ 84,786     $ 102,088     $ 3,659     $ 2,298,724  

Real estate construction loans

    184,449       -       33,939       3,313       221,701  

Commercial mortgage loans

    3,686,788       127,436       208,827       -       4,023,051  

Residential mortgage loans and equity lines

    1,510,647       -       15,885       -       1,526,532  

Installment and other loans

    14,555       -       -       -       14,555  

Total gross loans

  $ 7,504,630     $ 212,222     $ 360,739     $ 6,972     $ 8,084,563  

 

The allowance for loan losses and the reserve for off-balance sheet credit commitments are significant estimates that can and do change based on management’s process in analyzing the loan portfolio and on management’s assumptions about specific borrowers, underlying collateral, and applicable economic and environmental conditions, among other factors.

 

 
20

 

 

The following table presents the balance in the allowance for loan losses by portfolio segment and based on impairment method as of March 31, 2014, and as of December 31, 2013:

 

           

Real Estate

   

Commercial

   

Residential

                 
   

Commercial

   

Construction

   

Mortgage

   

Mortgage Loans

   

Installment and

         
   

Loans

   

Loans

   

Loans

   

and Equity Lines

   

Other Loans

   

Total

 
   

(In thousands)

 

March 31, 2014

                                               

Loans individually evaluated for impairment

                                               

Allowance

  $ 4,663     $ 3,129     $ 6,165     $ 538     $ -     $ 14,495  

Balance

  $ 30,013     $ 33,859     $ 106,913     $ 18,526     $ -     $ 189,311  
                                                 

Loans collectively evaluated for impairment

                                               

Allowance

  $ 60,119     $ 7,497     $ 75,161     $ 11,839     $ 27     $ 154,643  

Balance

  $ 2,199,867     $ 219,973     $ 4,086,074     $ 1,595,099     $ 11,958     $ 8,112,971  
                                                 

Total allowance

  $ 64,782     $ 10,626     $ 81,326     $ 12,377     $ 27     $ 169,138  

Total balance

  $ 2,229,880     $ 253,832     $ 4,192,987     $ 1,613,625     $ 11,958     $ 8,302,282  
                                                 

December 31, 2013

                                               

Loans individually evaluated for impairment

                                               

Allowance

  $ 2,519     $ 3,460     $ 6,584     $ 721     $ -     $ 13,284  

Balance

  $ 31,968     $ 34,420     $ 114,544     $ 19,848     $ -     $ 200,780  
                                                 

Loans collectively evaluated for impairment

                                               

Allowance

  $ 62,584     $ 8,539     $ 78,169     $ 11,284     $ 29     $ 160,605  

Balance

  $ 2,266,756     $ 187,281     $ 3,908,507     $ 1,506,684     $ 14,555     $ 7,883,783  
                                                 

Total allowance

  $ 65,103     $ 11,999     $ 84,753     $ 12,005     $ 29     $ 173,889  

Total balance

  $ 2,298,724     $ 221,701     $ 4,023,051     $ 1,526,532     $ 14,555     $ 8,084,563  

 

 
21

 

 

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2014, and March 31, 2013. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

           

Real Estate

   

Commercial

   

Residential

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

Mortgage Loans

   

and Other

         
   

Loans

   

Loans

   

Loans

   

and Equity Lines

   

Loans

   

Total

 
   

(In thousands)

 
                                                 

2014 Beginning Balance

  $ 65,103     $ 11,999     $ 84,753     $ 12,005     $ 29     $ 173,889  

Provision/(credit) for possible credit losses

    4,888       (1,398 )     (4,306 )     447       (2 )     (371 )

Charge-offs

    (7,226 )     -       (1,698 )     (78 )     -       (9,002 )

Recoveries

    2,017       25       2,577       3       -       4,622  

Net (charge-offs)/recoveries

    (5,209 )     25       879       (75 )     -       (4,380 )
                                                 

March 31, 2014 Ending Balance

  $ 64,782     $ 10,626     $ 81,326     $ 12,377     $ 27     $ 169,138  

Reserve for impaired loans

  $ 4,663     $ 3,129     $ 6,165     $ 538     $ -     $ 14,495  

Reserve for non-impaired loans

  $ 60,119     $ 7,497     $ 75,161     $ 11,839     $ 27     $ 154,643  

Reserve for off-balance sheet credit commitments

  $ 929     $ 326     $ 445     $ 33     $ 1     $ 1,734  
                                                 

2013 Beginning Balance

  $ 66,101     $ 23,017     $ 82,473     $ 11,703     $ 28     $ 183,322  

Provision/(credit) for possible credit losses

    (3,310 )     (2,399 )     2,968       795       4       (1,942 )

Charge-offs

    (2,690 )     -       (990 )     (410 )     -       (4,090 )

Recoveries

    955       79       365       3       -       1,402  

Net (charge-offs)/recoveries

    (1,735 )     79       (625 )     (407 )     -       (2,688 )
                                                 

March 31, 2013 Ending Balance

  $ 61,056     $ 20,697     $ 84,816     $ 12,091     $ 32     $ 178,692  

Reserve for impaired loans

  $ 1,717     $ 8,080     $ 6,242     $ 1,318     $ -     $ 17,357  

Reserve for non-impaired loans

  $ 59,339     $ 12,617     $ 78,574     $ 10,773     $ 32     $ 161,335  

Reserve for off-balance sheet credit commitments

  $ 837     $ 311     $ 2,122     $ 33     $ 2     $ 3,305  

 

8. Commitments and Contingencies

 

The Company is involved in various litigation concerning transactions entered into in the normal course of business. Management, after consultation with legal counsel, does not believe that the resolution of such litigation will have a material effect upon its consolidated financial condition, results of operations, or liquidity taken as a whole. Although the Company establishes accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, the Company does not have accruals for all legal proceedings where there is a risk of loss. In addition, amounts accrued may not represent the ultimate loss to the Company from the legal proceedings in question. Thus, ultimate losses may be higher or lower, and possibly significantly so, than the amounts accrued for legal loss contingencies.

 

In the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans, or through commercial or standby letters of credit, and financial guarantees. These instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying condensed consolidated balance sheets. The contractual or notional amount of these instruments indicates a level of activity associated with a particular class of financial instrument and is not a reflection of the level of expected losses, if any.

 

 
22

 

 

9. Borrowed Funds

 

Securities Sold Under Agreements to Repurchase. Securities sold under agreements to repurchase were $700.0 million with a weighted average rate of 3.92% at March 31, 2014, compared to $800.0 million with a weighted average rate of 3.87% at December 31, 2013. In the first quarter of 2014, the Company prepaid securities sold under agreements to repurchase totaling $100 million with a weighted average rate of 3.50% and incurred prepayment penalties of $3.4 million. In 2013, the Company prepaid securities sold under agreements to repurchase totaling $450 million with a weighted average rate of 3.79% and incurred prepayment penalties of $22.6 million. Five floating-to-fixed rate agreements totaling $300.0 million have initial floating rates for a period of time ranging from six months to one year, with floating rates ranging from the three-month LIBOR rate minus 200 basis points to the three-month LIBOR rate minus 340 basis points. Thereafter, the rates are fixed for the remainder of the term, with interest rates ranging from 4.78% to 5.07%. After the initial floating rate term, the counter parties have the right to terminate the transaction at par at the fixed rate reset date and quarterly thereafter. Four fixed-to-floating rate agreements totaling $200.0 million have initial fixed rates ranging from 1.00% to 3.50% with initial fixed rate terms ranging from six months to 18 months. For the remaining term, the rates float at 8% minus the three-month LIBOR rate with a maximum rate ranging from 3.50% to 3.75% and a minimum rate of 0.0%. After the initial fixed rate term, the counter parties have the right to terminate the transaction at par at the floating rate reset date and quarterly thereafter. The table below provides summary data for the $500 million of callable securities sold under agreements to repurchase as of March 31, 2014:

 

(Dollars in millions)

 

Fixed-to-floating

   

Floating-to-fixed

   

Total

 

Rate type

 

Float Rate

   

Fixed Rate

         

Rate index

 

8% minus 3 month LIBOR

                 

Maximum rate

    3.75 %     3.50 %     3.50 %                        

Minimum rate

    0.0 %     0.0 %     0.0 %                        

No. of agreements

    1       2       1       1       4       9  

Amount

  $ 50.0     $ 100.0     $ 50.0     $ 100.0     $ 200.0     $ 500.0  

Weighted average rate

    3.75 %     3.50 %     3.50 %     4.78 %     5.00 %     4.38 %

Final maturity

 

2014

   

2014

   

2015

   

2014

   

2017

         

 

The table below provides summary data for non-callable fixed rate securities sold under agreements to repurchase as of March 31, 2014:

 

   

No. of

   

Amount

   

Weighted Average

 

Maturity

 

Agreements

   

(In thousands)

   

Interest Rate

 

1 year to 3 years

    1     $ 50,000       2.69 %

3 years to 5 years

    3       150,000       2.81 %

Total

    4     $ 200,000       2.78 %

 

These transactions are accounted for as collateralized financing transactions and recorded at the amounts at which the securities were sold. The Company may have to provide additional collateral for the repurchase agreements, as necessary. The underlying collateral pledged for the repurchase agreements consists of U.S. Treasury securities, U.S. government agency securities, and mortgage-backed securities with a fair value of $808.0 million as of March 31, 2014, and $906.1 million as of December 31, 2013.

 

 
23

 

 

Advances from the FHLB. Advances from the FHLB were $636.2 million with weighted average rate of 0.30% at March 31, 2014, compared to $521.2 million with weighted average rate of 0.17% at December 31, 2013. The following relates to the outstanding advances at March 31, 2014, and December 31, 2013:

 

 

   

March 31, 2014

   

December 31, 2013

 
   

Amount

   

Weighted Average

   

Amount

   

Weighted Average

 

Maturity

 

(In thousands)

   

Interest Rate

   

(In thousands)

   

Interest Rate

 

Within 90 days

  $ 490,000       0.11 %   $ 475,000       0.06 %

1 - 3 years

    100,000       1.01 %     -       -  

4 - 5 years

    46,200       1.24 %     46,200       1.24 %
    $ 636,200       0.30 %   $ 521,200       0.17 %

 

10. Income Taxes

 

Income tax expense totaled $17.9 million, or an effective tax rate of 36.4%, for the first quarter of 2014, compared to an income tax expense of $16.9 million, or an effective tax rate of 36.9%, for the same period a year ago. The effective tax rate includes the impact of the utilization of low income housing tax credits and recognition of other tax credits for both years.

 

As of December 31, 2013, the Company had income tax refunds receivable of $8.6 million. These income tax receivables are included in other assets in the accompanying condensed consolidated balance sheets.

 

The Company’s tax returns are open for audits by the Internal Revenue Service back to 2010 and by the California Franchise Tax Board back to 2003. The Company is under audit by the California Franchise Tax Board for the years 2003 to 2007. As the Company is presently under audit by a number of tax authorities, it is reasonably possible that unrecognized tax benefits could change significantly over the next twelve months. The Company does not expect that any such changes would have a material impact on its annual effective tax rate.

 

11. Fair Value Measurements

 

The Company adopted ASC Topic 820 on January 1, 2008, and determined the fair values of our financial instruments based on the following:

 

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Observable prices in active markets for similar assets or liabilities; prices for identical or similar assets or liabilities in markets that are not active; directly observable market inputs for substantially the full term of the asset and liability; market inputs that are not directly observable but are derived from or corroborated by observable market data.

 

Level 3 – Unobservable inputs based on the Company’s own judgment about the assumptions that a market participant would use.

 

 
24

 

 

The Company uses the following methodologies to measure the fair value of its financial assets and liabilities on a recurring basis:

 

Securities Available for Sale. For certain actively traded agency preferred stocks, mutual funds, and U.S. Treasury securities, the Company measures the fair value based on quoted market prices in active exchange markets at the reporting date, a Level 1 measurement. The Company also measures securities by using quoted market prices for similar securities or dealer quotes, a Level 2 measurement. This category generally includes U.S. Government agency securities, state and municipal securities, mortgage-backed securities (“MBS”), commercial MBS, collateralized mortgage obligations, asset-backed securities, corporate bonds and trust preferred securities.

 

Trading Securities. The Company measures the fair value of trading securities based on quoted market prices in active exchange markets at the reporting date, a Level 1 measurement. The Company also measures the fair value for other trading securities based on quoted market prices for similar securities or dealer quotes, a Level 2 measurement.

 

Warrants. The Company measures the fair value of warrants based on unobservable inputs based on assumption and management judgment, a Level 3 measurement.

 

Currency Option and Foreign Exchange Contracts. The Company measures the fair value of currency option and foreign exchange contracts based on dealer quotes on a recurring basis, a Level 2 measurement.

 

The valuation techniques for the assets and liabilities valued on a nonrecurring basis are as follows:

 

Impaired Loans. The Company does not record loans at fair value on a recurring basis. However, from time to time, nonrecurring fair value adjustments to collateral dependent impaired loans are recorded based on either the current appraised value of the collateral, a Level 2 measurement, or management’s judgment and estimation of value reported on older appraisals that are then adjusted based on recent market trends, a Level 3 measurement.

 

Goodwill. The Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350. The two-step impairment testing process, if needed, begins by assigning net assets and goodwill to the two reporting unitsCommercial Lending and Retail Banking.  The Company then completes “step one” of the impairment test by comparing the fair value of each reporting unit (as determined based on the discussion below) with the recorded book value (or “carrying amount”) of its net assets, with goodwill included in the computation of the carrying amount.  If the fair value of a reporting unit exceeds its carrying amount, goodwill of that reporting unit is not considered impaired, and “step two” of the impairment test is not necessary.  If the carrying amount of a reporting unit exceeds its fair value, step two of the impairment test is performed to determine the amount of impairment.  Step two of the impairment test compares the carrying amount of the reporting unit’s goodwill to the “implied fair value” of that goodwill.  The implied fair value of goodwill is computed by assuming that all assets and liabilities of the reporting unit would be adjusted to the current fair value, with the offset as an adjustment to goodwill.  This adjusted goodwill balance is the implied fair value used in step two.  An impairment charge is recognized for the amount by which the carrying amount of goodwill exceeds its implied fair value. In connection with the determination of fair value, certain data and information is utilized, including earnings forecasts at the reporting unit level for the next four years.  Other key assumptions include terminal values based on future growth rates and discount rates for valuing the cash flows, which have inputs for the risk-free rate, market risk premium, and adjustments to reflect inherent risk and required market returns. Because of the significance of unobservable inputs in the valuation of goodwill impairment, goodwill subject to nonrecurring fair value adjustments is classified as a Level 3 measurement.

 

 
25

 

 

Core Deposit Intangibles. Core deposit intangibles is initially recorded at fair value based on a valuation of the core deposits acquired and is amortized over its estimated useful life to its residual value in proportion to the economic benefits consumed. The Company assesses the recoverability of this intangible asset on a nonrecurring basis using the core deposits remaining at the assessment date and the fair value of cash flows expected to be generated from the core deposits, a Level 3 measurement.

 

Other Real Estate Owned. Real estate acquired in the settlement of loans is initially recorded at fair value based on the appraised value of the property on the date of transfer, less estimated costs to sell, a Level 2 measurement. From time to time, nonrecurring fair value adjustments are made to other real estate owned based on the current updated appraised value of the property, also a Level 2 measurement, or management’s judgment and estimation of value reported on older appraisals that are then adjusted based on recent market trends, a Level 3 measurement.

 

Investments in Venture Capital. The Company periodically reviews its investments in venture capital for other-than-temporary impairment on a nonrecurring basis. Investments in venture capital were written down to their fair value based on available financial reports from venture capital partnerships and management’s judgment and estimation, a Level 3 measurement.

 

Equity Investments. The Company records equity investments at fair value on a nonrecurring basis based on quoted market prices in active exchange markets at the reporting date, a Level 1 measurement.

 

 
26

 

 

The following tables present the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of March 31, 2014, and December 31, 2013:

 

March 31, 2014

 

Fair Value Measurements Using

   

Total at

 
   

Level 1

   

Level 2

   

Level 3

   

Fair Value

 

Assets

 

(In thousands)

 
                                 

Securities available-for-sale

                               

U.S. Treasury securities

  $ 475,259     $ -     $ -     $ 475,259  

Mortgage-backed securities

    -       921,153       -       921,153  

Collateralized mortgage obligations

    -       43       -       43  

Corporate debt securities

    -       162,681       -       162,681  

Mutual funds

    5,757       -       -       5,757  

Preferred stock of government sponsored entities

    -       13,444       -       13,444  

Other equity securities

    560       -       -       560  

Total securities available-for-sale

    481,576       1,097,321       -       1,578,897  

Warrants

    -       -       28       28  

Option contracts

    -       3       -       3  

Foreign exchange contracts

    -       5,093       -       5,093  

Total assets

  $ 481,576     $ 1,102,417     $ 28     $ 1,584,021  
                                 

Liabilities

                               
                                 

Option contracts

  $ -     $ 2     $ -     $ 2  

Foreign exchange contracts

    -       3,322       -       3,322  

Total liabilities

  $ -     $ 3,324     $ -     $ 3,324  

  

December 31, 2013

 

Fair Value Measurements Using

   

Total at

 
   

Level 1

   

Level 2

   

Level 3

   

Fair Value

 

Assets

 

(In thousands)

 
                                 

Securities available-for-sale

                               

U.S. Treasury securities

  $ 460,193     $ -     $ -     $ 460,193  

Mortgage-backed securities

    -       952,815       -       952,815  

Collateralized mortgage obligations

    -       6,106       -       6,106  

Asset-backed securities

    -       123       -       123  

Corporate debt securities

    -       150,304       -       150,304  

Mutual funds

    5,724       -       -       5,724  

Preferred stock of government sponsored entities

    -       11,403       -       11,403  

Total securities available-for-sale

    465,917       1,120,751       -       1,586,668  

Trading securities

    -       4,936       -       4,936  

Warrants

    -       -       30       30  

Foreign exchange contracts

    -       6,182       -       6,182  

Total assets

  $ 465,917     $ 1,131,869     $ 30     $ 1,597,816  
                                 

Liabilities

                               
                                 

Foreign exchange contracts

  $ -     $ 6,140     $ -     $ 6,140  

Total liabilities

  $ -     $ 6,140     $ -     $ 6,140  

 

The Company measured the fair value of its warrants on a recurring basis using significant unobservable inputs. The fair value of warrants was $28,000 at March 31, 2014, compared to $30,000 at December 31, 2013. The fair value adjustment of warrants was included in other operating income in the first quarter of 2014.

 

 
27

 

 

For financial assets measured at fair value on a nonrecurring basis that were still reflected in the balance sheet at March 31, 2014, the following table provides the level of valuation assumptions used to determine each adjustment, the carrying value of the related individual assets as of March 31, 2014, and December 31, 2013, and the total losses/(gains) for the periods indicated:

 

   

March 31, 2014

   

Total Losses / (Gains)

 
   

Fair Value Measurements Using

   

Total at

   

Three months ended

 
   

Level 1

   

Level 2

   

Level 3

   

Fair Value

   

March 31, 2014

   

March 31, 2013

 

Assets

 

(In thousands)

 
                                                 

Impaired loans by type:

                                               

Commercial loans

  $ -     $ -     $ 13,436     $ 13,436     $ -     $ 463  

Commercial mortgage loans

    -       -       28,784       28,784       -       41  

Construction- residential

    -       -       500       500       -       -  

Construction- other

    -       -       15,376       15,376       -       -  

Residential mortgage loans and equity lines

    -       -       13,113       13,113       -       189  

Land loans

    -       -       30       30       -       48  

Total impaired loans

    -       -       71,239       71,239       -       741  

Other real estate owned (1)

    -       18,261       14,337       32,598       183       (66 )

Investments in venture capital

    -       -       5,827       5,827       111       92  

Equity investments

    177       -       -       177       -       -  

Total assets

  $ 177     $ 18,261     $ 91,403     $ 109,841     $ 294     $ 767  

 

(1) Other real estate owned balance of $44.9 million in the condensed consolidated balance sheet is net of estimated disposal costs.

 

 

 

   

December 31, 2013

   

Total Losses / (Gains)

 
   

Fair Value Measurements Using

   

Total at

   

Twelve months ended

 
   

Level 1

   

Level 2

   

Level 3

   

Fair Value

   

December 31, 2013

   

December 31, 2012

 

Assets

 

(In thousands)

 
                                                 

Impaired loans by type:

                                               

Commercial loans

  $ -     $ -     $ 7,584     $ 7,584     $ 5,731     $ -  

Commercial mortgage loans

    -       -       29,001       29,001       125       440  

Construction- residential

    -       -       500       500       -       -  

Construction- other

    -       -       15,363       15,363       -       65  

Residential mortgage loans and equity lines

    -       -       14,236       14,236       213       605  

Land loans

    -       -       29       29       -       162  

Total impaired loans

    -       -       66,713       66,713       6,069       1,272  

Other real estate owned (1)

    -       13,248       26,498       39,746       (3,134 )     10,904  

Investments in venture capital

    -       -       8,900       8,900       409       309  

Equity investments

    642       -       -       642       -       181  

Total assets

  $ 642     $ 13,248     $ 102,111     $ 116,001     $ 3,344     $ 12,666  

 

(1) Other real estate owned balance of $53.0 million in the consolidated balance sheet is net of estimated disposal costs.

 

The significant unobservable (Level 3) inputs used in the fair value measurement of collateral for collateral-dependent impaired loans was primarily based on the appraised value of collateral adjusted by estimated sales cost and commissions. The Company generally obtains new appraisal reports every nine months. As the Company’s primary objective in the event of default would be to monetize the collateral to settle the outstanding balance of the loan, less marketable collateral would receive a larger discount. During the reported periods, collateral discounts ranged from 55% in the case of accounts receivable collateral to 65% in the case of inventory collateral.

 

 
28

 

 

The significant unobservable inputs used in the fair value measurement of loans held for sale was primarily based on the quoted price or sale price adjusted by estimated sales cost and commissions. The significant unobservable inputs used in the fair value measurement of other real estate owned (“OREO”) was primarily based on the appraised value of OREO adjusted by estimated sales cost and commissions.

 

The Company applies estimated sales cost and commissions ranging from 3% to 6% to collateral value of impaired loans, quoted price, or loan sale price of loans held for sale, and appraised value of OREOs.

 

The significant unobservable inputs in the Black-Scholes option pricing model for the fair value of warrants are their expected life ranging from 1 to 4 years, risk-free interest rate from 0.46% to 1.35%, and stock volatility from 11.4% to 16.0%.

 

12. Fair Value of Financial Instruments

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments.

 

Cash and Cash Equivalents. For cash and cash equivalents, the carrying amount was assumed to be a reasonable estimate of fair value, a Level 1 measurement.

 

Short-term Investments. For short-term investments, the carrying amount was assumed to be a reasonable estimate of fair value, a Level 1 measurement.

 

Securities Purchased under Agreements to Resell. The fair value of securities purchased under agreements to resell is based on dealer quotes, a Level 2 measurement.

 

Securities. For securities, including securities held-to-maturity, available-for-sale, and for trading, fair values were based on quoted market prices at the reporting date. If a quoted market price was not available, fair value was estimated using quoted market prices for similar securities or dealer quotes. For certain actively traded agency preferred stocks and U.S. Treasury securities, the Company measures the fair value based on quoted market prices in active exchange markets at the reporting date, a Level 1 measurement. The Company also measures securities by using quoted market prices for similar securities or dealer quotes, a Level 2 measurement. This category generally includes U.S. Government agency securities, state and municipal securities, mortgage-backed securities (“MBS”), commercial MBS, collateralized mortgage obligations, asset-backed securities, and corporate bonds.

 

Loans. Fair values were estimated for portfolios of loans with similar financial characteristics. Each loan category was further segmented into fixed and adjustable rate interest terms and by performing and non-performing categories.

 

The fair value of performing loans was calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, a Level 3 measurement.

 

The fair value of impaired loans was calculated based on the net realizable fair value of the collateral or the observable market price of the most recent sale or quoted price from loans held for sale. The Company does not record loans at fair value on a recurring basis. Nonrecurring fair value adjustments to collateral dependent impaired loans are recorded based on the current appraised value of the collateral, a Level 2 measurement.

 

 
29

 

 

      Deposit Liabilities. The fair value of demand deposits, savings accounts, and certain money market deposits was assumed to be the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit was estimated using the rates currently offered for deposits with similar remaining maturities, a Level 3 measurement.

 

      Securities Sold under Agreements to Repurchase. The fair value of securities sold under agreements to repurchase is based on dealer quotes, a Level 2 measurement.

 

      Advances from Federal Home Loan Bank (“FHLB”). The fair value of the advances is based on quotes from the FHLB to settle the advances, a Level 2 measurement.

 

Other Borrowings. This category includes borrowings from other financial institutions.  The fair value of other borrowings is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk, a Level 3 measurement. 

 

Long-term Debt. The fair value of long-term debt is estimated based on the quoted market prices or dealer quotes, a Level 2 measurement.

 

Currency Option and Foreign Exchange Contracts. The Company measures the fair value of currency option and foreign exchange contracts based on dealer quotes, a Level 2 measurement.

 

Interest Rate Swaps. Fair value of interest rate swaps was derived from observable market prices for similar assets, a Level 2 measurement.

 

Off-Balance-Sheet Financial Instruments. The fair value of commitments to extend credit, standby letters of credit, and financial guarantees written were estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. The fair value of guarantees and letters of credit was based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date. The fair value of off-balance-sheet financial instruments was based on the assumptions that a market participant would use, a Level 3 measurement.

 

Fair value was estimated in accordance with ASC Topic 825. Fair value estimates were made at specific points in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Bank’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Bank’s financial instruments, fair value estimates were based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates were subjective in nature and involved uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

 
30

 

 

The following table presents the estimated fair value of financial instruments as of March 31, 2014, and as of December 31, 2013:

 

   

March 31, 2014

   

December 31, 2013

 
   

Carrying

           

Carrying

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 
   

(In thousands)

 

Financial Assets

                               

Cash and due from banks

  $ 161,657     $ 161,657     $ 153,747     $ 153,747  

Short-term investments

    620,306       620,306       516,938       516,938  

Securities available-for-sale

    1,578,897       1,578,897       1,586,668       1,586,668  

Trading securities

    -       -       4,936       4,936  

Loans, net

    8,120,208       8,045,314       7,897,187       7,760,490  

Investment in Federal Home Loan Bank stock

    29,901       29,901       25,000       25,000  

Warrants

    28       28       30       30  

 

   

Notional

           

Notional

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Option contracts

  $ 590     $ 3     $ 200     $ 0  

Foreign exchange contracts

    270,675       5,093       267,644       6,182  
                                 

 

Financial Liabilities

 

Carrying

           

Carrying

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 
                                 

Deposits

  $ 8,232,625     $ 8,233,462     $ 7,981,305     $ 7,977,639  

Securities sold under agreements to repurchase

    700,000       739,254       800,000       852,835  

Advances from Federal Home Loan Bank

    636,200       636,531       521,200       521,560  

Other borrowings

    19,025       16,337       19,062       16,107  

Long-term debt

    121,136       59,305       121,136       58,970  

 

   

Notional

           

Notional

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Option contracts

  $ 590     $ 2     $ -     $ -  

Foreign exchange contracts

    227,655       3,322       236,350       6,140  
                                 

 

   

Notional

           

Notional

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Off-Balance Sheet Financial Instruments

                               

Commitments to extend credit

  $ 1,946,254     $ (2,066 )   $ 1,858,669     $ (2,187 )

Standby letters of credit

    48,825       (210 )     45,058       (205 )

Other letters of credit

    51,704       (34 )     54,098       (34 )

Bill of lading guarantees

    173       -       80       -  

 

 
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The following tables present the level in the fair value hierarchy for the estimated fair values of only financial instruments that are not already included on the condensed consolidated balance sheets at fair value as of March 31, 2014, and December 31, 2013.

 

   

March 31, 2014

 
   

Estimated

                         
   

Fair Value

                         
   

Measurements

   

Level 1

   

Level 2

   

Level 3

 
   

(In thousands)

 

Financial Assets

                               

Cash and due from banks

  $ 161,657     $ 161,657     $ -     $ -  

Short-term investments

    620,306       620,306       -       -  

Securities available-for-sale

    1,578,897       481,576       1,097,321       -  

Loans, net

    8,045,314       -       -       8,045,314  

Investment in Federal Home Loan Bank stock

    29,901       -       29,901       -  

Warrants

    28       -       -       28  

Financial Liabilities

                               

Deposits

    8,233,462       -       -       8,233,462  

Securities sold under agreements to repurchase

    739,254       -       739,254       -  

Advances from Federal Home Loan Bank

    636,531       -       636,531       -  

Other borrowings

    16,337       -       -       16,337  

Long-term debt

    59,305       -       59,305       -  

 

   

December 31, 2013

 
   

Estimated

                         
   

Fair Value

                         
   

Measurements

   

Level 1

   

Level 2

   

Level 3

 
   

(In thousands)

 

Financial Assets

                               

Cash and due from banks

  $ 153,747     $ 153,747     $ -     $ -  

Short-term investments

    516,938       516,938       -       -  

Securities available-for-sale

    1,586,668       465,917       1,120,751       -  

Trading securities

    4,936       -       4,936       -  

Loans, net

    7,760,490       -       -       7,760,490  

Investment in Federal Home Loan Bank stock

    25,000       -       25,000       -  

Warrants

    30       -       -       30  

Financial Liabilities

                               

Deposits

    7,977,639       -       -       7,977,639  

Securities sold under agreements to repurchase

    852,835       -       852,835       -  

Advances from Federal Home Loan Bank

    521,560       -       521,560       -  

Other borrowings

    16,107       -       -       16,107  

Long-term debt

    58,970       -       58,970       -  

 

13. Goodwill and Goodwill Impairment

 

The Company’s policy is to assess goodwill for impairment at the reporting unit level on an annual basis or between annual assessments if a triggering event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value.  

 

The Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350. The two-step impairment testing process, if needed, begins by assigning net assets and goodwill to our two reporting unitsCommercial Lending and Retail Banking.  The Company then completes “step one” of the impairment test by comparing the fair value of each reporting unit (as determined based on the discussion below) with the recorded book value (or “carrying amount”) of its net assets, with goodwill included in the computation of the carrying amount.  If the fair value of a reporting unit exceeds its carrying amount, goodwill of that reporting unit is not considered impaired, and “step two” of the impairment test is not necessary.  If the carrying amount of a reporting unit exceeds its fair value, step two of the impairment test is performed to determine the amount of impairment.  Step two of the impairment test compares the carrying amount of the reporting unit’s goodwill to the “implied fair value” of that goodwill.  The implied fair value of goodwill is computed by assuming that all assets and liabilities of the reporting unit would be adjusted to the current fair value, with the offset as an adjustment to goodwill.  This adjusted goodwill balance is the implied fair value used in step two.  An impairment charge is recognized for the amount by which the carrying amount of goodwill exceeds its implied fair value.

 

 
32

 

 

At March 31, 2014, the Company’s market capitalization was above book value and there was no triggering event that required the Company to assess goodwill for impairment as of an interim date.

 

14. Financial Derivatives

 

It is the policy of the Company not to speculate on the future direction of interest rates. However, the Company enters into financial derivatives in order to seek mitigation of exposure to interest rate risks related to our interest-earning assets and interest-bearing liabilities. We believe that these transactions, when properly structured and managed, may provide a hedge against inherent interest rate risk in the Company’s assets or liabilities and against risk in specific transactions. In such instances, the Company may protect its position through the purchase or sale of interest rate futures contracts for a specific cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, floors, financial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, we seek to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bank’s Investment Committee.

 

The Company follows ASC Topic 815 that establishes accounting and reporting standards for financial derivatives, including certain financial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all financial derivatives as assets or liabilities in the Company’s consolidated balance sheet and measurement of those financial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a financial derivative is designated as a hedge and, if so, the type of hedge.

 

The Company enters into foreign exchange forward contracts and foreign currency option contracts with various counter parties to mitigate the risk of fluctuations in foreign currency exchange rates for foreign exchange certificates of deposit, foreign exchange contracts, or foreign currency option contracts entered into with our clients. These contracts are not designated as hedging instruments and are recorded at fair value in our condensed consolidated balance sheets. Changes in the fair value of these contracts as well as the related foreign exchange certificates of deposit, foreign exchange contracts, or foreign currency option contracts are recognized immediately in net income as a component of non-interest income. Period end gross positive fair values are recorded in other assets and gross negative fair values are recorded in other liabilities. At March 31, 2014, the notional amount of option contracts totaled $1.2 million with a net positive fair value of $1,000. Spot and forward contracts in the total notional amount of $270.7 million had a positive fair value of $5.1 million at March 31, 2014. Spot and forward contracts in the total notional amount of $227.7 million had a negative fair value of $3.3 million at March 31, 2014. At December 31, 2013, the notional amount of option contracts totaled $200,000 with a net positive fair value of $83. Spot and forward contracts in the total notional amount of $267.6 million had a positive fair value of $6.2 million at December 31, 2013. Spot and forward contracts in the total notional amount of $236.3 million had a negative fair value of $6.1 million at December 31, 2013.

 

 
33

 

 

15. Balance Sheet Offsetting

 

Certain financial instruments, including resell and repurchase agreements, securities lending arrangements and derivatives, may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements or similar agreements. The Company’s securities sold with agreement to repurchase and derivative transactions with upstream financial institution counter parties are generally executed under International Swaps and Derivative Association master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. Nonetheless, the Company does not generally offset such financial instruments for financial reporting purposes.

 

Financial instruments that are eligible for offset in the condensed consolidated balance sheets, as of March 31, 2014, and December 31, 2013, are presented in the following table:

 

                           

Gross Amounts Not Offset in the Statement of Financial Position

 

(In thousands)

 

Gross Amounts of Recognized Liabilities

   

Gross Amounts Offset in the Balance Sheet

   

Net Amounts of Liabilities Presented in the Balance Sheet

   

Financial Instruments

   

Collateral Posted

   

Net Amount

 

March 31, 2014

                                               

Securities sold under agreements to repurchase

  $ 700,000     $ -     $ 700,000     $ -     $ (700,000 )   $ -  
                                                 

December 31, 2013

                                               

Securities sold under agreements to repurchase

  $ 800,000     $ -     $ 800,000     $ -     $ (800,000 )   $ -  

 

16. Stockholders’ Equity

 

Total equity was $1.49 billion at March 31, 2014, an increase of $35.4 million, or 2.4%, from $1.46 billion at December 31, 2013, primarily due to increases in net income of $31.3 million and decreases in unrealized losses on securities available for sale of $7.6 million offset by common stock cash dividends of $4.0 million.

 

The accumulated other comprehensive loss as of March 31, 2014, was all from unrealized losses on securities available-for-sale.

 

 
34

 

 

Activity in accumulated other comprehensive income, net of tax, and reclassification out of accumulated other comprehensive income for the three months ended March 31, 2014, was as follows:

 

   

Three months ended March 31, 2014

   

Three months ended March 31, 2013

 
   

Pre-tax

   

Tax expense

   

Net-of-tax

   

Pre-tax

   

Tax expense

   

Net-of-tax

 
   

(In thousands)

   

(In thousands)

 

Beginning balance, net of tax

                  $ (29,729 )                   $ 465  

Net unrealized gains arising during the period

  $ 19,140     $ 8,047     $ 11,094     $ 7,947     $ 3,343     $ 4,604  

Reclassification adjustment for net securities gains included in net income

    (5,960     (2,506     (3,455     (6,292 )     (2,645 )     (3,647 )

Net unrealized gains arising from transferring securities held-to-maturity to available-for-sale

    -       -       -       38,052       15,997       22,055  

Total other comprehensive income

  $ 13,180     $ 5,541     $ 7,639     $ 39,707     $ 16,695     $ 23,012  

Ending balance, net of tax

                  $ (22,090 )                   $ 23,477  

 

17. Subsequent Events

 

On April 23, 2014, the Company repurchased $2.0 million par value of its Junior Subordinated Notes issued through Cathay Capital Trust IV which mature on September 6, 2037, at a price of 72.25% of par. The gain on repurchase of these Junior Subordinated Notes was $555,000.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion is given based on the assumption that the reader has access to and has read the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Critical Accounting Policies

 

The discussion and analysis of the Company’s unaudited condensed consolidated balance sheets and results of operations are based upon its unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues, and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

 

Management of the Company considers the following to be critical accounting policies:

 

Accounting for the allowance for credit losses involves significant judgments and assumptions by management, which have a material impact on the carrying value of net loans. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances as described in “Allowance for Credit Losses” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

 
35

 

 

Accounting for investment securities involves significant judgments and assumptions by management, which have a material impact on the carrying value of securities and the recognition of any “other-than-temporary” impairment to our investment securities. The judgments and assumptions used by management are described in “Investment Securities” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Accounting for income taxes involves significant judgments and assumptions by management, which have a material impact on the amount of taxes currently payable and the income tax expense recorded in the financial statements. The judgments and assumptions used by management are described in “Income Taxes” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Accounting for goodwill and goodwill impairment involves significant judgments and assumptions by management, which have a material impact on the amount of goodwill and noninterest expense recorded in the financial statements. The judgments and assumptions used by management are described in “Goodwill and Goodwill Impairment” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Highlights

 

 

Diluted earnings per share increased 30.0% to $0.39 per share for the first quarter of 2014 compared to $0.30 per share for the same quarter a year ago.

 

Total loans increased $217.7 million, or 2.7%, in the first quarter of 2014, to $8.3 billion at March 31, 2014, compared to $8.1 billion at December 31, 2013.

 

Quarterly Statement of Operations Review

 

Net Income

 

Net income available to common stockholders for the quarter ended March 31, 2014, was $31.3 million, an increase of $7.6 million, or 32.1%, compared to a net income available to common stockholders of $23.7 million for the same quarter a year ago. Diluted earnings per share available to common stockholders for the quarter ended March 31, 2014, was $0.39 compared to $0.30 for the same quarter a year ago due primarily to the elimination of dividends on preferred stock, a decrease in the cost associated with debt redemption, and an increase in net interest income.

 

Return on average stockholders’ equity was 8.53% and return on average assets was 1.19% for the quarter ended March 31, 2014, compared to a return on average stockholders’ equity of 7.20% and a return on average assets of 1.12% for the same quarter a year ago.

 

 
36

 

 

Financial Performance

 

   

Three months ended March 31,

 
   

2014

   

2013

 

Net income (in millions)

  $ 31.3     $ 28.8  

Net income available to common stockholders (in millions)

  $ 31.3     $ 23.7  

Basic earnings per common share

  $ 0.39     $ 0.30  

Diluted earnings per common share

  $ 0.39     $ 0.30  

Return on average assets

    1.19 %     1.12 %

Return on average total stockholders' equity

    8.53 %     7.20 %

Efficiency ratio

    49.44 %     51.71 %

 

Net Interest Income Before Provision for Credit Losses

 

Net interest income before provision for credit losses increased $2.6 million, or 3.2%, to $82.7 million during the first quarter of 2014 compared to $80.1 million during the same quarter a year ago. The increase was due primarily to the decrease in interest expense from securities sold under agreements to repurchase.

 

The net interest margin, on a fully taxable-equivalent basis, was 3.38% for the first quarter of 2014, compared to 3.30% for the fourth quarter of 2013 and 3.35% for the first quarter of 2013. The increase in the net interest margin was due mainly to the prepayment of securities sold under agreements to repurchase during the last twelve months. 

 

For the first quarter of 2014, the yield on average interest-earning assets was 4.14%, on a fully taxable-equivalent basis, the cost of funds on average interest-bearing liabilities was 0.99%, and the cost of interest bearing deposits was 0.65%. In comparison, for the first quarter of 2013, the yield on average interest-earning assets was 4.26%, on a fully taxable-equivalent basis, the cost of funds on average interest-bearing liabilities was 1.18%, and the cost of interest bearing deposits was 0.63%. The interest spread, defined as the difference between the yield on average interest-earning assets and the cost of funds on average interest-bearing liabilities, increased seven basis points to 3.15% for the quarter ended March 31, 2014, from 3.08% for the same quarter a year ago, primarily for the reason discussed above.

 

 
37

 

 

The following table sets forth information concerning average interest-earning assets, average interest-bearing liabilities, and the average yields and rates paid on those assets and liabilities for the three months ended March 31, 2014, and March 31, 2013. Average outstanding amounts included in the table are daily averages.

 

Interest-Earning Assets and Interest-Bearing Liabilities

 
   

Three months ended March 31,

 
   

2014

   

2013

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 

(Dollars in thousands)

 

Balance

   

Expense

   

Rate (1)(2)

   

Balance

   

Expense

   

Rate (1)(2)

 

Interest earning assets:

                                               

Commercial loans

  $ 2,260,590     $ 21,312       3.82 %   $ 2,073,827     $ 20,768       4.06 %

Residential mortgage loans

    1,567,706       18,470       4.71       1,357,346       15,942       4.70  

Commercial mortgage loans

    4,075,694       49,614       4.94       3,761,187       49,706       5.36  

Real estate construction loans

    233,245       3,310       5.76       181,254       2,387       5.34  

Other loans and leases

    19,951       26       0.53       13,252       37       1.13  

Total loans and leases (1)

    8,157,186       92,732       4.61       7,386,866       88,840       4.88  

Taxable securities

    1,581,642       7,576       1.94       2,006,091       11,786       2.38  

Tax-exempt securities (3)

    -       -       -       124,182       1,488       4.86  

Federal Home Loan Bank stock

    25,054       450       7.28       41,041       250       2.47  

Interest bearing deposits

    148,241       449       1.23       196,615       208       0.43  

Total interest-earning assets

    9,912,123       101,207       4.14       9,754,795       102,572       4.26  

Non-interest earning assets:

                                               

Cash and due from banks

    136,063                       139,378                  

Other non-earning assets

    786,069                       763,909                  

Total non-interest earning assets

    922,132                       903,287                  

Less: Allowance for loan losses

    (174,934 )                     (183,547 )                

Deferred loan fees

    (13,341 )                     (10,071 )                

Total assets

  $ 10,645,980                     $ 10,464,464                  
                                                 

Interest bearing liabilities:

                                               

Interest bearing demand accounts

  $ 682,765     $ 273       0.16     $ 600,110     $ 235       0.16  

Money market accounts

    1,275,726       1,927       0.61       1,164,125       1,580       0.55  

Savings accounts

    498,390       92       0.07       466,952       92       0.08  

Time deposits

    4,171,061       8,400       0.82       3,878,847       7,615       0.80  

Total interest-bearing deposits

    6,627,942       10,692       0.65       6,110,034       9,522       0.63  
                                                 

Securities sold under agreements to repurchase

    707,222       6,930       3.97       1,197,222       11,393       3.86  

Other borrowings

    175,252       199       0.46       48,807       80       0.66  

Long-term debt

    121,136       728       2.44       171,136       924       2.19  

Total interest-bearing liabilities

    7,631,552       18,549       0.99       7,527,199       21,919       1.18  

Non-interest bearing liabilities:

                                               

Demand deposits

    1,445,269                       1,221,552                  

Other liabilities

    82,954                       82,940                  

Total equity

    1,486,205                       1,632,773                  

Total liabilities and equity

  $ 10,645,980                     $ 10,464,464                  

Net interest spread (4)

                    3.15 %                     3.08 %

Net interest income (4)

          $ 82,658                     $ 80,653          

Net interest margin (4)

                    3.38 %                     3.35 %

 

(1) Yields and amounts of interest earned include loan fees. Non-accrual loans are included in the average balance.

(2) Calculated by dividing net interest income by average outstanding interest-earning assets.

(3) The average yield has been adjusted to a fully taxable-equivalent basis for certain securities of states and political subdivisions

      and other securities held using a statutory federal income tax rate of 35%.

(4) Net interest income, net interest spread, and net interest margin on interest-earning assets have been adjusted to a

     fully taxable-equivalent basis using a statutory federal income tax rate of 35%.

 

 
38

 

 

The following table summarizes the changes in interest income and interest expense attributable to changes in volume and changes in interest rates:

 

Taxable-Equivalent Net Interest Income — Changes Due to Rate and Volume(1)

 
   

Three months ended March 31,

 
      2014-2013  
   

Increase (Decrease) in

 
   

Net Interest Income Due to:

 

(Dollars in thousands)

 

Changes in Volume

   

Changes in Rate

   

Total Change

 

Interest-earning assets:

                       

Loans and leases

    9,020       (5,128 )     3,892  

Taxable securities

    (2,248 )     (1,962 )     (4,210 )

Tax-exempt securities (2)

    (1,488 )     -       (1,488 )

Federal Home Loan Bank stock

    (131 )     331       200  

Deposits with other banks

    (64 )     305       241  

Total changes in interest income

    5,089       (6,454 )     (1,365 )
                         

Interest-bearing liabilities:

                       

Interest bearing demand accounts

    33       5       38  

Money market accounts

    159       188       347  

Savings accounts

    6       (6 )     -  

Time deposits

    585       200       785  

Securities sold under agreements to repurchase

    (4,801 )     338       (4,463 )

Other borrowed funds

    151       (32 )     119  

Long-term debt

    (294 )     98       (196 )

Total changes in interest expense

    (4,161 )     791       (3,370 )

Changes in net interest income

  $ 9,250     $ (7,245 )   $ 2,005  

 

(1) Changes in interest income and interest expense attributable to changes in both volume and rate have been

      allocated proportionately to changes due to volume and changes due to rate.

(2) The amount of interest earned on certain securities of states and political subdivisions and other securities

      held has been adjusted to a fully taxable-equivalent basis using a statutory federal income tax rate of 35%.

 

Provision for Credit Losses

 

Provision for credit losses was zero for both the first quarter of 2014 and the first quarter of 2013. The provision for credit losses was based on the review of the adequacy of the allowance for loan losses at March 31, 2014. The provision or reversal for credit losses represents the charge against or benefit toward current earnings that is determined by management, through a credit review process, as the amount needed to establish an allowance that management believes to be sufficient to absorb credit losses inherent in the Company’s loan portfolio, including unfunded commitments. The following table summarizes the charge-offs and recoveries for the periods indicated:

 

   

Three months ended

 
   

March 31, 2014

   

December 31, 2013

   

March 31, 2013

 
   

(In thousands)

 

Charge-offs:

                       

Commercial loans

  $ 7,226     $ 11,045     $ 2,690  

Real estate loans (1)

    1,776       626       1,130  

Real estate- land loans

    -       -       270  

Total charge-offs

    9,002       11,671       4,090  

Recoveries:

                       

Commercial loans

    2,017       724       955  

Construction loans- residential

    16       1       46  

Construction loans- other

    9       27       33  

Real estate loans (1)

    2,577       1,749       359  

Real estate- land loans

    3       896       9  

Total recoveries

    4,622       3,397       1,402  

Net charge-offs

  $ 4,380     $ 8,274     $ 2,688  

 

(1) Real estate loans include commercial mortgage loans, residential mortgage loans and equity lines.

 

 
39

 

 

Non-Interest Income

 

Non-interest income, which includes revenues from depository service fees, letters of credit commissions, securities gains (losses), gains (losses) on loan sales, wire transfer fees, and other sources of fee income, was $14.6 million for the first quarter of 2014, a decrease of $322,000, or 2.2%, compared to $14.9 million for the first quarter of 2013. The decrease in non-interest income in the first quarter of 2014 was primarily due to decreases of $438,000 in gains on sale of loans and of $332,000 in gains on sale of securities partially offset by an increase of $304,000 in commissions from wealth management. 

 

Non-Interest Expense

 

Non-interest expense decreased $1.0 million, or 2.2%, to $48.1 million in the first quarter of 2014 compared to $49.1 million in the same quarter a year ago. The efficiency ratio was 49.44% in the first quarter of 2014 compared to 51.71% for the same quarter a year ago.  

 

Prepayment penalties decreased $2.2 million to $3.4 million in the first quarter of 2014 compared to $5.6 million in the same quarter a year ago. The Company prepaid $100.0 million of securities sold under agreements to repurchase in the first quarter of 2014 compared to $100.0 million in the same quarter a year ago. Amortization of core deposit premium decreased $1.2 million to $172,000 in the first quarter of 2014 compared to $1.4 million in the same quarter a year ago as a result of the full amortization of the core deposit premium from the General Bank acquisition. Other professional services expenses decreased $661,000 due to the completion of core system conversion in 2013. Offsetting the above decreases were a $1.0 million increase in litigation expense, a $741,000 increase in operations of affordable housing investments primarily due to new investments, a $598,000 increase in salaries and employee benefits primarily due to higher bonus accruals and amortization of long term incentive compensation awards, and a $416,000 increase in FDIC and state assessments.

 

Income Taxes

 

The effective tax rate for the first quarter of 2014 was 36.4% compared to 36.9% for the first quarter of 2013. The effective tax rate includes the impact of the utilization of low income housing tax credits.

 

Balance Sheet Review

 

Assets

 

Total assets were $11.29 billion at March 31, 2014, an increase of $301.9 million, or 2.7%, from $11.0 billion at December 31, 2013, primarily due to a $217.7 million increase in loans and a $103.4 million increase in short-term investments.

 

Investment Securities

 

Investment securities represented 14.0% of total assets at March 31, 2014, compared with 14.4% of total assets at December 31, 2013. The carrying value of investment securities at March 31, 2014, was $1.58 billion compared with $1.59 billion at December 31, 2013. Securities available-for-sale are carried at fair value and had a net unrealized loss, net of tax, of $22.1 million at March 31, 2014, compared with a net unrealized loss, net of tax, of $29.7 million at December 31, 2013. During the first quarter of 2013, due to the ongoing discussions regarding corporate income tax rates which could have a negative impact on the after-tax yields and fair values of the Company’s portfolio of municipal securities, the Company determined it may sell such securities in response to market conditions. As a result, the Company reclassified its municipal securities from securities held-to-maturity to securities available-for-sale. Concurrent with this reclassification, the Company also reclassified all other securities held-to-maturity, which together with the municipal securities had an amortized cost on the date of transfer of $722.5 million, to securities available-for-sale. At the reclassification date, a net unrealized gain was recorded in other comprehensive income for these securities totaling $40.5 million.

 

 
40

 

 

The following tables reflect the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of investment securities as of March 31, 2014, and December 31, 2013:

 

   

March 31, 2014

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. treasury securities

  $ 475,139     $ 120     $ -     $ 475,259  

Mortgage-backed securities

    969,042       1,860       49,749       921,153  

Collateralized mortgage obligations

    82       -       39       43  

Corporate debt securities

    165,716       423       3,458       162,681  

Mutual funds

    6,000               243       5,757  

Preferred stock of government sponsored entities

    535       12,909               13,444  

Other equity securities

    500       60               560  

Total securities available-for-sale

  $ 1,617,014     $ 15,372     $ 53,489     $ 1,578,897  

Total investment securities

  $ 1,617,014     $ 15,372     $ 53,489     $ 1,578,897  

 

   

December 31, 2013

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. treasury securities

  $ 460,095     $ 99     $ 1     $ 460,193  

Mortgage-backed securities

    1,010,294       7,049       64,529       952,814  

Collateralized mortgage obligations

    5,929       231       54       6,106  

Asset-backed securities

    123       -       -       123  

Corporate debt securities

    154,955       298       4,949       150,304  

Mutual funds

    6,000       -       275       5,725  

Preferred stock of government sponsored entities

    569       10,834       -       11,403  

Total securities available-for-sale

  $ 1,637,965     $ 18,511     $ 69,808     $ 1,586,668  

Total investment securities

  $ 1,637,965     $ 18,511     $ 69,808     $ 1,586,668  

 

For additional information, see Note 6 to the Company’s condensed consolidated financial statements presented elsewhere in this report.

 

Investment securities having a carrying value of $853.6 million at March 31, 2014, and $926.5 million at December 31, 2013, were pledged to secure public deposits, other borrowings, treasury tax and loan, Federal Home Loan Bank advances, securities sold under agreements to repurchase, interest rate swaps, and foreign exchange transactions. 

 

 
41

 

 

Loans

 

Gross loans were $8.30 billion at March 31, 2014, an increase of $217.7 million, or 2.7%, from $8.08 billion at December 31, 2013, primarily due to increases of $169.9 million, or 4.2%, in commercial mortgage loans, $86.0 million, or 6.3%, in residential mortgage loans, and $32.1 million, or 14.5%, in real estate construction loans, offset by a decrease of $68.8 million, or 3.0%, in commercial loans. The following table sets forth the classification of loans by type, mix, and percentage change as of the dates indicated:

 

   

March 31, 2014

   

% of Gross Loans

   

December 31, 2013

   

% of Gross Loans

   

% Change

 

Type of Loans

 

(Dollars in thousands)

 

Commercial loans

  $ 2,229,880       26.9 %   $ 2,298,724       28.50 %     -3.0 %

Residential mortgage loans

    1,441,230       17.4       1,355,255       16.8       6.3  

Commercial mortgage loans

    4,192,987       50.5       4,023,051       49.8       4.2  

Equity lines

    172,395       2.1       171,277       2.2       0.7  

Real estate construction loans

    253,832       3.0       221,701       2.5       14.5  

Installment and other loans

    11,958       0.1       14,555       0.2       (17.8 )

Gross loans

  $ 8,302,282       100 %   $ 8,084,563       100 %     2.7 %
                                         

Allowance for loan losses

    (169,138 )             (173,889 )             (2.7 )

Unamortized deferred loan fees

    (12,936 )             (13,487 )             (4.1 )

Total loans, net

  $ 8,120,208             $ 7,897,187               2.8 %

 

Non-performing Assets

 

Non-performing assets include loans past due 90 days or more and still accruing interest, non-accrual loans, and other real estate owned (“OREO”). The Company’s policy is to place loans on non-accrual status if interest and/or principal is past due 90 days or more, or in cases where management deems the full collection of principal and interest unlikely. After a loan is placed on non-accrual status, any previously accrued but unpaid interest is reversed and charged against current income and subsequent payments received are generally first applied towards the outstanding principal balance of the loan. Depending on the circumstances, management may elect to continue the accrual of interest on certain past due loans if partial payment is received and/or the loan is well collateralized and in the process of collection. The loan is generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled.

 

Management reviews the loan portfolio regularly for problem loans. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of the loan agreements. Such loans are placed under closer supervision with consideration given to placing the loans on non-accrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-off.

 

The ratio of non-performing assets to total assets was 1.0% at March 31, 2014, compared to 1.3% at December 31, 2013. Total non-performing assets decreased $20.9 million, or 15.3%, to $116.2 million at March 31, 2014, compared to $137.2 million at December 31, 2013, primarily due to a $12.8 million, or 15.4%, decrease in non-accrual loans and a $8.1 million, or 15.3%, decrease in OREO.

 

As a percentage of gross loans plus OREO, our non-performing assets decreased to 1.39% at March 31, 2014, from 1.69% at December 31, 2013. The non-performing portfolio loan coverage ratio, defined as the allowance for credit losses to non-performing loans, increased to 239.4% at March 31, 2014, from 208.2% at December 31, 2013.

 

 
42

 

 

The following table presents the changes in non-performing assets and troubled debt restructurings (TDRs) at March 31, 2014, compared to December 31, 2013, and to March 31, 2013:

 

(Dollars in thousands)

 

March 31, 2014

   

December 31, 2013

   

% Change

   

March 31, 2013

   

% Change

 

Non-performing assets

                                       

Accruing loans past due 90 days or more

  $ 974     $ 982       (1 )   $ 800       22  

Non-accrual loans:

                                       

Construction loans- residential

    3,313       3,313       -       3,271       1  

Construction loans- non-residential

    24,729       25,273       (2 )     32,966       (25 )

Land loans

    6,502       6,502       -       8,325       (22 )

Commercial real estate loans, excluding land loans

    10,540       13,119       (20 )     30,896       (66 )

Commercial loans

    13,806       21,232       (35 )     13,192       5  

Residential mortgage loans

    11,498       13,744       (16 )     11,679       (2 )

Total non-accrual loans:

  $ 70,388     $ 83,183       (15 )   $ 100,329       (30 )

Total non-performing loans

    71,362       84,165       (15 )     101,129       (29 )

Other real estate owned

    44,853       52,985       (15 )     45,316       (1 )

Total non-performing assets

  $ 116,215     $ 137,150       (15 )   $ 146,445       (21 )

Accruing troubled debt restructurings (TDRs)

  $ 118,922     $ 117,597       1     $ 130,215       (9 )

Non-accrual TDRs (included in non-accrual loans above)

  $ 37,797     $ 38,769       (3 )   $ 49,878       (24 )
                                         

Allowance for loan losses

  $ 169,138     $ 173,889       (3 )   $ 178,692       (5 )

Allowance for off-balance sheet credit commitments

    1,734       1,362       27       3,304       (48 )

Allowance for credit losses

  $ 170,872     $ 175,251       (2 )   $ 181,996       (6 )
                                         

Total gross loans outstanding, at period-end

  $ 8,302,282     $ 8,084,563       3     $ 7,364,340       13  

Allowance for loan losses to non-performing loans, at period-end

    237.01 %     206.60 %             176.70 %        

Allowance for loan losses to gross loans, at period-end

    2.04 %     2.15 %             2.43 %        

Allowance for credit losses to gross loans, at period-end

    2.06 %     2.17 %             2.47 %        

 

Non-accrual Loans

 

At March 31, 2014, total non-accrual loans were $70.4 million, an decrease of $29.9 million, or 29.8%, from $100.3 million at March 31, 2013, and a decrease of $12.8 million, or 15.4%, from $83.2 million at December 31, 2013. The allowance for the collateral-dependent loans is calculated based on the difference between the outstanding loan balance and the value of the collateral as determined by recent appraisals, sales contracts, or other available market price information. The allowance for collateral-dependent loans varies from loan to loan based on the collateral coverage of the loan at the time of designation as non-performing. We continue to monitor the collateral coverage, based on recent appraisals, of these loans on a quarterly basis and adjust the allowance accordingly. Non-accrual loans also include those troubled debt restructurings that do not qualify for accrual status.

 

 
43

 

 

The following tables present the type of properties securing the non-accrual portfolio loans and the type of businesses the borrowers engaged in as of the dates indicated:

 

   

March 31, 2014

   

December 31, 2013

 
   

Real

           

Real

         
   

Estate (1)

   

Commercial

   

Estate (1)

   

Commercial

 
   

(In thousands)

 

Type of Collateral

                               

Single/multi-family residence

  $ 15,624     $ 3,039     $ 22,370     $ 2,030  

Commercial real estate

    34,457       1,167       33,079       1,366  

Land

    6,502       -       6,502       -  

Unsecured

    -       9,599       -       17,836  

Total

  $ 56,583     $ 13,805     $ 61,951     $ 21,232  

 

(1) Real estate includes commercial mortgage loans, real estate construction loans,

      residential mortgage loans and equity lines.

 

   

March 31, 2014

   

December 31, 2013

 
   

Real

           

Real

         
   

Estate (1)

   

Commercial

   

Estate (1)

   

Commercial

 
   

(In thousands)

 

Type of Business

                               

Real estate development

  $ 29,007     $ 900     $ 31,895     $ 5,866  

Wholesale/Retail

    16,736       8,083       16,796       3,526  

Food/Restaurant

    617       214       569       173  

Import/Export

    -       4,608       -       11,667  

Other

    10,223       -       12,691       -  

Total

  $ 56,583     $ 13,805     $ 61,951     $ 21,232  

 

(1) Real estate includes commercial mortgage loans, real estate construction loans,

      residential mortgage loans and equity lines.

 

Other Real Estate Owned 

 

At March 31, 2014, OREO totaled $44.9 million, which decreased $8.1 million, or 15.3%, compared to $53.0 million at December 31, 2013.

 

Impaired Loans

 

A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement based on current circumstances and events. The assessment for impairment occurs when and while such loans are on non-accrual as a result of delinquency status of over 90 days or receipt of information indicating that full collection of principal is doubtful, or when the loan has been restructured in a troubled debt restructuring. Those loans with a balance less than our defined selection criteria, generally a loan amount less than $500,000 (less than $100,000 for quarters before June 30, 2012), are treated as a homogeneous portfolio. If loans meeting the defined criteria are not collateral dependent, we measure the impairment based on the present value of the expected future cash flows discounted at the loan’s effective interest rate. If loans meeting the defined criteria are collateral dependent, we measure the impairment by using the loan’s observable market price or the fair value of the collateral. We obtain an appraisal to determine the amount of impairment at the date that the loan becomes impaired. The appraisals are based on “as is” or bulk sale valuations. To ensure that appraised values remain current, we generally obtain an updated appraisal every six months from qualified independent appraisers. Furthermore, if the most current appraisal is dated more than three months prior to the effective date of the impairment test, we validate the most current value with third party market data appropriate to the location and property type of the collateral. If the third party market data indicates that the value of our collateral has declined since the most recent valuation date, we adjust downward the value of the property to reflect current market conditions. If the fair value of the collateral, less cost to sell, is less than the recorded amount of the loan, we then recognize impairment by creating or adjusting an existing valuation allowance with a corresponding charge to the provision for loan losses. If an impaired loan is expected to be collected through liquidation of the collateral, the amount of impairment, excluding disposal costs, which range between 3% to 6% of the fair value, depending on the size of the impaired loan, is charged off against the allowance for loan losses. Non-accrual impaired loans, including TDRs, are not returned to accrual status unless the unpaid interest has been brought current and full repayment of the recorded balance is expected or if the borrower has made six consecutive monthly payments of the scheduled amounts due, and TDRs are reviewed for continued impairment until they are no longer reported as TDRs.

 

 
44

 

 

At March 31, 2014, recorded investment in impaired loans totaled $189.3 million and was comprised of non-accrual loans of $70.4 million and accruing TDRs of $118.9 million. At December 31, 2013, recorded investment in impaired loans totaled $200.8 million and was comprised of non-accrual loans of $83.2 million and accruing TDRs of $117.6 million. For impaired loans, the amounts previously charged off represent 15.0% at March 31, 2014, and 23.9% at December 31, 2013, of the contractual balances for impaired loans. As of March 31, 2014, $56.6 million, or 80.4%, of the $70.4 million of non-accrual loans that were secured by real estate compared to $62.0 million, or 74.5%, of the $83.2 million of non-accrual loans that were secured by real estate at December 31, 2013. In light of changing property values in the current economic fluctuation affecting the real estate markets, the Bank has obtained current appraisals, sales contracts, or other available market price information which provide updated factors in evaluating potential loss.

 

At March 31, 2014, $14.5 million of the $169.1 million allowance for loan losses was allocated for impaired loans and $154.6 million was allocated to the general allowance. At December 31, 2013, $13.3 million of the $173.9 million allowance for loan losses was allocated for impaired loans and $160.6 million was allocated to the general allowance.

 

The allowance for credit losses to non-accrual loans increased to 242.8% at March 31, 2014, from 210.7% at December 31, 2013, primarily due to decreases in non-accrual loans. Non-accrual loans also include those TDRs that do not qualify for accrual status.    

 

 
45

 

 

The following table presents impaired loans and the related allowance as of the dates indicated:

 

   

Impaired Loans

 
   

March 31, 2014

   

December 31, 2013

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Allowance

   

Unpaid Principal Balance

   

Recorded Investment

   

Allowance

 
   

(In thousands)

 
                                                 

With no allocated allowance

                                               

Commercial loans

  $ 14,001     $ 11,914     $ -     $ 20,992     $ 18,905     $ -  

Real estate construction loans

    25,157       14,854       -       25,401       15,097       -  

Commercial mortgage loans

    73,274       71,934       -       105,593       78,930       -  

Residential mortgage loans and equity lines

    4,876       4,876       -       4,892       4,892       -  

Subtotal

  $ 117,308     $ 103,578     $ -     $ 156,878     $ 117,824     $ -  

With allocated allowance

                                               

Commercial loans

  $ 27,772     $ 18,099     $ 4,663     $ 22,737     $ 13,063     $ 2,519  

Real estate construction loans

    28,158       19,005       3,129       28,475       19,323       3,460  

Commercial mortgage loans

    35,363       34,979       6,165       39,223       35,613       6,584  

Residential mortgage loans and equity lines

    14,083       13,650       538       16,535       14,957       721  

Subtotal

  $ 105,376     $ 85,733     $ 14,495     $ 106,970     $ 82,956     $ 13,284  

Total impaired loans

  $ 222,684     $ 189,311     $ 14,495     $ 263,848     $ 200,780     $ 13,284  

 

Loan Interest Reserves 

 

In accordance with customary banking practice, construction loans and land development loans are originated where interest on the loan is disbursed from pre-established interest reserves included in the total original loan commitment. Our construction and land development loans generally include optional renewal terms after the maturity of the initial loan term. New appraisals are obtained prior to extension or renewal of these loans in part to determine the appropriate interest reserve to be established for the new loan term. Loans with interest reserves are underwritten to the same criteria, including loan to value and, if applicable, pro forma debt service coverage ratios, as loans without interest reserves. Construction loans with interest reserves are monitored on a periodic basis to gauge progress towards completion. Interest reserves are frozen if it is determined that additional draws would result in a loan to value ratio that exceeds policy maximums based on collateral property type. Our policy limits in this regard are consistent with supervisory limits and range from 65% in the case of land to 85% in the case of one to four family residential construction projects.

 

As of March 31, 2014, construction loans of $187.9 million were disbursed with pre-established interest reserves of $21.2 million compared to $160.8 million of such loans disbursed with pre-established interest reserves of $20.0 million at December 31, 2013.  The balance for construction loans with interest reserves which have been extended was $26.6 million with pre-established interest reserves of $2.1 million at March 31, 2014, compared to $20.5 million with pre-established interest reserves of $1.8 million at December 31, 2013.  Land loans of $26.8 million were disbursed with pre-established interest reserves of $2.3 million at March 31, 2014, compared to $32.8 million land loans disbursed with pre-established interest reserves of $3.0 million at December 31, 2013.  The balance for land loans with interest reserves which have been extended was zero at March 31, 2014, compared to $1.7 million land loans with pre-established interest reserves of $53,000 at December 31, 2013. 

 

 
46

 

 

At March 31, 2014, the Bank had no loans on non-accrual status with available interest reserves.  At March 31, 2014, $3.3 million of non-accrual residential construction loans, $24.7 million of non-accrual non-residential construction loans, and $32,000 of non-accrual land loans had been originated with pre-established interest reserves.  At December 31, 2013, the Bank had no loans on non-accrual status with available interest reserves.  At December 31, 2013, $3.3 million of non-accrual residential construction loans, $25.3 million of non-accrual non-residential construction loans, and $32,000 of non-accrual land loans had been originated with pre-established interest reserves.   While loans with interest reserves are typically expected to be repaid in full according to the original contractual terms, some loans require one or more extensions beyond the original maturity.  Typically, these extensions are required due to construction delays, delays in sales or lease of property, or some combination of these two factors.

 

Loan Concentration

 

Most of the Company’s business activities are with customers located in the predominantly Asian areas of Southern and Northern California; New York City, New York; Dallas and Houston, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; Edison, New Jersey; Las Vegas, Nevada, and Hong Kong. The Company has no specific industry concentration, and generally its loans are collateralized with real property or other pledged collateral of the borrowers. Loans are generally expected to be paid off from the operating profits of the borrowers, refinancing by another lender, or through sale by the borrowers of the collateral. There were no loan concentrations to multiple borrowers in similar activities which exceeded 10% of total loans as of March 31, 2014, or as of December 31, 2013.

 

The federal banking regulatory agencies issued final guidance on December 6, 2006, regarding risk management practices for financial institutions with high or increasing concentrations of commercial real estate (“CRE”) loans on their balance sheets. The regulatory guidance reiterates the need for sound internal risk management practices for those institutions that have experienced rapid growth in CRE lending, have notable exposure to specific types of CRE, or are approaching or exceeding the supervisory criteria used to evaluate the CRE concentration risk, but the guidance is not to be construed as a limit for CRE exposure. The supervisory criteria are: (1) total reported loans for construction, land development, and other land represent 100% of the institution’s total risk-based capital, and (2) both total CRE loans represent 300% or more of the institution’s total risk-based capital and the institution’s CRE loan portfolio has increased 50% or more within the last thirty-nine months. Total loans for construction, land development, and other land represented 24% of the Bank’s total risk-based capital as of March 31, 2014, and 23% as of December 31, 2013. Total CRE loans represented 253% of total risk-based capital as of March 31, 2014, and 249% as of December 31, 2013 and were below the Bank’s internal limit for CRE loans of 300% of total capital at both dates.

 

Allowance for Credit Losses

 

The Bank maintains the allowance for credit losses at a level that is considered adequate to absorb the estimated and known risks in the loan portfolio and off-balance sheet unfunded credit commitments. Allowance for credit losses is comprised of the allowance for loan losses and the reserve for off-balance sheet unfunded credit commitments. With this risk management objective, the Bank’s management has an established monitoring system that 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.

 

 
47

 

 

In addition, the Bank’s Board of Directors has established a written credit policy that includes a credit review and control system which it believes should be effective in ensuring that the Bank maintains an adequate allowance for credit losses. The Board of Directors provides oversight for the allowance evaluation process, including quarterly evaluations, and determines whether the allowance is adequate to absorb losses in the credit portfolio. The determination of the amount of the allowance for credit losses and the provision for credit losses is based on management’s current judgment about the credit quality of the loan portfolio and takes into consideration known relevant internal and external factors that affect collectability when determining the appropriate level for the allowance for credit losses. The nature of the process by which the Bank determines the appropriate allowance for credit losses requires the exercise of considerable judgment. Additions to the allowance for credit losses are made by charges to the provision for credit losses. While management utilizes its best judgment based on the information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Bank’s control, including the performance of the Bank’s loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications. Identified credit exposures that are determined to be uncollectible are charged against the allowance for credit losses. Recoveries of previously charged off amounts, if any, are credited to the allowance for credit losses. A weakening of the economy or other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies, or defaults, and a higher level of non-performing assets, net charge-offs, and provision for credit losses in future periods.

 

The allowance for loan losses was $169.2 million and the allowance for off-balance sheet unfunded credit commitments was $1.7 million at March 31, 2014, which represented the amount believed by management to be sufficient to absorb credit losses inherent in the loan portfolio, including unfunded commitments. The allowance for credit losses, which is the sum of the allowances for loan losses and for off-balance sheet unfunded credit commitments, was $170.9 million at March 31, 2014, compared to $175.3 million at December 31, 2013, a decrease of $4.4 million, or 2.5%. The allowance for credit losses represented 2.06% of period-end gross loans and 239.4% of non-performing loans at March 31, 2014. The comparable ratios were 2.17% of period-end gross loans and 208.2% of non-performing loans at December 31, 2013.

 

 
48

 

 

The following table sets forth information relating to the allowance for loan losses, charge-offs, recoveries, and the reserve for off-balance sheet credit commitments for the periods indicated:

 

   

For the three months ended

 
   

March 31, 2014

   

March 31, 2013

   

December 31, 2013

 

Allowance for Loan Losses

 

(Dollars in thousands)

 

Balance at beginning of period

  $ 173,889     $ 183,322     $ 181,452  

Provision for credit losses

    -       -       -  

Transfers from/(to) reserve for off-balance sheet credit commitments

    (371 )     (1,942 )     711  

Charge-offs :

                       

Commercial loans

    (7,226 )     (2,690 )     (11,045 )

Real estate loans

    (1,776 )     (1,130 )     (626 )

Land loans

    -       (270 )     -  

Total charge-offs

    (9,002 )     (4,090 )     (11,671 )

Recoveries:

                       

Commercial loans

    2,017       955       724  

Construction loans-residential

    16       46       1  

Construction loans-other

    9       33       27  

Real estate loans

    2,577       359       1,749  

Land loans

    3       9       896  

Total recoveries

    4,622       1,402       3,397  
                         

Balance at end of period

  $ 169,138     $ 178,692     $ 173,889  

Reserve for off-balance sheet credit commitments

                       

Balance at beginning of period

  $ 1,362     $ 1,362     $ 2,074  

Provision/(reversal) for credit losses/transfers

    372       1,942       (712 )

Balance at end of period

  $ 1,734     $ 3,304     $ 1,362  
                         

Average loans outstanding during period ended

  $ 8,157,186     $ 7,386,866     $ 7,945,343  

Total gross loans outstanding, at period-end

  $ 8,302,282     $ 7,364,340     $ 8,084,563  

Total non-performing loans, at period-end

  $ 71,362     $ 101,129     $ 84,165  

Ratio of net charge-offs to average loans outstanding during the period

    0.22 %     0.15 %     0.42 %

Provision for loan losses to average loans outstanding during the period

    -       -       -  

Allowance for loan losses to non-performing loans at period-end

    237.01 %     176.70 %     206.60 %

Allowance for loan losses to gross loans at period-end

    2.04 %     2.43 %     2.15 %

 

Our allowance for loan losses consists of the following:

 

 

 • 

Specific allowance: For impaired loans, we provide specific allowances for loans that are not collateral dependent based on an evaluation of the present value of the expected future cash flows discounted at the loan’s effective interest rate and for loans that are collateral dependent based on the fair value of the underlying collateral determined by the most recent valuation information received, which may be adjusted based on factors such as changes in market conditions from the time of valuation. If the measure of the impaired loan is less than the recorded investment in the loan, the deficiency will be charged off against the allowance for loan losses or, alternatively, a specific allocation will be established.

 

 

General allowance: The unclassified portfolio is segmented on a group basis. Segmentation is determined by loan type and common risk characteristics. The non-impaired loans are grouped into 23 segments: two commercial segments, ten commercial real estate segments, three residential construction segments, three non-residential construction segments, one SBA segment, one installment loans segment, one residential mortgage segment, one equity lines of credit segment, and one overdrafts segment. The allowance is provided for each segmented group based on the group’s historical loan loss experience aggregated based on loan risk classifications which takes into account the current financial condition of the borrowers and guarantors, the prevailing value of the underlying collateral if collateral dependent, charge-off history, management’s knowledge of the portfolio, general economic conditions, environmental factors including the trends in delinquency and non-accrual, and other significant factors, such as the national and local economy, volume and composition of the portfolio, strength of management and loan staff, underwriting standards, and concentration of credit. In addition, management reviews reports on past-due loans to ensure appropriate classification.

 

 
49

 

 

The table set forth below reflects management’s allocation of the allowance for loan losses by loan category and the ratio of each loan category to the total average loans as of the dates indicated:

 

(Dollars in thousands)

 

March 31, 2014

   

December 31, 2013

 
           

Percentage of

           

Percentage of

 
           

Loans in Each

           

Loans in Each

 
           

Category

           

Category

 
           

to Average

           

to Average

 

Type of Loan:

 

Amount

   

Gross Loans

   

Amount

   

Gross Loans

 

Commercial loans

  $ 64,782       27.7 %   $ 65,103       28.2 %

Residential mortgage loans (1)

    12,377       19.2       12,005       18.6  

Commercial mortgage loans

    81,326       50.0       84,753       50.7  

Real estate construction loans

    10,626       2.9       11,999       2.3  

Installment and other loans

    27       0.2       29       0.2  

Total

  $ 169,138       100 %   $ 173,889       100 %

 

(1) Residential mortgage loans includes equity lines.

  

The allowance allocated to commercial loans was $64.8 million at March 31, 2014, compared to $65.1 million at December 31, 2013. The decrease is due primarily to decreases in commercial loans from $2.3 billion at December 31, 2013, to $2.2 billion at March 31, 2014.

 

The allowance allocated to commercial mortgage loans decreased from $84.8 million at December 31, 2013, to $81.3 million at March 31, 2014, which was due primarily to decreases in loss experience from commercial mortgage loans and to the net recoveries of $0.9 million during the first quarter of 2014. The overall allowance for total commercial mortgage loans was 1.9% at March 31, 2014, and 2.1% at December 31, 2013.

 

The allowance allocated for construction loans decreased to $10.6 million, or 4.2%, of construction loans at March 31, 2014, compared to $12.0 million, or 5.4%, of construction loans at December 31, 2013, primarily due to decreases in loss experience from construction loans which are evaluated on a collective basis.

 

Deposits

 

Total deposits were $8.23 billion at March 31, 2014, an increase of $251.3 million, or 3.1%, from $7.98 billion at December 31, 2013, primarily due to a $145.1 million, or 15.6%, increase in time deposits under $100,000, a $50.8 million, or 1.6%, increase in time deposits of $100,000 or more, a $46.9 million, or 3.3%, increase in non-interest bearing demand deposits, and a $24.4 million, or 4.9%, increase in saving deposits, offset by a $24.9 million, or 1.9%, decrease in money market deposits. 

 

 
50

 

 

The following table displays the deposit mix as of the dates indicated:

 

   

March 31, 2014

   

% of Total

   

December 31, 2013

   

% of Total

 

Deposits

 

(Dollars in thousands)

 

Non-interest-bearing demand deposits

  $ 1,488,720       18.1 %   $ 1,441,858       18.1 %

NOW deposits

    692,925       8.4       683,873       8.6  

Money market deposits

    1,261,419       15.3       1,286,338       16.1  

Savings deposits

    523,950       6.4       499,520       6.2  

Time deposits under $100,000

    1,076,329       13.1       931,204       11.7  

Time deposits of $100,000 or more

    3,189,282       38.7       3,138,512       39.3  

Total deposits

  $ 8,232,625       100.0 %   $ 7,981,305       100.0 %

 

Borrowings

 

Borrowings include federal funds purchased, securities sold under agreements to repurchase, funds obtained as advances from the Federal Home Loan Bank (“FHLB”) of San Francisco, and borrowings from other financial institutions.

 

Securities sold under agreements to repurchase were $700.0 million with a weighted average rate of 3.92% at March 31, 2014, compared to $800.0 million with a weighted average rate of 3.87% at December 31, 2013. In the first quarter of 2014, the Company prepaid securities sold under agreements to repurchase totaling $100 million with a weighted average rate of 3.50% and incurred prepayment penalties of $3.4 million. In 2013, the Company prepaid securities sold under agreements to repurchase totaling $450 million with a weighted average rate of 3.79% and incurred prepayment penalties of $22.6 million. Five floating-to-fixed rate agreements totaling $300.0 million have initial floating rates for a period of time ranging from six months to one year, with floating rates ranging from the three-month LIBOR rate minus 200 basis points to the three-month LIBOR rate minus 340 basis points. Thereafter, the rates are fixed for the remainder of the term, with interest rates ranging from 4.78% to 5.07%. After the initial floating rate term, the counter parties have the right to terminate the transaction at par at the fixed rate reset date and quarterly thereafter. Four fixed-to-floating rate agreements totaling $200.0 million have initial fixed rates ranging from 1.00% to 3.50% with initial fixed rate terms ranging from six months to 18 months. For the remaining term, the rates float at 8% minus the three-month LIBOR rate with a maximum rate ranging from 3.50% to 3.75% and a minimum rate of 0.0%. After the initial fixed rate term, the counter parties have the right to terminate the transaction at par at the floating rate reset date and quarterly thereafter. The table below provides summary data for the $500 million of callable securities sold under agreements to repurchase as of March 31, 2014:

  

(Dollars in millions)

 

Fixed-to-floating

   

Floating-to-fixed

   

Total

 

Rate type

 

Float Rate

   

Fixed Rate

         

Rate index

 

8% minus 3 month LIBOR

                         

Maximum rate

    3.75 %     3.50 %     3.50 %                        

Minimum rate

    0.0 %     0.0 %     0.0 %                        

No. of agreements

    1       2       1       1       4       9  

Amount

  $ 50.0     $ 100.0     $ 50.0     $ 100.0     $ 200.0     $ 500.0  

Weighted average rate

    3.75 %     3.50 %     3.50 %     4.78 %     5.00 %     4.38 %

Final maturity

 

2014

   

2014

   

2015

   

2014

   

2017

         

 

 
51

 

  

The table below provides summary data for non-callable fixed rate securities sold under agreements to repurchase as of March 31, 2014:

 

   

No. of

   

Amount

   

Weighted Average

 

Maturity

 

Agreements

   

(In thousands)

   

Interest Rate

 

1 year to 3 years

    1     $ 50,000       2.69 %

3 years to 5 years

    3       150,000       2.81 %

Total

    4     $ 200,000       2.78 %

 

These transactions are accounted for as collateralized financing transactions and recorded at the amounts at which the securities were sold. The Company may have to provide additional collateral for the repurchase agreements, as necessary. The underlying collateral pledged for the repurchase agreements consists of U.S. Treasury securities, U.S. government agency securities, and mortgage-backed securities with a fair value of $808.0 million as of March 31, 2014, and $906.1 million as of December 31, 2013.

 

Advances from the FHLB were $636.2 million with weighted average rate of 0.30% at March 31, 2014, compared to $521.2 million with weighted average rate of 0.17% at December 31, 2013. The following relates to the outstanding advances at March 31, 2014, and December 31, 2013:

 

   

March 31, 2014

   

December 31, 2013

 
   

Amount

   

Weighted Average

   

Amount

   

Weighted Average

 

Maturity

 

(In thousands)

   

Interest Rate

   

(In thousands)

   

Interest Rate

 

Within 90 days

  $ 490,000       0.11 %   $ 475,000       0.06 %

1 - 3 years

    100,000       1.01 %     -       -  

4 - 5 years

    46,200       1.24 %     46,200       1.24 %
    $ 636,200       0.30 %   $ 521,200       0.17 %

 

Long-term Debt

 

Long-term debt was $121.1 million at March 31, 2014, compared to $121.1 million at December 31, 2013. Long-term debt is comprised of Junior Subordinated Notes, which qualifies as Tier I capital for regulatory purposes, issued in connection with our various pooled trust preferred securities offerings.

 

 
52

 

 

Off-Balance-Sheet Arrangements and Contractual Obligations

 

The following table summarizes the Company’s contractual obligations to make future payments as of March 31, 2014. Payments for deposits and borrowings do not include interest. Payments related to leases are based on actual payments specified in the underlying contracts.

 

   

Payment Due by Period

 
           

More than

   

3 years or

                 
           

1 year but

   

more but

                 
   

1 year

   

less than

   

less than

   

5 years

         
   

or less

   

3 years

   

5 years

   

or more

   

Total

 
   

(In thousands)

 
                                         

Contractual obligations:

                                       

Deposits with stated maturity dates

  $ 3,560,858     $ 457,579     $ 247,163     $ 11     $ 4,265,611  

Securities sold under agreements to repurchase (1)

    300,000       200,000       -       -       500,000  

Securities sold under agreements to repurchase (2)

    -       50,000       150,000       -       200,000  

Advances from the Federal Home Loan Bank

    490,000       100,000       46,200       -       636,200  

Other borrowings

    -       -       -       19,025       19,025  

Long-term debt

    -       -       -       121,136       121,136  

Operating leases

    5,826       7,741       3,858       3,276       20,701  

Total contractual obligations and other commitments

  $ 4,306,685     $ 665,320     $ 647,221     $ 143,448     $ 5,762,674  

 

(1) These repurchase agreements have a final maturity of 5-years, 7-years and 10-years from origination date but are callable

      on a quarterly basis after six months, one year, or 18 months for the 7-year term and one year for the 5-year and 10-year terms.

(2) These repurchase agreements are non-callable.

 

In the normal course of business, we enter into various transactions, which, in accordance with U.S. generally accepted accounting principles, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the condensed consolidated balance sheets.

 

Loan Commitments. We enter into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for credit losses.

 

Standby Letters of Credit. Standby letters of credit are written conditional commitments issued by us to secure the obligations of a customer to a third party. In the event the customer does not perform in accordance with the terms of an agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek reimbursement from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

 

 
53

 

 

Capital Resources

 

Total equity was $1.49 billion at March 31, 2014, an increase of $35.4 million, or 2.4%, from $1.46 billion at December 31, 2013, primarily due to increases in net income of $31.3 million and decreases in unrealized losses on securities available for sale of $7.6 million offset by common stock cash dividends of $4.0 million.

 

The following table summarizes changes in total equity for the three months ended March 31, 2014:

 

   

Three months ended

 

(In thousands)

 

March 31, 2014

 

Net income

  $ 31,259  

Stock issued to directors

    350  

Proceeds from shares issued through the Dividend Reinvestment Plan

    386  

Net tax short-fall from stock-based compensation expense

    (1,227 )

Share-based compensation

    1,003  

Other comprehensive income

    7,639  

Cash dividends paid to common stockholders

    (3,980 )

Net increase in total equity

  $ 35,430  

 

Capital Adequacy Review

 

Management seeks to maintain the Company’s capital at a level sufficient to support future growth, protect depositors and stockholders, and comply with various regulatory requirements.

 

Both the Bancorp’s and the Bank’s regulatory capital continued to exceed the regulatory minimum requirements as of March 31, 2014. In addition, the capital ratios of the Bank place it in the “well capitalized” category which is defined as institutions with a Tier 1 risk-based capital ratio equal to or greater than 6.0%, total risk-based capital ratio equal to or greater than 10.0%, and Tier 1 leverage capital ratio equal to or greater than 5.0%.

 

 
54

 

 

The following table presents Bancorp’s and the Bank’s capital and leverage ratios as of March 31, 2014, and December 31, 2013:

 

   

Cathay General Bancorp

   

Cathay Bank

 
   

March 31, 2014

   

December 31, 2013

   

March 31, 2014

   

December 31, 2013

 

(Dollars in thousands)

 

Balance

   

%

   

Balance

   

%

   

Balance

   

%

   

Balance

   

%

 
                                                                 

Tier 1 capital (to risk-weighted assets)

  $ 1,317,017       14.96     $ 1,288,892       15.04     $ 1,277,119       14.51     $ 1,244,480       14.53  

Tier 1 capital minimum requirement

    352,144       4.00       342,899       4.00       351,991       4.00       342,701       4.00  

Excess

  $ 964,873       10.96     $ 945,993       11.04     $ 925,128       10.51     $ 901,779       10.53  
                                                                 

Total capital (to risk-weighted assets)

  $ 1,433,451       16.28     $ 1,401,319       16.35     $ 1,387,867       15.77     $ 1,352,415       15.79  

Total capital minimum requirement

    704,289       8.00       685,799       8.00       703,982       8.00       685,402       8.00  

Excess

  $ 729,162       8.28     $ 715,520       8.35     $ 683,885       7.77     $ 667,013       7.79  
                                                                 

Tier 1 capital (to average assets) – Leverage ratio

  $ 1,317,017       12.70     $ 1,288,892       12.48     $ 1,277,119       12.32     $ 1,244,480       12.06  

Minimum leverage requirement

    414,650       4.00       413,158       4.00       414,562       4.00       412,815       4.00  

Excess

  $ 902,367       8.70     $ 875,734       8.48     $ 862,557       8.32     $ 831,665       8.06  
                                                                 

Risk-weighted assets

  $ 8,803,607             $ 8,572,487             $ 8,799,770             $ 8,567,523          

Total average assets (1)

  $ 10,366,258             $ 10,328,952             $ 10,364,053             $ 10,320,368          

 

(1) The quarterly total average assets reflect all debt securities at amortized cost, equity security with readily determinable

      fair values at the lower of cost or fair value, and equity securities without readily determinable fair values at historical cost.

 

In July 2013, the federal bank regulatory agencies adopted final regulations which revised their risk-based and leverage capital requirements for banking organizations to meet requirements of the Dodd-Frank Act and to implement international agreements reached by the Basel Committee on Banking Supervision that were intended to improve both the quality and quantity of banking organizations’ capital (“Basel III”). Although many of the rules contained in these final regulations are applicable only to large, internationally active banks, some of them will apply on a phased in basis to all banking organizations, including the Company and the Bank.

 

The following are among the new requirements that will be phased in beginning January 1, 2015:

 

 

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

 

 

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

 

 

A minimum non-risk-based leverage ratio is set at 4.00% eliminating a 3.00% exception for higher rated banks.

 

 

Changes in the permitted composition of Tier 1 capital to exclude trust preferred securities, mortgage servicing rights and certain deferred tax assets and include unrealized gains and losses on available for sale debt and equity securities.

 

 

A new additional capital conservation buffer of 2.5% of risk weighted assets over each of the required capital ratios that will be phased in from 2016 to 2019 must be met to avoid limitations in the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses.

 

 

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

 

 

An additional “countercyclical capital buffer” is required for larger and more complex institutions.

 

 
55

 

 

Management believes that, as of March 31, 2014, Bancorp and the Bank would meet all capital adequacy requirements under the Basel III rules on a fully phased-in basis as if such requirements were currently in effect.

 

Dividend Policy

 

Holders of common stock are entitled to dividends as and when declared by our Board of Directors out of funds legally available for the payment of dividends. Although we have historically paid cash dividends on our common stock, we are not required to do so. The amount of future dividends will depend on our earnings, financial condition, capital requirements and other factors, and will be determined by our Board of Directors. As discussed in “Regulatory Matters” below, we are subject to Federal Reserve supervisory policies, including informing and consulting with the Federal Reserve Bank of San Francisco sufficiently in advance of any planned capital actions (i.e. increased dividend payments or stock redemptions) and we have notified the Federal Reserve Bank of San Francisco that our Board of Directors expects to increase the common stock dividend to $.07 per share during the second quarter. There can be no assurance that our regulators will not object to any capital actions. The terms of our Junior Subordinated Notes also limit our ability to pay dividends.

 

The Company declared cash dividends of $.05 per share on 79,595,528 shares outstanding on March 3, 2014, for distribution to holders of our common stock on March 13, 2014. Total cash dividends of $4.0 million were paid during the first quarter of 2014.

 

Country Risk Exposures

 

The Company’s total assets were $11.3 billion and total foreign country risk net exposures were $923.7 million at March 31, 2014. Total foreign country risk net exposures at March 31, 2014, were comprised primarily of $372.7 million from Hong Kong, $181.3 million from England, $143.7 million from China, $44.2 million from France, $39.6 million from Switzerland, $30.1 million from Australia, $28.8 million from Korea, $21.2 million from Taiwan, $19.4 million from Japan, $17.1 million from the Philippines, $14.1 million from Canada, and $9.5 million from Singapore. Risk is determined based on location of the borrowers, issuers, and counter parties.

 

All foreign country risk net exposures were to non-sovereign counter parties except $9.2 million due from the Hong Kong Monetary Authority at March 31, 2014.

 

Unfunded loan exposures were $79.3 million at March 31, 2014, and were comprised primarily of $43.9 million unfunded loans to borrowers of Hong Kong residence, $22.2 million unfunded loans to two financial institution in China, $5.6 million unfunded loans to borrowers of Taiwan residence, $4.3 million unfunded loans to borrowers of China residence, and $2.7 million unfunded loans to borrowers of Philippines residence.

 

 
56

 

 

Financial Derivatives

 

It is the policy of the Company not to speculate on the future direction of interest rates. However, the Company enters into financial derivatives in order to seek mitigation of exposure to interest rate risks related to our interest-earning assets and interest-bearing liabilities. We believe that these transactions, when properly structured and managed, may provide a hedge against inherent interest rate risk in the Company’s assets or liabilities and against risk in specific transactions. In such instances, the Company may protect its position through the purchase or sale of interest rate futures contracts for a specific cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, floors, financial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, we seek to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bank’s Investment Committee.

 

The Company follows ASC Topic 815 which established accounting and reporting standards for financial derivatives, including certain financial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all financial derivatives as assets or liabilities in the Company’s condensed consolidated balance sheets and measurement of those financial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a financial derivative is designated as a hedge and, if so, the type of hedge.

 

The Company enters into foreign exchange forward contracts and foreign currency option contracts with various counter parties to mitigate the risk of fluctuations in foreign currency exchange rates for foreign exchange certificates of deposit, foreign exchange contracts, or foreign currency option contracts entered into with our clients. These contracts are not designated as hedging instruments and are recorded at fair value in our condensed consolidated balance sheets. Changes in the fair value of these contracts as well as the related foreign exchange certificates of deposit, foreign exchange contracts, or foreign currency option contracts are recognized immediately in net income as a component of non-interest income. Period end gross positive fair values are recorded in other assets and gross negative fair values are recorded in other liabilities. At March 31, 2014, the notional amount of option contracts totaled $1.2 million with a net positive fair value of $1,000. Spot and forward contracts in the total notional amount of $270.7 million had a positive fair value of $5.1 million at March 31, 2014. Spot and forward contracts in the total notional amount of $227.7 million had a negative fair value of $3.3 million at March 31, 2014. At December 31, 2013, the notional amount of option contracts totaled $200,000 with a net positive fair value of $83. Spot and forward contracts in the total notional amount of $267.6 million had a positive fair value of $6.2 million at December 31, 2013. Spot and forward contracts in the total notional amount of $236.3 million had a negative fair value of $6.1 million at December 31, 2013.

 

Liquidity

 

Liquidity is our ability to maintain sufficient cash flow to meet maturing financial obligations and customer credit needs, and to take advantage of investment opportunities as they are presented in the marketplace. Our principal sources of liquidity are growth in deposits, proceeds from the maturity or sale of securities and other financial instruments, repayments from securities and loans, federal funds purchased, securities sold under agreements to repurchase, and advances from the FHLB. At March 31, 2014, our liquidity ratio (defined as net cash plus short-term and marketable securities to net deposits and short-term liabilities) was 16.5% compared to 15.3% at December 31, 2013.

 

 
57

 

 

The Bank is a shareholder of the FHLB of San Francisco, enabling it to have access to lower cost FHLB financing when necessary. As of March 31, 2014, the Bank had an approved credit line with the FHLB totaling $3.46 billion. Advances from the FHLB were $636.2 million at March 31, 2014. The Bank expects to be able to access this source of funding, if required, in the near term. The Bank has pledged a portion of its commercial loans to the Federal Reserve Bank’s Discount Window under the Borrower-in-Custody program to secure these borrowings. At March 31, 2014, the borrowing capacity under the Borrower-in-Custody program was $92.7 million.

 

Liquidity can also be provided through the sale of liquid assets, which consist of federal funds sold, securities sold under agreements to repurchase, and unpledged investment securities. At March 31, 2014, investment securities and trading securities totaled $1.58 billion, with $853.6 million pledged as collateral for borrowings and other commitments. The remaining $725.3 million was available as additional liquidity or to be pledged as collateral for additional borrowings.

 

Approximately 83.5% of the Company’s time deposits mature within one year or less as of March 31, 2014. Management anticipates that there may be some outflow of these deposits upon maturity due to the keen competition in the Bank’s marketplace. However, based on our historical run-off experience, we expect that the outflow will be minimal and can be replenished through our normal growth in deposits. Management believes the above-mentioned sources will provide adequate liquidity to the Bank to meet its daily operating needs.

 

The business activities of Bancorp consist primarily of the operation of the Bank and limited activities in other investments. Under the memorandum of understanding Bancorp entered into with the Federal Reserve Bank of San Francisco (“FRB SF”), which was terminated effective April 5, 2013, we agreed that we would not, without the FRB SF’s prior written approval, receive any dividends or any other form of payment or distribution representing a reduction of capital from the Bank. The Bank paid dividends to Bancorp totaling $138.0 million during 2013. The Bank did not pay dividends to Bancorp in the first quarter of 2014.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We use a net interest income simulation model to measure the extent of the differences in the behavior of the lending and funding rates to changing interest rates, so as to project future earnings or market values under alternative interest rate scenarios. Interest rate risk arises primarily through the Company’s traditional business activities of extending loans and accepting deposits. Many factors, including economic and financial conditions, movements in interest rates, and consumer preferences affect the spread between interest earned on assets and interest paid on liabilities. The net interest income simulation model is designed to measure the volatility of net interest income and net portfolio value, defined as net present value of assets and liabilities, under immediate rising or falling interest rate scenarios in 100 basis point increments.

 

Although the modeling is very helpful in managing interest rate risk, it does require significant assumptions for the projection of loan prepayment rates on mortgage related assets, loan volumes and pricing, and deposit and borrowing volume and pricing, that might prove inaccurate. Because these assumptions are inherently uncertain, the model cannot precisely estimate net interest income, or precisely predict the effect of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the differences between actual experience and the assumed volume, changes in market conditions, and management strategies, among other factors. The Company monitors its interest rate sensitivity and attempts to reduce the risk of a significant decrease in net interest income caused by a change in interest rates.

 

 
58

 

 

We have established a tolerance level in our policy to define and limit net interest income volatility to a change of plus or minus 15% when the hypothetical rate change is plus or minus 200 basis points. When the net interest rate simulation projects that our tolerance level will be met or exceeded, we seek corrective action after considering, among other things, market conditions, customer reaction, and the estimated impact on profitability. The Company’s simulation model also projects the net economic value of our portfolio of assets and liabilities. We have established a tolerance level in our policy to value the net economic value of our portfolio of assets and liabilities to a change of plus or minus 15% when the hypothetical rate change is plus or minus 200 basis points.

 

The table below shows the estimated impact of changes in interest rate on net interest income and market value of equity as of March 31, 2014:

 

 

         

Net Interest

   

Market Value

 
         

Income

   

of Equity

 
 

Change in Interest Rate (Basis Points)

   

Volatility (1)

   

Volatility (2)

 
 

+200

      11.1       (6.7
 

+100

      5.7       (2.9
    -100            (1.0 )     0.0  
    -200            (1.6 )     1.6  

 

(1) The percentage change in this column represents net interest income of the Company for 12 months

      in a stable interest rate environment versus the net interest income in the various rate scenarios.

(2) The percentage change in this column represents net portfolio value of the Company in a stable

      interest rate environment versus the net portfolio value in the various rate scenarios.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report. Based upon their evaluation, the principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

There has not been any change in our internal control over financial reporting that occurred during the first fiscal quarter of 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 
59

 

 

PART II - OTHER INFORMATION

 

ITEM 1.     LEGAL PROCEEDINGS.

 

Bancorp’s wholly-owned subsidiary, Cathay Bank, is a party to ordinary routine litigation from time to time incidental to various aspects of its operations. Management does not believe that any such litigation is expected to have a material adverse impact on the Company’s consolidated financial condition or results of operations.

 

ITEM 1A.     RISK FACTORS.

 

There is no material change in the risk factors as previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, in response to Item 1A in Part I of Form 10-K.

 

ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

ISSUER PURCHASES OF EQUITY SECURITIES

Period

(a) Total Number of Shares (or Units) Purchased

(b) Average Price Paid per Share (or Unit)

(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs

(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs

Month #1 (January 1, 2014 - January 31, 2014)

0

$0

0

622,500

Month #2 (February 1, 2014 - February 28, 2014)

0

$0

0

622,500

Month #3 (March 1, 2014 - March 31, 2014)

0

$0

0

622,500

Total

0

$0

0

622,500

 

For a discussion of limitations on the payment of dividends, see “Dividend Policy,” and “Liquidity” under Part I—Item 2—“Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

 
60

 

 

ITEM 3.     DEFAULTS UPON SENIOR SECURITIES.

 

Not applicable.

 

ITEM 4.     MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5.     OTHER INFORMATION.

 

None.

 

ITEM 6.     EXHIBITS.

 

 

(i)

Exhibit 31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

(ii)

Exhibit 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

(iii)

Exhibit 32.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

(iv)

Exhibit 32.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

(v)

Exhibit 101.INS XBRL Instance Document *

 

 

(vi)

Exhibit 101.SCH XBRL Taxonomy Extension Schema Document*

 

 

(vii)

Exhibit 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document*

 

 

(viii)

Exhibit 101.DEF XBRL Taxonomy Extension Definition Linkbase Document*

 

 

(ix)

Exhibit 101.LAB XBRL Taxonomy Extension Label Linkbase Document*

 

 

(x)

Exhibit 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document*

 

____________________

* XBRL (Extensible Business Reporting Language) information shall not be deemed to be filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, shall not be deemed to be filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise shall not be subject to liability under these sections, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, except as expressly set forth by specific reference in such filing.

 

 
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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

Cathay General Bancorp

(Registrant)

 

       
Date: May 8, 2014      
       

 

 

 

 

 

 

/s/ Dunson K. Cheng

 

 

 

Dunson K. Cheng

Chairman, President, and

Chief Executive Officer

 

 

Date: May 8, 2014      
       

 

 

 

 

 

 

/s/ Heng W. Chen

 

 

 

Heng W. Chen

Executive Vice President and

Chief Financial Officer

 

 

 

62