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CATHAY GENERAL BANCORP - Quarter Report: 2019 September (Form 10-Q)

caty20190930_10q.htm
 

 

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 UNITED STATES

securities and exchange commission

Washington, D.C. 20549

 

FORM 10-Q

 

[ X ]      quarterly report pursuant to section 13 or 15(d) of THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended  September 30, 2019

OR

[     ]     transition report pursuant to section 13 or 15 (d) of the SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                                                                  to                                                                    

Commission file number 001-31830
Cathay General Bancorp 
(Exact name of registrant as specified in its charter)

 Delaware

 

95-4274680

(State of other jurisdiction of incorporation

 

(I.R.S. Employer

or organization)

 

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)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock

CATY

Nasdaq Global Select Market

 

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 every Interactive Data File required to be submitted 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 such files).

Yes ☑          No ☐

 

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

 

Large accelerated filer ☑                                  

  Accelerated filer ☐  

Non-accelerated filer      ☐                               

  Smaller reporting company ☐  

Emerging growth company ☐

     

 

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

 

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

 

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, 79,706,517 shares outstanding as of October 31, 2019.

 

 

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CATHAY GENERAL BANCORP AND SUBSIDIARies

3Rd quarter 2019 REPORT ON FORM 10-Q

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PART I – FINANCIAL INFORMATION

3

 

 

 

Item 1.

FINANCIAL STATEMENTS (Unaudited)

3

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

8

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS

42

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

66

Item 4.

CONTROLS AND PROCEDURES

67

 

 

 

PART II  – OTHER INFORMATION

67

 

 

 

Item 1.

LEGAL PROCEEDINGS

67

Item 1A.

RISK FACTORS

68

Item 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

68

Item 3.

DEFAULTS UPON SENIOR SECURITIES

69

Item 4.

MINE SAFETY DISCLOSURES

69

Item 5.

OTHER INFORMATION

69

Item 6.

EXHIBITS

69

 

 

 

 

 

 

SIGNATURES

70

 

 

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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, loan and deposit growth, investment and expenditure plans, financing needs and availability, level of nonperforming assets, 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, uncertainties and other factors that could cause actual results to differ materially from our historical experience and our present expectations or projections. Such risks, uncertainties and other factors include, but are not limited to:

 

 

U.S. and international business, economic and market 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 laws and regulations;

 

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;

 

our ability to attract deposits and other sources of funding or liquidity;

 

fluctuations in interest rates;

 

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

 

our ability to realize returns on our loans, investments and financings, including in tax-advantaged projects;

 

inflation and deflation;

 

environmental liabilities;

 

our ability to compete with larger competitors;

 

our ability to retain key personnel;

 

successful management of reputational risk;

 

natural disasters and geopolitical events;

 

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general business, economic and market conditions in the local markets where the Bank has operations;

 

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

 

our ability to adapt our systems to the expanding use of technology in banking;

 

risk management processes and strategies;

 

adverse results in legal proceedings;

 

the impact of regulatory enforcement actions, if any;

 

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;

 

fluctuations in the Bancorp’s stock price;

 

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

 

issuances of preferred stock;

 

capital level requirements and 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, 2018 (Item 1A in particular), other reports and registration statements filed with the Securities and Exchange Commission (“SEC”), and other filings Bancorp 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. We have no intention and undertake no obligation to update any forward-looking statement or to announce publicly any revision of any forward-looking statement to reflect developments, events, occurrences or circumstances after the date of such statement, 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) 279-3296.

 

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PART I – FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS (Unaudited)

 

CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

   

September 30, 2019

   

December 31, 2018

 
   

(In thousands, except share and per share data)

 

Assets

               

Cash and due from banks

  $ 257,189     $ 225,333  

Short-term investments and interest-bearing deposits

    567,957       374,957  

Securities available-for-sale (amortized cost of $1,422,431 at September 30, 2019 and $1,267,731 at December 31, 2018)

    1,427,438       1,242,509  

Loans held for sale

    36,778        

Loans

    14,728,554       13,995,788  

Less: Allowance for loan losses

    (125,908 )     (122,391 )

Unamortized deferred loan fees, net

    (1,081 )     (1,565 )

Loans, net

    14,601,565       13,871,832  

Equity securities

    32,862       25,098  

Federal Home Loan Bank stock

    17,250       17,250  

Other real estate owned, net

    11,329       12,674  

Affordable housing investments and alternative energy partnerships, net

    321,929       282,734  

Premises and equipment, net

    103,820       103,189  

Customers’ liability on acceptances

    12,503       22,709  

Accrued interest receivable

    52,337       51,650  

Goodwill

    372,189       372,189  

Other intangible assets, net

    6,821       7,194  

Right-of-use assets - operating leases

    34,518        

Other assets

    148,481       175,419  

Total assets

  $ 18,004,966     $ 16,784,737  
                 

Liabilities

               

Deposits:

               

Non-interest-bearing demand deposits

  $ 2,939,924     $ 2,857,443  

Interest-bearing deposits:

               

NOW deposits

    1,282,267       1,365,763  

Money market deposits

    2,095,328       2,027,404  

Savings deposits

    721,547       738,656  

Time deposits

    7,619,203       6,713,074  

Total deposits

    14,658,269       13,702,340  

Advances from the Federal Home Loan Bank

    600,000       530,000  

Other borrowings of affordable housing investments

    30,767       17,298  

Long-term debt

    160,386       189,448  

Deferred payments from acquisition

    7,602       18,458  

Acceptances outstanding

    12,503       22,709  

Lease liabilities - operating leases

    36,142        

Other liabilities

    253,403       182,618  

Total liabilities

    15,759,072       14,662,871  

Commitments and contingencies

           

Stockholders’ Equity

               

Common stock, $0.01 par value, 100,000,000 shares authorized; 90,041,474 issued and 79,706,511 outstanding at September 30, 2019, and 89,826,317 issued and 80,501,948 outstanding at December 31, 2018

    900       898  

Additional paid-in-capital

    947,880       942,062  

Accumulated other comprehensive loss, net

    (833 )     (18,006 )

Retained earnings

    1,616,485       1,479,149  

Treasury stock, at cost (10,334,963 shares at September 30, 2019, and 9,324,369 shares at December 31, 2018)

    (318,538 )     (282,237 )

Total equity

    2,245,894       2,121,866  

Total liabilities and equity

  $ 18,004,966     $ 16,784,737  

 

See accompanying Notes to 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 September 30,

   

Nine months ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands, except share and per share data)

 

Interest and Dividend Income

                               

Loans receivable, including loan fees

  $ 187,827     $ 168,179     $ 548,395     $ 478,128  

Investment securities

    8,687       7,546       24,454       21,212  

Federal Home Loan Bank stock

    301       303       903       1,079  

Deposits with banks

    1,016       838       4,289       3,667  

Total interest and dividend income

    197,831       176,866       578,041       504,086  
                                 

Interest Expense

                               

Time deposits

    40,378       22,135       113,992       56,593  

Other deposits

    6,626       5,474       17,591       14,892  

Securities sold under agreements to repurchase

          124             1,446  

Advances from Federal Home Loan Bank

    1,661       1,430       5,976       3,286  

Long-term debt

    1,948       2,220       6,087       6,465  

Deferred payments from acquisition

    93       399       502       946  

Short-term borrowings

    125             198        

Total interest expense

    50,831       31,782       144,346       83,628  
                                 

Net interest income before reversal for credit losses

    147,000       145,084       433,695       420,458  

Reversal for credit losses

    (2,000 )     (1,500 )     (2,000 )     (4,500 )

Net interest income after reversal for credit losses

    149,000       146,584       435,695       424,958  
                                 

Non-Interest Income

                               

Net gains/(losses) from equity securities

    364       391       7,764       (4,580 )

Securities losses, net

    (121 )     (14 )     (108 )     (14 )

Letters of credit commissions

    1,602       1,459       4,733       4,110  

Depository service fees

    1,119       1,219       3,617       3,905  

Gain from acquisition

                      340  

Other operating income

    7,424       4,780       20,097       17,151  

Total non-interest income

    10,388       7,835       36,103       20,912  
                                 

Non-Interest Expense

                               

Salaries and employee benefits

    31,915       30,514       97,200       91,491  

Occupancy expense

    5,579       5,186       16,617       15,808  

Computer and equipment expense

    2,741       2,772       8,453       8,477  

Professional services expense

    5,952       5,286       17,209       17,055  

Data processing service expense

    3,246       3,080       9,737       9,450  

FDIC and regulatory assessments

    2,582       2,555       7,190       6,732  

Marketing expense

    2,436       1,263       5,556       5,521  

Other real estate owned expense/(income)

    190       (21 )     839       (236 )

Amortization of investments in low income housing and alternative energy partnerships

    6,997       11,115       26,909       21,989  

Amortization of core deposit intangibles

    172       190       515       704  

Acquisition and integration costs

          179             2,083  

Other operating expense

    3,770       3,845       15,871       10,949  

Total non-interest expense

    65,580       65,964       206,096       190,023  
                                 

Income before income tax expense

    93,808       88,455       265,702       255,847  

Income tax expense

    20,973       18,698       53,944       48,610  

Net income

  $ 72,835     $ 69,757     $ 211,758     $ 207,237  
                                 

Other Comprehensive Income, net of tax

                               

Unrealized holding gains/(losses) on securities available-for-sale

    1,233       (2,538 )     21,216       (16,803 )

Unrealized holding (losses)/gains on cash flow hedge derivatives

    (793 )     1,666       (4,119 )     4,595  

Less: reclassification adjustments for losses included in net income

    (85 )     (10 )     (76 )     (10 )

Total other comprehensive gain/(loss), net of tax

    525       (862 )     17,173       (12,198 )

Total other comprehensive income

  $ 73,360     $ 68,895     $ 228,931     $ 195,039  
                                 

Net Income Per Common Share:

                               

Basic

  $ 0.91     $ 0.86     $ 2.64     $ 2.55  

Diluted

  $ 0.91     $ 0.85     $ 2.64     $ 2.53  

Cash dividends paid per common share

  $ 0.31     $ 0.24     $ 0.93     $ 0.72  

Average Common Shares Outstanding:

                               

Basic

    79,736,814       81,311,899       80,096,855       81,224,555  

Diluted

    79,993,830       81,855,271       80,330,616       81,770,874  

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

                           

Accumulated

                         
   

Common Stock

   

Additional

   

Other

                   

Total

 
   

Number of

           

Paid-in

   

Comprehensive

   

Retained

   

Treasury

   

Stockholders'

 

Three months ended

 

Shares

   

Amount

   

Capital

   

Loss

   

Earnings

   

Stock

   

Equity

 
   

(In thousands, except share data)

 

Balance at June 30, 2019

    79,818,003     $ 900     $ 945,250     $ (1,358 )   $ 1,568,351     $ (313,846 )   $ 2,199,297  

Dividend Reinvestment Plan

    23,508             841                         841  

Purchases of treasury stock

    (135,000 )                             (4,692 )     (4,692 )

Stock-based compensation

                1,789                         1,789  

Cash dividends of $0.31 per share

                            (24,701 )           (24,701 )

Change in other comprehensive loss 

                      525                   525  

Net income 

                            72,835             72,835  

Balance at September 30, 2019

    79,706,511     $ 900     $ 947,880     $ (833 )   $ 1,616,485     $ (318,538 )   $ 2,245,894  

 

                           

Accumulated

                         
   

Common Stock

   

Additional

   

Other

                   

Total

 
   

Number of

           

Paid-in

   

Comprehensive

   

Retained

   

Treasury

   

Stockholders'

 
   

Shares

   

Amount

   

Capital

   

Loss

   

Earnings

   

Stock

   

Equity

 
   

(In thousands, except share data)

 

Balance at June 30, 2018

    81,255,683     $ 895     $ 937,224     $ (22,921 )   $ 1,389,227     $ (239,589 )   $ 2,064,836  

Dividend Reinvestment Plan

    15,513             657                         657  

Warrants exercised

    124,851       1       (1 )                        

Stock-based compensation

                1,921                         1,921  

Cash dividends of $0.24 per share

                            (19,532 )           (19,532 )

Change in other comprehensive loss

                      (862 )                 (862 )

Net income

                            69,757             69,757  

Balance at September 30, 2018

    81,396,047     $ 896     $ 939,801     $ (23,783 )   $ 1,439,452     $ (239,589 )   $ 2,116,777  

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

                           

Accumulated

                         
   

Common Stock

   

Additional

   

Other

                   

Total

 
   

Number of

           

Paid-in

   

Comprehensive

   

Retained

   

Treasury

   

Stockholders'

 

Nine months ended

 

Shares

   

Amount

   

Capital

   

Loss

   

Earnings

   

Stock

   

Equity

 
   

(In thousands, except share data)

 

Balance at December 31, 2018

    80,501,948     $ 898     $ 942,062     $ (18,006 )   $ 1,479,149     $ (282,237 )   $ 2,121,866  

Dividend Reinvestment Plan 

    70,798       1       2,521                         2,522  

Restricted stock units vested

    123,199       1                               1  

Shares withheld related to net share settlement of RSUs

                (2,300 )                       (2,300 )

Stock issued to directors

    21,160             749                         749  

Purchases of treasury stock

    (1,010,594 )                             (36,301 )     (36,301 )

Stock-based compensation

                4,848                         4,848  

Cash dividends of $0.93 per share

                            (74,422 )           (74,422 )

Change in other comprehensive loss

                      17,173                   17,173  

Net income

                            211,758             211,758  

Balance at September 30, 2019

    79,706,511     $ 900     $ 947,880     $ (833 )   $ 1,616,485     $ (318,538 )   $ 2,245,894  

 

                           

Accumulated

                         
   

Common Stock

   

Additional

   

Other

                   

Total

 
   

Number of

           

Paid-in

   

Comprehensive

   

Retained

   

Treasury

   

Stockholders'

 
   

Shares

   

Amount

   

Capital

   

Loss

   

Earnings

   

Stock

   

Equity

 
   

(In thousands, except share data)

 

Balance at December 31, 2017

    80,893,379     $ 891     $ 932,874     $ (2,511 )   $ 1,281,639     $ (239,589 )   $ 1,973,304  

Cumulative effect of changes in accounting principles

                      (8,559 )     8,559              

Reclassification of tax effects in accumulated other comprehensive income resulting from the new corporate income tax rate

                      (515 )     515              

Dividend Reinvestment Plan

    46,070             1,982                         1,982  

Restricted stock units vested

    89,471       2                               2  

Warrants exercised

    315,187       3       (3 )                        

Shares withheld related to net share settlement of RSUs

                (1,865 )                       (1,865 )

Stock issued to directors

    16,060             650                         650  

Stock options exercised

    35,880             838                         838  

Stock-based compensation

                5,325                         5,325  

Cash dividends of $0.72 per share

                            (58,498 )           (58,498 )

Change in other comprehensive loss

                      (12,198 )                 (12,198 )

Net income

                            207,237             207,237  

Balance at September 30, 2018

    81,396,047     $ 896     $ 939,801     $ (23,783 )   $ 1,439,452     $ (239,589 )   $ 2,116,777  

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   

Nine months ended September 30,

 
   

2019

   

2018

 
   

(In thousands)

 

Cash Flows from Operating Activities

               

Net income

  $ 211,758     $ 207,237  

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

               

Reversal for credit losses

    (2,000 )     (4,500 )

Provision for losses on other real estate owned 

    494        

Deferred tax liability

    9,911       2,342  

Depreciation and amortization

    5,009       5,593  

Amortization of right-of-use asset

    6,248        

Change in operating lease liabilities

    (5,298 )      

Net gains on sale and transfer of other real estate owned 

    (193 )     (567 )

Net gains on sale of held-for-sale loans

    (795 )      

Proceeds from sales of held-for sale loans

    38,742       8,000  

Amortization on alternative energy partnerships, venture capital and other investments 

    27,009       5,384  

Net (gain)/loss on sales and calls of securities

    108       14  

Amortization/accretion of security premiums/discounts, net

    2,376       2,371  

Loss on sales or disposal of fixed assets

          107  

Unrealized (gain)/loss on equity securities

    (7,764 )     4,580  

Stock based compensation and stock issued to officers as compensation

    5,597       5,976  

Net change in accrued interest receivable and other assets

    (31,640 )     (7,863 )

Gain on acquisition

          (340 )

Net change in other liabilities

    64,186       10,998  

Net cash provided by operating activities

    323,748       239,332  
                 

Cash Flows from Investing Activities

               

Decrease in interest-bearing deposits

          5,000  

Purchase of investment securities available-for-sale

    (539,979 )     (448,805 )

Proceeds from sale of investment securities available-for-sale

    149,725       99,644  

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

    233,058       346,328  

Purchase of Federal Home Loan Bank stock

    (975 )     (5,430 )

Redemptions of Federal Home Loan Bank stock

    975       11,265  

Net increase in loans

    (803,291 )     (771,290 )

Purchase of premises and equipment 

    (5,125 )     (4,496 )

Proceeds from sales of other real estate owned 

    1,905       3,302  

Net increase in investment in affordable housing and alternative energy partnerships

    (35,952 )     (36,666 )

Net cash used for investing activities

    (999,659 )     (801,148 )
                 

Cash Flows from Financing Activities

               

Net increase in deposits

    955,679       890,823  

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

          (100,000 )

Advances from Federal Home Loan Bank

    3,610,000       4,495,000  

Repayment of Federal Home Loan Bank borrowings

    (3,540,000 )     (4,610,000 )

Cash dividends paid 

    (74,422 )     (58,498 )

Repayment of other borrowings

    (39,918 )     (37,117 )

Proceeds from other borrowings

    25,507       29,554  

Purchases of treasury stock

    (36,301 )      

Proceeds from shares issued under Dividend Reinvestment Plan 

    2,522       1,982  

Proceeds from exercise of stock options 

          838  

Taxes paid related to net share settlement of RSUs

    (2,300 )     (3,550 )

Net cash provided by financing activities

    900,767       609,032  
                 

Decrease in cash, cash equivalents, and restricted cash 

    224,856       47,216  

Cash, cash equivalents, and restricted cash, beginning of the period 

    600,290       534,801  

Cash, cash equivalents, and restricted cash, end of the period

  $ 825,146     $ 582,017  
                 

Supplemental disclosure of cash flow information

               

Cash paid during the period:

               

Interest 

  $ 137,422     $ 79,877  

Income taxes paid

  $ 43,507     $ 48,072  

Non-cash investing and financing activities:

               

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

  $ 21,292     $ (16,793 )

Net change in unrealized holding loss on cash flow hedge derivatives

  $ (4,119 )   $ 4,595  

Transfers to other real estate owned from loans held for investment

  $ 860     $ 1,646  

Loans transferred from held for investment to held for sale, net 

  $ 75,285     $  

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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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, with Bancorp, the “Company”), ten limited partnerships investing in affordable housing investments in which the Bank is the sole limited partner, Asia Realty Corp. and GBC Venture Capital, Inc. 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 September 30, 2019, the Bank operates 25 branches in Southern California, 13 branches in Northern California, 10 branches in New York State, four in Washington State, three in Illinois, two in Texas, onein Maryland, Massachusetts, Nevada, and New Jersey, one in Hong Kong, and a representative office in Taipei, Beijing, and Shanghai. 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 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, 2019. 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, 2018.

 

The preparation of the Condensed Consolidated Financial Statements in accordance with GAAP requires management of the Company 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 the Condensed Consolidated Financial Statements. Actual results could differ from those estimates. The Company expects that the most significant estimates subject to change are the allowance for loan losses.

 

 

3. Recent Accounting Pronouncements

 

Accounting Standards Adopted in 2019

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842),” which requires lessees to recognize leases on their balance sheets and disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-01, “Land Easement Practical Expedient for Transition to Topic 842” ASU No. 2018-10, “Codification Improvements to Topic 842, Leases” and ASU No. 2018-11, “Targeted Improvements.” The new standard establishes a right-of-use model (“ROU”) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.

 

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The Company has adopted this guidance using the modified-retrospective transition method, which allows the adoption of the accounting standard prospectively without adjusting comparative prior period financial information using the effective date as our date of initial application. Consequently, the Company will not update financial information nor provide the disclosures required under the new standard for dates and periods before January 1, 2019.

 

The new standard provides a number of optional practical expedients in transition. We have elected the ‘package of practical expedients’, which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We also elected all of the new standard’s available transition practical expedients.

 

Upon adoption, we recognized an operating lease liability of $41.2 million, and a corresponding ROU asset of $40.6 million based on the present value of the remaining minimum lease payments under current leasing standards for existing operating leases.

 

We elected the short-term lease recognition exemption for all leases that qualify. Consequently, we will not recognize ROU assets or lease liabilities, for those leases that qualify, including existing short-term leases of those assets in transition. We also elected the practical expedient to not separate lease and non-lease components for all of our leases. See Note 10.

 

In March 2017, the FASB issued ASU 2017-08, “Receivables- Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” This update amends the amortization period for certain purchased callable debt securities held at a premium. The amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. This update affects all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company does not expect the adoption of this guidance to have an impact on the Company’s Consolidated Financial Statements since the accounting on the Company’s purchased callable debt securities have been consistent with the requirements of ASU 2017-8.

 

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815),” which targeted improvements to accounting for hedging activities. The amendments in this update are intended to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. To meet that objective, the amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. ASU 2017-12, which became effective for us on January 1, 2019, did not have a material impact on our financial statements.

 

In October 2018, the FASB issued ASU 2018-16, “Derivatives and Hedging (Topic 815) - Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this update permit use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the interest rates on direct U.S. Treasury obligations, the LIBOR swap rate, the OIS rate based on the Fed Funds Effective Rate and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. ASU 2018-16, which became effective for us on January 1, 2019, did not have a material impact on our financial statements.

 

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In March 2019, the FASB amended ASU 2016-02, “Leases (Topic 842),” to align the guidance for fair value of the underlying asset by lessors that are not manufacturers or dealers in Topic 842 with that of existing guidance. As a result, the fair value of the underlying asset at lease commencement is its cost, reflecting any volume or trade discounts that may apply. However, if there has been a significant lapse of time between when the underlying asset is acquired and when the lease commences, the definition of fair value (in Topic 820, Fair Value Measurement) should be applied. (Issue 1). The ASU also requires lessors within the scope of Topic 942, Financial Services—Depository and Lending, to present all “principal payments received under leases” within investing activities. (Issue 2). Finally, the ASU exempts both lessees and lessors from having to provide certain interim disclosures in the fiscal year in which a company adopts the new leases standard. (Issue 3). The transition and effective date provisions apply to Issue 1 and Issue 2. They do not apply to Issue 3 because the amendments for that Issue are to the original transition requirements in Topic 842. The effective date of those amendments is for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company has adopted the amendments of this guidance as part of the adoption of Topic 842 on January 1, 2019, using the transition methodology set forth in paragraph 842-10-65-1(c).

 

Other Accounting Standards

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”  This update requires an entity to use a broader range of reasonable and supportable (“R&S”) forecasts, in addition to historical experience and current conditions, to develop an expected credit loss estimate, referred to as the Current Expected Credit Loss (“CECL”) model, for financial assets and net investments that are not accounted for at fair value through net income.  Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses to the amount by which fair value is below amortized cost.  ASU 2016-13 becomes effective for interim and annual periods beginning after December 15, 2019. 

 

The Company has established a multidisciplinary project team and implementation plan, reached accounting decisions on various matters, developed a conceptual framework, and engaged an outside firm to develop econometric regression models for net losses during the R&S forecast period. The Company continues to test and refine the CECL models and has completed one preliminary calculation with two more scheduled before adoption. The Company continues to perform testing and sensitivity analysis on its modeling assumptions and results. Our planned approach for estimating expected life-time credit losses is expected to include, among other things, the following key components for all loan portfolio segments: a. The use of a probability of default/loss given default methodology; b. A number of scenarios based on forecasts from an outside economic forecasting company to develop economic forecasts for the R&S period; c. An initial R&S forecast period of six quarters for all loan portfolio segments, which reflects management's expectation of losses based on forward-looking economic scenarios over that time; d. A post-R&S reversion period of six quarters using a linear transition to the historical loss rates for each loan pool; e. A historical loss period that includes the last recession; and f. Prepayments rates based on our historical experience.  The ultimate impact is expected to be influenced by, among other things, the macroeconomic conditions and forecasts at adoption; and other management judgments.  We plan to adopt this new standard on January 1, 2020. We are not yet able to disclose the quantitative effect on our consolidated financial position and results of operations as we are continuing to evaluate the impact of the adoption of this ASU.

 

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In January 2017, the FASB issued ASU 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This update simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Adoption of this update is on a prospective basis and the amendments in this update are to be applied to annual periods beginning after December 15, 2019. Adoption of ASU 2017-04 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

 

In July 2017, the FASB issued ASU 2017-11, “Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815).” There are two parts to this update. Part I of this update addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments that result in the strike price being reduced on the basis of the pricing of future equity offerings. Part II of this update addresses the difficulty in navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. The amendments in this update are effective for fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in part I of this update should be applied in either of the following ways: (i) Retrospectively to outstanding financial instruments with a down round feature by means of a cumulative-effect adjustment to the statement of financial position as of the beginning of the first fiscal year and interim periods in which the pending content that links to this paragraph is effective; or (ii) Retrospectively to outstanding financial instruments with a down round feature for each prior reporting period presented in accordance with the guidance on accounting changes in paragraphs 250-10-45-5 through 45-10. The amendments to Part II of this update do not require any transition guidance because those amendments do not have an accounting effect. The Company is currently evaluating the impact on its Consolidated Financial Statements.

 

In August 2018, the FASB issued ASU No. 2018-13, “Disclosure Framework Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. As ASU No. 2018-13 only revises disclosure requirements, we do not expect it to have a material impact on the Company’s Consolidated Financial Statements.

 

In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which clarifies and improves areas of guidance related to the recently issued standards on credit losses (ASU 2016-13), hedging (ASU 2017-12), and recognition of financial instruments (ASU 2016-01). The amendments generally have the same effective dates as their related standards. If already adopted, the amendments of ASU 2016-01 and ASU 2016-13 are effective for fiscal years beginning after December 15, 2019 and the amendments of ASU 2017-12 are effective as of the beginning of the Company’s next annual reporting period; early adoption is permitted. The Company previously adopted both ASU 2017-12 and ASU 2016-01 and does not expect the amendments of ASU 2019-04 will have a material impact on the Company’s Consolidated Financial Statements. The Company is continuing to evaluate the impact of ASU 2016-13 and will consider the amendments of ASU 2019-04 as part of that process.

 

In May 2019, the FASB issued ASU No. 2019-05, “Financial Instruments Credit Losses (Topic 326); Targeted Transition Relief.” This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument by instrument basis. ASU 2019-05 has the same effective date as ASU 2016-13 (i.e., the first quarter of 2020). The Company does not have financial instruments that were previously recorded at amortized cost, and therefore, ASU 2019-05 is not expected to impact the Company’s Consolidated Financial Statements.

 

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4. Cash, Cash Equivalents and Restricted Cash

 

The Company manages its cash and cash equivalents, which consist of cash on hand, amounts due from banks, and short-term investments with original maturity of three months or less, based upon the Company’s operating, investment, and financing activities. For the purpose of reporting cash flows, these same accounts are included in cash and cash equivalents.

 

The Company is required to maintain reserves with the Federal Reserve Bank. Reserve requirements are based on a percentage of deposit liabilities. The average reserve balances required were $144 thousand and $5.4 million for the nine months ended September 30, 2019 and for the year ended December 31, 2018, respectively. As of September 30, 2019 and December 31, 2018, the Bancorp had $9.1 million and $1.8 million, respectively, on deposit in a cash margin account that serves as collateral for the Bancorp’s interest rate swaps. As of September 30, 2019 and December 31, 2018, the Company held $27.4 million and $7.8 million, respectively, in a restricted escrow account with a major bank for its alternative energy investments.

 

In the unaudited condensed consolidated statement of cash flows, the amounts for the nine months ended September 30, 2018 have been corrected in the current year and differ from the previously reported amounts of zero for decrease in interest-bearing deposits, $806.1 million for net cash used for investing activities, $42.2 million increase in cash and cash equivalents and $539.8 million for cash and cash equivalents, beginning of period. 

 

 

5. Earnings per Share

 

Basic earnings per share excludes 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. Outstanding stock options and restricted stock units (“RSUs”) 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 September 30,

   

Nine months ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands, except share and per share data)

 
                                 

Net income

  $ 72,835     $ 69,757     $ 211,758     $ 207,237  
                                 

Weighted-average shares:

                               

Basic weighted-average number of common shares outstanding

    79,736,814       81,311,899       80,096,855       81,224,555  

Dilutive effect of weighted-average outstanding common share equivalents

                               

Warrants

          234,105             268,988  

RSUs

    257,016       309,267       233,761       277,331  

Diluted weighted-average number of common shares outstanding

    79,993,830       81,855,271       80,330,616       81,770,874  
                                 

Average stock options and restricted stock units with anti-dilutive effect

    32,321       1,854       47,690       15,625  

Earnings per common share:

                               

Basic

  $ 0.91     $ 0.86     $ 2.64     $ 2.55  

Diluted

  $ 0.91     $ 0.85     $ 2.64     $ 2.53  

 

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6. Stock-Based Compensation

 

Pursuant to the Company’s 2005 Incentive Plan, as amended and restated, the Company may grant incentive stock options (employees only), non-statutory stock options, common stock awards, restricted stock, RSUs, stock appreciation rights and cash awards to non-employee directors and eligible employees.

 

There were 35,880 stock option shares exercised in the nine months ended September 30, 2018 with no stock options outstanding thereafter. The Company received $838 thousand from the exercise of stock options for 35,880 shares at $23.37 per share that had an aggregate intrinsic value of $718 thousand in the nine months ended September 30, 2018.

 

RSUs are generally granted at no cost to the recipient. RSUs generally vest ratably over three years or cliff vest after one or three years of continued employment from the date of the grant. While a portion of RSUs may be time-vesting awards, others may vest subject to the attainment of specified performance goals and are referred to as “performance-based RSUs.” All RSUs are subject to forfeiture until vested.

 

Performance-based RSUs are granted at the target amount of awards. Based on the Company’s attainment of specified performance goals and consideration of market conditions, the number of shares that vest can be adjusted to a minimum of zero and to a maximum of 150% of the target. The amount of performance-based RSUs that are eligible to vest is determined at the end of each performance period and is then added together to determine the total number of performance shares that are eligible to vest. Performance-based RSUs generally cliff vest three years from the date of grant.

 

Compensation costs for the time-based awards are based on the quoted market price of the Company’s stock at the grant date. Compensation costs associated with performance-based RSUs are based on grant date fair value, which considers both market and performance conditions. Compensation costs of both time-based and performance-based awards are recognized on a straight-line basis from the grant date until the vesting date of each grant.

 

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The following table presents RSU activity during the nine months ended September 30, 2019:

 

   

Time-Based RSUs

   

Performance-Based RSUs

 
           

Weighted-Average

           

Weighted-Average

 
           

Grant Date

           

Grant Date

 
   

Shares

   

Fair Value

   

Shares

   

Fair Value

 

Balance at December 31, 2018

    284,493     $ 35.79       265,659     $ 32.90  

Granted

    108,925       36.37       124,586       36.37  

Vested

    (92,868 )     35.12       (92,501 )     38.36  

Forfeited

    (17,002 )     38.42              

Balance at September 30, 2019

    283,548     $ 36.08       297,744     $ 32.65  

 

The compensation expense recorded for RSUs was $1.8 million and $1.9 million for the three months ended September 30, 2019 and 2018, respectively. For the nine months ended September 30, 2019 and 2018, the compensation expense recorded for RSUs was $4.8 million and $5.3 million, respectively. Unrecognized stock-based compensation expense related to RSUs was $11.5 million and $11.8 million as of September 30, 2019 and 2018, respectively. As of September 30, 2019, these costs are expected to be recognized over the next 2.0 years for time-based and performance-based RSU’s.

 

As of September 30, 2019, 2,389,185 shares were available for future grants under the Company’s 2005 Incentive Plan, as amended and restated.

 

Tax benefit from share-based payment arrangements reduced income tax expense by $0.6 million and $0.8 million in the nine months ended September 30, 2019 and 2018, respectively.

 

 

7. Investment Securities

 

The following tables set forth the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of securities available-for-sale as of September 30, 2019, and December 31, 2018:

 

   

September 30, 2019

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. government agency entities

  $ 92,477     $ 750     $ 273     $ 92,954  

U.S. government sponsored entities

    350,000             2,301       347,699  

Mortgage-backed securities

    880,406       7,714       1,385       886,735  

Collateralized mortgage obligations

    683             18       665  

Corporate debt securities 

    98,865       533       13       99,385  

Total

  $ 1,422,431     $ 8,997     $ 3,990     $ 1,427,438  

 

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December 31, 2018

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. treasury securities 

  $ 124,801     $     $ 50     $ 124,751  

U.S. government agency entities

    6,066             195       5,871  

U.S. government sponsored entities

    400,000             11,638       388,362  

Mortgage-backed securities

    670,874       960       15,089       656,745  

Collateralized mortgage obligations

    1,005             28       977  

Corporate debt securities

    64,985       818             65,803  

Total

  $ 1,267,731     $ 1,778     $ 27,000     $ 1,242,509  

 

The amortized cost and fair value of securities available-for-sale as of September 30, 2019, by contractual maturities, are set forth in the tables 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.

 

   

September 30, 2019

 
   

Securities Available-For-Sale

 
   

Amortized Cost

   

Fair Value

 
   

(In thousands)

 
                 

Due in one year or less

  $ 19,993     $ 20,103  

Due after one year through five years

    429,449       427,578  

Due after five years through ten years

    41,718       41,710  

Due after ten years

    931,271       938,047  

Total

  $ 1,422,431     $ 1,427,438  

 

Equity Securities - The adoption of ASU 2016-01 resulted in approximately $8.6 million being reclassified from accumulated other comprehensive income to retained earnings, representing an increase to retained earnings as of January 1, 2018. The Company recognized a net gain of $0.4 million for the three months ended September 30, 2019, due to the increase in fair value of equity investments with readily determinable fair values compared to a net gain of $0.4 million for the three months ended September 30, 2018. The Company recognized a net gain of $7.8 million for the nine months ended September 30, 2019, due to the increase in fair value of equity investments with readily determinable fair values compared to a net loss of $4.6 million for the nine months ended September 30, 2018. Equity securities were $32.9 million and $25.1 million as of September 30, 2019 and December 31, 2018, respectively.

 

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The following tables set forth the gross unrealized losses and related fair value of the Company’s investment portfolio, aggregated by investment category and the length of time that individual security has been in a continuous unrealized loss position, as of  September 30, 2019 and  December 31, 2018:

 

   

September 30, 2019

 
   

Less than 12 Months

   

12 Months or Longer

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
   

(In thousands)

 

Securities Available-for-Sale

                                               

U.S. government agency entities

  $ 49,796     $ 108     $ 3,748     $ 165     $ 53,544     $ 273  

U.S. government sponsored entities

                347,699       2,301       347,699       2,301  

Mortgage-backed securities

    115,727       220       146,666       1,165       262,393       1,385  

Collateralized mortgage obligations

                665       18       665       18  

Corporate debt securities

    28,819       13                   28,819       13  

Total

  $ 194,342     $ 341     $ 498,778     $ 3,649     $ 693,120     $ 3,990  

 

   

December 31, 2018

 
   

Less than 12 Months

   

12 Months or Longer

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
   

(In thousands)

 

Securities Available-for-Sale

                                               

U.S. treasury securities

  $ 124,751     $ 50     $     $     $ 124,751     $ 50  

U.S. government agency entities

    3,388       77       2,483       118       5,871       195  

U.S. government sponsored entities

                388,362       11,638       388,362       11,638  

Mortgage-backed securities

    48,528       502       507,701       14,587       556,229       15,089  

Collateralized mortgage obligations

                977       28       977       28  

Total

  $ 176,667     $ 629     $ 899,523     $ 26,371     $ 1,076,190     $ 27,000  

 

To the Company’s knowledge, the unrealized losses were primarily attributed to yield curve movement, together with widened liquidity spreads and credit spreads. The issuers have not, to the Company’s knowledge, established any cause for default on these securities. Management believes the gross unrealized losses detailed in the table above are temporary. The Company expects to recover the amortized cost basis of its securities and has no present intent to sell and will not be required to sell available-for-sale securities that have declined below their cost before their anticipated recovery. Accordingly, noother than temporary impairment write-downs were recorded on the Company’s Condensed Consolidated Statement of Operations and Comprehensive Income in the nine months ended September 30, 2019 and 2018.

 

Securities available-for-sale having a carrying value of $20.8 million and $28.5 million as of September 30, 2019 and December 31, 2018, respectively, were pledged to secure public deposits, other borrowings and treasury tax and loan.

 

 

8.Loans

 

Most of the Company’s business activities are with customers located in the high-density Asian-populated areas of Southern and Northern California; New York City, New York; Dallas and Houston, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; Edison, New Jersey; Rockville, Maryland; and Las Vegas, Nevada. The Company also has loan customers in Hong Kong. The Company has no specific industry concentration, and generally its loans are secured by real property or other collateral of the borrowers. The Company generally expects loans 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.

 

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The types of loans in the Company’s Condensed Consolidated Balance Sheets as of September 30, 2019, and December 31, 2018, were as follows:

 

   

September 30, 2019

   

December 31, 2018

 
   

(In thousands)

 
                 

Commercial loans 

  $ 2,668,061     $ 2,741,965  

Residential mortgage loans 

    4,010,739       3,693,853  

Commercial mortgage loans 

    7,135,599       6,724,200  

Equity lines 

    315,252       249,967  

Real estate construction loans

    593,816       581,454  

Installment and other loans 

    5,087       4,349  

Gross loans

  $ 14,728,554     $ 13,995,788  

Allowance for loan losses

    (125,908 )     (122,391 )

Unamortized deferred loan fees, net

    (1,081 )     (1,565 )

Total loans, net

  $ 14,601,565     $ 13,871,832  
                 

Loans held for sale 

  $ 36,778     $  

 

As of September 30, 2019, recorded investment in impaired loans totaled $88.8 million and was comprised of non-accrual loans of $47.2 million and accruing troubled debt restructured loans (“TDRs”) of $41.6 million. As of December 31, 2018, recorded investment in impaired loans totaled $106.9 million and was comprised of non-accrual loans of $41.8 million and accruing TDRs of $65.1 million. For impaired loans, the amounts previously charged off represent 1.9% and 9.3% of the contractual balances for impaired loans as of September 30, 2019 and December 31, 2018, respectively.

 

The following table presents the average recorded investment and interest income recognized on impaired loans for the periods indicated:

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

Average Recorded Investment

   

Interest Income Recognized

   

Average Recorded Investment

   

Interest Income Recognized

   

Average Recorded Investment

   

Interest Income Recognized

   

Average Recorded Investment

   

Interest Income Recognized

 
   

(In thousands)

 
                                                                 

Commercial loans 

  $ 38,659     $ 208     $ 48,772     $ 461     $ 41,132     $ 705     $ 46,920     $ 1,152  

Real estate construction loans

    4,662             5,980             4,734             7,490        

Commercial mortgage loans 

    40,699       332       55,375       576       51,323       1,034       59,314       1,757  

Residential mortgage loans and equity lines 

    13,133       78       13,724       108       13,126       237       14,032       279  

Total impaired loans

  $ 97,153     $ 618     $ 123,851     $ 1,145     $ 110,315     $ 1,976     $ 127,756     $ 3,188  

 

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

 

   

September 30, 2019

   

December 31, 2018

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Allowance

   

Unpaid Principal Balance

   

Recorded Investment

   

Allowance

 
   

(In thousands)

 
                                                 

With no allocated allowance

                                               

Commercial loans

  $ 24,711     $ 20,492     $     $ 32,015     $ 30,368     $  

Real estate construction loans

    5,776       4,629             5,776       4,873        

Commercial mortgage loans

    11,663       11,517             34,129       24,409        

Residential mortgage loans and equity lines

    6,808       6,770             5,685       5,665        

Subtotal

  $ 48,958     $ 43,408     $     $ 77,605     $ 65,315     $  
                                                 

With allocated allowance

                                               

Commercial loans

  $ 13,251     $ 13,234     $ 744     $ 6,653     $ 6,570     $ 1,837  

Commercial mortgage loans

    26,356       26,288       536       27,099       27,063       877  

Residential mortgage loans and equity lines

    7,011       5,917       221       8,934       7,938       1,088  

Subtotal

  $ 46,618     $ 45,439     $ 1,501     $ 42,686     $ 41,571     $ 3,802  

Total impaired loans

  $ 95,576     $ 88,847     $ 1,501     $ 120,291     $ 106,886     $ 3,802  

 

The following tables present the aging of the loan portfolio by type as of September 30, 2019, and as of December 31, 2018:

 

   

September 30, 2019

 
   

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

 
   

(In thousands)

 
                                                         

Commercial loans

  $ 29,905     $ 8,736     $     $ 22,970     $ 61,611     $ 2,606,450     $ 2,668,061  

Real estate construction loans

                      4,629       4,629       589,187       593,816  

Commercial mortgage loans

    2,926       3,687       683       12,330       19,626       7,115,973       7,135,599  

Residential mortgage loans and equity lines

    286                   7,271       7,557       4,318,434       4,325,991  

Installment and other loans

                                  5,087       5,087  

Total loans

  $ 33,117     $ 12,423     $ 683     $ 47,200     $ 93,423     $ 14,635,131     $ 14,728,554  

 

   

December 31, 2018

 
   

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

 
   

(In thousands)

 
                                                         

Commercial loans

  $ 25,494     $ 2,454     $ 514     $ 18,805     $ 47,267     $ 2,694,698     $ 2,741,965  

Real estate construction loans

          3,156             4,872       8,028       573,426       581,454  

Commercial mortgage loans

    10,797       8,545       3,259       10,611       33,212       6,690,988       6,724,200  

Residential mortgage loans and equity lines

    9,687       336             7,527       17,550       3,926,270       3,943,820  

Installment and other loans

                                  4,349       4,349  

Total loans

  $ 45,978     $ 14,491     $ 3,773     $ 41,815     $ 106,057     $ 13,889,731     $ 13,995,788  

 

The determination of the amount of the allowance for loan 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 loan losses. The nature of the process by which the Bank determines the appropriate allowance for loan losses requires the exercise of considerable judgment. This allowance evaluation process is also applied to TDRs since they are considered to be impaired loans. 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, market and environmental conditions, among other factors.

 

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A TDR 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 six 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.

 

As of September 30, 2019, accruing TDRs were $41.6 million and non-accrual TDRs were $19.8 million compared to accruing TDRs of $65.1 million and non-accrual TDRs of $24.2 million as of December 31, 2018. The Company allocated specific reserves of $1.2 million to accruing TDRs and $141 thousand to non-accrual TDRs as of September 30, 2019, and $1.5 million to accruing TDRs and $826 thousand to non-accrual TDRs as of December 31, 2018. The following tables set forth TDRs that were modified during the three and nine months ended September 30, 2019 and 2018, their specific reserves as of September 30, 2019 and 2018, and charge-offs for the three and nine months ended September 30, 2019 and 2018:

 

   

Three Months Ended September 30, 2019

   

September 30, 2019

 
   

No. of Contracts

   

Pre-Modification Outstanding Recorded Investment

   

Post-Modification Outstanding Recorded Investment

   

Charge-offs

   

Specific Reserve

 
   

(In thousands)

 
                                         

Commercial loans

    3     $ 7,585     $ 6,165     $     $ 89  

Total

    3     $ 7,585     $ 6,165     $     $ 89  

 

   

Three Months Ended September 30, 2018

   

September 30, 2018

 
   

No. of Contracts

   

Pre-Modification Outstanding Recorded Investment

   

Post-Modification Outstanding Recorded Investment

   

Charge-offs

   

Specific Reserve

 
   

(In thousands)

 
                                         

Commercial loans

    3     $ 4,621     $ 4,621     $     $ 2,467  

Commercial mortgage loans

    1       339       339              

Residential mortgage loans and equity lines

    2       413       413             16  

Total

    6     $ 5,373     $ 5,373     $     $ 2,483  

 

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Table of Contents

 

   

Nine Months Ended September 30, 2019

   

September 30, 2019

 
   

No. of Contracts

   

Pre-Modification Outstanding Recorded Investment

   

Post-Modification Outstanding Recorded Investment

   

Charge-offs

   

Specific Reserve

 
   

(In thousands)

 
                                         

Commercial loans

    23     $ 25,937     $ 10,814     $     $ 125  

Total

    23     $ 25,937     $ 10,814     $     $ 125  

 

   

Nine Months Ended September 30, 2018

   

September 30, 2018

 
   

No. of Contracts

   

Pre-Modification Outstanding Recorded Investment

   

Post-Modification Outstanding Recorded Investment

   

Charge-offs

   

Specific Reserve

 
   

(In thousands)

 
                                         

Commercial loans

    21     $ 12,212     $ 12,212     $     $ 2,493  

Commercial mortgage loans

    7       14,626       14,626             119  

Residential mortgage loans and equity lines

    4       1,213       1,213             24  

Total

    32     $ 28,051     $ 28,051     $     $ 2,636  

 

Modifications of the loan terms in the nine months ended September 30, 2019 were in the form of extensions of maturity dates, which ranged generally from three to twelve months from the modification date. 

 

We expect that the TDRs on accruing status as of September 30, 2019, 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 September 30, 2019, and December 31, 2018, is set forth in the table below:

 

   

September 30, 2019

 
   

Payment Deferral

   

Rate

Reduction

   

Rate Reduction and Payment Deferral

   

Total

 
   

(In thousands)

 

Accruing TDRs

                               

Commercial loans 

  $ 10,756     $     $     $ 10,756  

Commercial mortgage loans 

    782       5,757       18,936       25,475  

Residential mortgage loans 

    2,931       319       2,166       5,416  

Total accruing TDRs

  $ 14,469     $ 6,076     $ 21,102     $ 41,647  

 

   

September 30, 2019

 
   

Payment Deferral

   

Rate

Reduction

   

Rate Reduction and Payment Deferral

   

Total

 
   

(In thousands)

 

Non-accrual TDRs

                               

Commercial loans 

  $ 18,057     $     $     $ 18,057  

Residential mortgage loans

    1,629             101       1,730  

Total non-accrual TDRs

  $ 19,686     $     $ 101     $ 19,787  

 

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December 31, 2018

 
   

Payment Deferral

   

Rate

Reduction

   

Rate Reduction and Payment Deferral

   

Total

 
   

(In thousands)

 

Accruing TDRs

                               

Commercial loans 

  $ 18,135     $     $     $ 18,135  

Commercial mortgage loans

    14,022       7,420       19,418       40,860  

Residential mortgage loans 

    3,353       327       2,396       6,076  

Total accruing TDRs

  $ 35,510     $ 7,747     $ 21,814     $ 65,071  

 

   

December 31, 2018

 
   

Payment Deferral

   

Rate

Reduction

   

Rate Reduction and Payment Deferral

   

Total

 
   

(In thousands)

 

Non-accrual TDRs

                               

Commercial loans 

  $ 13,771     $     $     $ 13,771  

Commercial mortgage loans 

    3,682             4,884       8,566  

Residential mortgage loans 

    1,741             111       1,852  

Total non-accrual TDRs

  $ 19,194     $     $ 4,995     $ 24,189  

 

The activity within TDRs for the periods indicated is set forth below:

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands)

 

Accruing TDRs

                               

Beginning balance

  $ 64,898     $ 84,487     $ 65,071     $ 68,566  

New restructurings 

    240       2,589       15,432       25,036  

Restructured loans restored to accrual status

          577             2,895  

Charge-offs 

    (1,341 )           (1,341 )      

Payments 

    (22,150 )     (13,055 )     (36,219 )     (19,801 )

Restructured loans placed on non-accrual status 

                (1,296 )     (2,098 )

Ending balance

  $ 41,647     $ 74,598     $ 41,647     $ 74,598  

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands)

 

Non-accrual TDRs

                               

Beginning balance 

  $ 22,457     $ 30,347     $ 24,189     $ 33,415  

New restructurings 

    7,345       2,784       10,505       3,015  

Restructured loans placed on non-accrual status 

                1,296       2,098  

Charge-offs

    (2,389 )           (3,607 )     (161 )

Payments 

    (7,626 )     (4,836 )     (12,596 )     (7,754 )

Restructured loans restored to accrual status 

          (577 )           (2,895 )

Ending balance

  $ 19,787     $ 27,718     $ 19,787     $ 27,718  

 

The Company considers a loan 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 a TDR during the previous twelve months and which had subsequently defaulted as of September 30, 2019.

 

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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 September 30, 2019, there were no commitments to lend additional funds to those borrowers whose loans had been restructured, were considered impaired, or were on non-accrual status.

 

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 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.

 

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The following tables set forth the loan portfolio by risk rating as of September 30, 2019 and December 31, 2018:

 

   

September 30, 2019

 
                               
   

Pass/Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(In thousands)

 

Commercial loans

  $ 2,432,623     $ 151,265     $ 84,173     $     $ 2,668,061  

Real estate construction loans

    514,725       74,462       4,629             593,816  

Commercial mortgage loans

    6,824,241       233,155       78,203             7,135,599  

Residential mortgage loans and equity lines

    4,317,793       927       7,271             4,325,991  

Installment and other loans

    5,087                         5,087  

Total gross loans

  $ 14,094,469     $ 459,809     $ 174,276     $     $ 14,728,554  

 

   

December 31, 2018

 
                               
   

Pass/Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(In thousands)

 

Commercial loans

  $ 2,603,901     $ 87,987     $ 50,077     $     $ 2,741,965  

Real estate construction loans

    514,406       62,175       4,873             581,454  

Commercial mortgage loans

    6,337,368       304,791       82,041             6,724,200  

Residential mortgage loans and equity lines

    3,934,762             9,058             3,943,820  

Installment and other loans

    4,349                         4,349  

Total gross loans

  $ 13,394,786     $ 454,953     $ 146,049     $     $ 13,995,788  

 

 

The following tables set forth the balance in the allowance for loan losses by portfolio segment and based on impairment method as of September 30, 2019 and December 31, 2018:

 

   

September 30, 2019

 
           

Real Estate

   

Commercial

   

Residential

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

Mortgage Loans

   

and

         
   

Loans

   

Loans

   

Loans

   

and Equity Lines

   

Other Loans

   

Total

 
   

(In thousands)

 

Loans individually evaluated for impairment

                                               

Allowance

  $ 744     $     $ 536     $ 221     $     $ 1,501  

Balance

  $ 33,726     $ 4,629     $ 37,805     $ 12,687     $     $ 88,847  

Loans collectively evaluated for impairment

                                               

Allowance 

  $ 57,805     $ 21,698     $ 32,931     $ 11,948     $ 25     $ 124,407  

Balance

  $ 2,634,335     $ 589,187     $ 7,097,794     $ 4,313,304     $ 5,087     $ 14,639,707  

Total allowance

  $ 58,549     $ 21,698     $ 33,467     $ 12,169     $ 25     $ 125,908  

Total balance

  $ 2,668,061     $ 593,816     $ 7,135,599     $ 4,325,991     $ 5,087     $ 14,728,554  

 

   

December 31, 2018

 
           

Real Estate

   

Commercial

   

Residential

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

Mortgage Loans

   

and

         
   

Loans

   

Loans

   

Loans

   

and Equity Lines

   

Other Loans

   

Total

 
   

(In thousands)

 

Loans individually evaluated for impairment

                                               

Allowance

  $ 1,837     $     $ 877     $ 1,088     $     $ 3,802  

Balance

  $ 36,940     $ 4,873     $ 51,471     $ 13,602     $     $ 106,886  

Loans collectively evaluated for impairment

                                               

Allowance 

  $ 53,141     $ 19,626     $ 32,610     $ 13,194     $ 18     $ 118,589  

Balance

  $ 2,705,025     $ 576,581     $ 6,672,729     $ 3,930,218     $ 4,349     $ 13,888,902  

Total allowance

  $ 54,978     $ 19,626     $ 33,487     $ 14,282     $ 18     $ 122,391  

Total balance

  $ 2,741,965     $ 581,454     $ 6,724,200     $ 3,943,820     $ 4,349     $ 13,995,788  

 

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The following tables set forth activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2019, and September 30, 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

Three months ended September 30, 2019 and 2018

 

                           

Residential

                 
           

Real Estate

   

Commercial

   

Mortgage Loans

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

and

   

and Other

         
   

Loans

   

Loans

   

Loans

   

Equity Lines

   

Loans

   

Total

 
   

(In thousands)

 
                                                 

June 30, 2019 Ending Balance

  $ 54,293     $ 21,010     $ 33,154     $ 14,164     $ 30     $ 122,651  

Provision/(reversal) for possible credit losses

    7,400       (2,690 )     (4,648 )     (2,057 )     (5 )     (2,000 )

Charge-offs

    (3,356 )                             (3,356 )

Recoveries

    212       3,378       4,961       62             8,613  

Net (charge-offs)/recoveries

    (3,144 )     3,378       4,961       62             5,257  

September 30, 2019 Ending Balance

  $ 58,549     $ 21,698     $ 33,467     $ 12,169     $ 25     $ 125,908  

 

                           

Residential

                 
           

Real Estate

   

Commercial

   

Mortgage Loans

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

and

   

and Other

         
   

Loans

   

Loans

   

Loans

   

Equity Lines

   

Loans

   

Total

 
   

(In thousands)

 
                                                 

June 30, 2018 Ending Balance

  $ 55,179     $ 20,663     $ 33,976     $ 12,062     $ 19     $ 121,899  

Provision/(reversal) for possible credit losses

    1,270       519       (4,138 )     842       7       (1,500 )

Charge-offs

    (122 )                             (122 )

Recoveries

    187       44       2,944       5             3,180  

Net recoveries

    65       44       2,944       5             3,058  

September 30, 2018 Ending Balance

  $ 56,514     $ 21,226     $ 32,782     $ 12,909     $ 26     $ 123,457  

 

Nine months ended September 30, 2019 and 2018

 

                           

Residential

                 
           

Real Estate

   

Commercial

   

Mortgage Loans

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

and

   

and Other

         
   

Loans

   

Loans

   

Loans

   

Equity Lines

   

Loans

   

Total

 
   

(In thousands)

 
                                                 

2019 Beginning Balance

  $ 54,978     $ 19,626     $ 33,487     $ 14,282     $ 18     $ 122,391  

Provision/(reversal) for possible credit losses

    8,262       (2,540 )     (5,234 )     (2,495 )     7       (2,000 )

Charge-offs

    (6,300 )                             (6,300 )

Recoveries

    1,609       4,612       5,214       382             11,817  

Net (charge-offs)/recoveries

    (4,691 )     4,612       5,214       382             5,517  

September 30, 2019 Ending Balance

  $ 58,549     $ 21,698     $ 33,467     $ 12,169     $ 25     $ 125,908  

Reserve for impaired loans

  $ 744     $     $ 536     $ 221     $     $ 1,501  

Reserve for non-impaired loans

  $ 57,805     $ 21,698     $ 32,931     $ 11,948     $ 25     $ 124,407  

Reserve for off-balance sheet credit commitments

  $ 2,505     $ 1,608     $ 121     $ 313     $ 3     $ 4,550  

 

                           

Residential

                 
           

Real Estate

   

Commercial

   

Mortgage Loans

   

Installment

         
   

Commercial

   

Construction

   

Mortgage

   

and

   

and Other

         
   

Loans

   

Loans

   

Loans

   

Equity Lines

   

Loans

   

Total

 
   

(In thousands)

 
                                                 

2018 Beginning Balance

  $ 49,796     $ 24,838     $ 37,610     $ 11,013     $ 22     $ 123,279  

Provision/(reversal) for possible credit losses

    6,097       (3,744 )     (8,672 )     1,815       4       (4,500 )

Charge-offs

    (629 )           (390 )                 (1,019 )

Recoveries

    1,250       132       4,234       81             5,697  

Net recoveries

    621       132       3,844       81             4,678  

September 30, 2018 Ending Balance

  $ 56,514     $ 21,226     $ 32,782     $ 12,909     $ 26     $ 123,457  

Reserve for impaired loans

  $ 2,506     $     $ 917     $ 281     $     $ 3,704  

Reserve for non-impaired loans

  $ 54,008     $ 21,226     $ 31,865     $ 12,628     $ 26     $ 119,753  

Reserve for off-balance sheet credit commitments

  $ 1,615     $ 1,174     $ 78     $ 215     $ 6     $ 3,088  

 

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Loans Held-for-Sale

 

At the time of commitment to originate or purchase a loan, the loan is determined to be held for investment if it is in the Company’s intent to hold the loan to maturity or for the “foreseeable future,” subject to periodic reviews under the Company’s evaluation processes, including asset/liability and credit risk management. When the Company subsequently changes its intent to hold certain loans, the loans are transferred from held-for-investment to held-for-sale at the lower of cost or fair value. As of September 30, 2019, there were approximately $36.8 million of loans held-for-sale, which were all comprised of residential mortgage loans. There were no loans held-for-sale as of December 31, 2018.

 

Loans Purchases, Transfers and Sales

 

The Company purchases and sells loans in the secondary market in the ordinary course of business. From time to time, purchased loans may be transferred from held-for-investment to held-for-sale, and write-downs to the allowance for loan losses are recorded, when appropriate. During the three and nine months ended September 30, 2019, the Company reclassified $75.3 million of residential mortgages from held-for-investment to held-for-sale. Net gains on sales of loans, excluding the lower of cost or fair value adjustments, were $0.8 million, for the three and nine months ended September 30, 2019. The Company recorded a lower of cost or fair value adjustment of $120 thousand during the three and nine months ended September 30, 2019. Noloan transfers were made during the three and nine months ended September 30, 2018.

 

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9. Commitments and Contingencies

 

From time to time, Bancorp and its subsidiaries are parties to litigation that arise in the ordinary course of business or otherwise are incidental to various aspects of its operations. Based upon information available to the Company and its review of any such litigation with counsel, management believes that the liability relating to such litigation, if any, would not be expected to have a material adverse impact on the Company’s 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 from time to time 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.

 

The Company’s unfunded commitments related to investments in qualified affordable housing and alternative energy partnerships were $131.4 million and $113.0 million as of September 30, 2019 and December 31, 2018, respectively.

 

 

10. Leases

 

The Company determines if a contract arrangement is a lease at inception and primarily enters into operating lease contracts for its branch locations, office space and certain equipment. As part of its property lease agreements, the Company may seek to include options to extend or terminate at lease when it is reasonably certain that the Company will exercise those options. The ROU lease asset also includes any lease payments made and lease incentives. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company does not possess any leases that have variable lease payments or residual value guarantees as of September 30, 2019.

 

Accounting Policy Elections - The Company has elected the package of practical expedients that permits the Company to not reassess our prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected all of the new standard’s available transition practical expedients, including the short-term lease recognition exemption that includes not recognizing ROU assets or lease liabilities for existing short-term leases, and the practical expedient to not separate lease and non-lease components for all of our leases.

 

Significant Assumptions - The Company uses its incremental borrowing rate to determine the present value of its lease liabilities. The Company calculated a weighted average borrowing rate of 3.14% and a weighted average remaining lease term of 5.47 years as of September 30, 2019.

 

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As of September 30, 2019, the Company recorded a ROU asset of $34.5 million, net of accumulated amortization of $6.2 million. Operating lease expense was $3.3 million and $10.1 million for the three and nine months ended September 30, 2019, respectively, and includes short-term leases that were immaterial. Operating cash flows from operating leases were $2.1 million and $6.2 million for the three and nine months ended September 30, 2019, respectively. The below maturity schedule represents the undiscounted lease payments for the 5-year period and thereafter as of September 30, 2019.

 

   

As of September 30, 2019

 
   

Operating Leases

 
   

(In thousands)

 

Remaining 2019

  $ 2,114  

2020

    8,543  

2021

    7,635  

2022

    6,428  

2023

    5,426  

Thereafter

    9,531  

Total lease payments

    39,677  

Less amount of payment representing interest

    (3,535 )

Total present value of lease payments

  $ 36,142  

 

The following table shows future minimum payments under operating leases with terms in excess of one year as of December 31, 2018.

 

   

As of December 31, 2018

 
   

Operating Leases

 
   

(In thousands)

 

2019

  $ 8,835  

2020

    7,220  

2021

    6,406  

2022

    5,406  

2023

    4,208  

Thereafter

    4,899  

Total minimum lease payments

  $ 36,974  

 

 

11. Borrowed Funds

 

Borrowings from the Federal Home Loan Bank (“FHLB”) - As of September 30, 2019, over-night borrowings from the FHLB were $330 million at an average rate of 2.08% compared to $200 million at an average rate of 2.56% as of December 31, 2018. Advances from the FHLB were $270 million at an average rate of 2.15% as of September 30, 2019 and $330 million at an average rate of 2.42% as of December 31, 2018. As of September 30, 2019, FHLB advances of $50 million will mature in December 2019, $75 million in May 2021, $50 million in June 2021, $75 million in July 2021, and $20 million in May 2023.

 

Other Borrowings - The Company owes a residual payable balance of $7.6 million to Bank SinoPac Co. related to the Company’s acquisition of SinoPac Bancorp, the parent of Far East National Bank. The remaining balance of $7.0 million, due in July 2020, has an interest rate of 3.60% (three month LIBOR rate plus 150 basis points) as of September 30, 2019.

 

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Table of Contents

 

Long-term Debt - On October 12, 2017, the Bank entered into a term loan agreement of $75.0 million with U.S. Bank. The loan has a floating rate of one-month LIBOR plus 175 basis points. As of September 30, 2019, the term loan has a remaining balance of $41.3 million and an interest rate of 3.875% compared to 4.125% at December 31, 2018. The principal amount of the long-term debt from U.S. Bank is due and payable in consecutive quarterly installments of $4.7 million each on the last day of each calendar quarter commencing December 31, 2018, with the final installment due and payable on October 12, 2020. We used the U.S. Bank loan proceeds to fund a portion of our acquisition of SinoPac Bancorp.

 

The Company established three special purpose trusts in 2003 and two in 2007 for the purpose of issuing Guaranteed Preferred Beneficial Interests in their Subordinated Debentures to outside investors (“Capital Securities”). The proceeds from the issuance of the Capital Securities as well as our purchase of the common stock of the special purpose trusts were invested in Junior Subordinated Notes of the Company (“Junior Subordinated Notes”). The trusts exist for the purpose of issuing the Capital Securities and investing in Junior Subordinated Notes. Subject to some limitations, payment of distributions out of the monies held by the trusts and payments on liquidation of the trusts, or the redemption of the Capital Securities, are guaranteed by the Company to the extent the trusts have funds on hand at such time. The obligations of the Company under the guarantees and the Junior Subordinated Notes are subordinate and junior in right of payment to all indebtedness of the Company and are structurally subordinated to all liabilities and obligations of the Company’s subsidiaries. The Company has the right to defer payments of interest on the Junior Subordinated Notes at any time or from time to time for a period of up to twenty consecutive quarterly periods with respect to each deferral period. Under the terms of the Junior Subordinated Notes, the Company may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock if it has deferred payment of interest on any Junior Subordinated Notes.

 

At September 30, 2019, Junior Subordinated Notes totaled $119.1 million with a weighted average interest rate of 4.29%, compared to $119.1 million with a weighted average rate of 4.96% at December 31, 2018. The Junior Subordinated Notes have a stated maturity term of 30 years.

 

 

12. Income Taxes

 

The effective tax rate for the first nine months of 2019 was 20.3% compared to 19.0% for the first nine months of 2018. The effective tax rate includes the impact of low-income housing and alternative energy investment tax credits. Income tax expense for the first nine months of 2019 was reduced by $0.6 million in benefits from the distribution of restricted stock units.

 

The Company’s tax returns are open for audit by the Internal Revenue Service back to 2016 and by the California Franchise Tax Board back to 2014. The Company is currently under audit by the Internal Revenue Service for 2017.

 

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.

 

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13. Fair Value Measurements

 

The Company 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.

 

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 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, U.S. Government sponsored entities, state and municipal securities, mortgage-backed securities (“MBS”), collateralized mortgage obligations and corporate bonds.

 

Equity Securities The Company measures the fair value based on quoted market prices in active exchange markets at the reporting date, a level 1 measurement. Equity securities are comprised of mutual funds, preferred stock of government-sponsored entities and other equity securities.

 

Foreign Exchange Contracts - The Company measures the fair value of foreign exchange contracts based on dealer quotes, a Level 2 measurement.

 

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

 

Interest Rate Swaps - Fair value of interest rate swaps is derived from third party models with observable market data, a Level 2 measurement.

 

Assets measured at estimated fair value on a non-recurring basis:

 

Certain assets or liabilities are required to be measured at estimated fair value on a nonrecurring basis subsequent to initial recognition. Generally, these adjustments are the result of lower-of-cost-or-fair value or other impairment write-downs of individual assets. In determining the estimated fair values during the period, the Company determined that substantially all the changes in estimated fair value were due to declines in market conditions versus instrument specific credit risk. For the nine months ended September 30, 2019 and December 31, 2018, there were no material adjustments to fair value for the Company’s assets and liabilities measured at fair value on a nonrecurring basis in accordance with GAAP.

 

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Table of Contents

 

The following tables present the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of September 30, 2019, and December 31, 2018:

 

   

September 30, 2019

         
   

Fair Value Measurements Using

   

Total Fair Value

 
   

Level 1

   

Level 2

   

Level 3

   

Measurements

 
   

(In thousands)

 

Assets

                               

Securities available-for-sale

                               

U.S. government agency entities

  $     $ 92,954     $     $ 92,954  

U.S. government sponsored entities

          347,699             347,699  

Mortgage-backed securities

          886,735             886,735  

Collateralized mortgage obligations

          665             665  

Corporate debt securities

          99,385             99,385  

Total securities available-for-sale

  $     $ 1,427,438     $     $ 1,427,438  
                                 

Equity securities

                               

Mutual funds

  $ 6,307     $     $     $ 6,307  

Preferred stock of government sponsored entities

    15,145                   15,145  

Other equity securities

    11,410                   11,410  

Total equity securities

  $ 32,862     $     $     $ 32,862  
                                 

Warrants

  $     $     $ 31     $ 31  

Interest rate swaps

          1,697             1,697  

Foreign exchange contracts

          965             965  

Total assets

  $ 32,862     $ 1,430,100     $ 31     $ 1,462,993  
                                 

Liabilities

                               

Option contracts

  $     $ 6     $     $ 6  

Interest rate swaps

          17,734             17,734  

Foreign exchange contracts

          2,435             2,435  

Total liabilities

  $     $ 20,175     $     $ 20,175  

 

   

December 31, 2018

         
   

Fair Value Measurements Using

   

Total Fair Value

 
   

Level 1

   

Level 2

   

Level 3

   

Measurements

 
   

(In thousands)

 

Assets

                               

Securities available-for-sale

                               

U.S. Treasury securities

  $ 124,751     $     $     $ 124,751  

U.S. government agency entities

          5,871             5,871  

U.S. government sponsored entities

          388,363             388,363  

Mortgage-backed securities

          656,744             656,744  

Collateralized mortgage obligations

          977             977  

Corporate debt securities

          65,803             65,803  

Total securities available-for-sale

  $ 124,751     $ 1,117,758     $     $ 1,242,509  
                                 

Equity securities

                               

Mutual funds

  $ 6,094     $     $     $ 6,094  

Preferred stock of government sponsored entities

    7,822                   7,822  

Other equity securities

    11,182                   11,182  

Total equity securities

  $ 25,098     $     $     $ 25,098  
                                 

Warrants

  $     $     $ 184     $ 184  

Interest rate swaps

          7,810             7,810  

Foreign exchange contracts

          397             397  

Total assets

  $ 149,849     $ 1,125,965     $ 184     $ 1,275,998  
                                 

Liabilities

                               

Option contracts

  $     $ 6     $     $ 6  

Interest rate swaps

          1,543             1,543  

Foreign exchange contracts

          1,763             1,763  

Total liabilities

  $     $ 3,312     $     $ 3,312  

 

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The Company measured the fair value of its warrants on a recurring basis using significant unobservable inputs. The fair value adjustment of warrants was included in other operating income in the third quarter of 2019. 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 6 years, risk-free interest rate from 1.77% to 1.87%, and stock volatility from 13.86% to 20.46%.

 

For financial assets measured at fair value on a nonrecurring basis that were still reflected in the Condensed Consolidated Balance Sheets as of September 30, 2019, the following tables set forth the level of valuation assumptions used to determine each adjustment, the carrying value of the related individual assets as of September 30, 2019, and December 31, 2018, and the total losses for the periods indicated:

 

   

As of September 30, 2019

           

Total Losses

 
   

Fair Value Measurements Using

   

Total Fair

   

For the Three Months Ended

   

For the Nine Months Ended

 
   

Level 1

   

Level 2

   

Level 3

   

Value

Measurements

   

September 30,

2019

   

September 30, 2018

   

September 30, 2019

   

September 30, 2018

 
   

(In thousands)

 

Assets

                                                               

Impaired loans by type:

                                                               

Commercial loans

  $     $     $ 12,491     $ 12,491     $     $     $     $  

Commercial mortgage loans

                25,752       25,752                          

Residential mortgage loans and equity lines

                5,696       5,696                          

Total impaired loans

                43,939       43,939                          

Loans held-for-sale

                36,778       36,778       120             120        

Other real estate owned (1) 

          7,625       4,343       11,968                   494        

Investments in venture capital and private company stock

                1,671       1,671       83       62       101       326  

Total assets

  $     $ 7,625     $ 86,731     $ 94,356     $ 203     $ 62     $ 715     $ 326  

 

(1) Other real estate owned balance of $11.3 million in the condensed consolidated balance sheet is net of estimated disposal costs. 

 

   

As of December 31, 2018

           

Total Losses/(Gains)

 
   

Fair Value Measurements Using

   

Total Fair Value

   

For the Twelve Months Ended

 
   

Level 1

   

Level 2

   

Level 3

   

Measurements

   

December 31, 2018

   

December 31, 2017

 
   

(In thousands)

 

Assets

                                               

Impaired loans by type:

                                               

Commercial loans

  $     $     $ 4,733     $ 4,733     $     $ 25  

Commercial mortgage loans

                26,186       26,186              

Residential mortgage loans and equity lines

                6,850       6,850              

Total impaired loans

                37,769       37,769             25  

Other real estate owned (1)

          9,023       4,343       13,366       (619 )     457  

Investments in venture capital and private company stock

                2,162       2,162       330       392  

Total assets

  $     $ 9,023     $ 44,274     $ 53,297     $ (289 )   $ 874  

 

(1) Other real estate owned balance of $12.7 million in the Consolidated Balance Sheets 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 are primarily based on the appraised value of collateral adjusted by estimated sales cost and commissions. The Company generally obtains new appraisal reports every twelve months as appropriate. 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 2018 reported period, collateral discounts ranged from 55% in the case of accounts receivable collateral to 65% in the case of inventory collateral. In the current year, the Company began using borrower specific collateral discounts with various discount levels.

 

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The significant unobservable inputs used in the fair value measurement of other real estate owned (“OREO”) are 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% of the collateral value of impaired loans, quoted price, or loan sale price of loans held for sale, and appraised value of OREO.

 

 

14. Fair Value of Financial Instruments

 

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

 

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

 

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

 

Securities Available for Sale - For certain 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, U.S. Government sponsored entities, state and municipal securities, mortgage-backed securities (“MBS”), collateralized mortgage obligations and corporate bonds.

 

Equity Securities The Company measures the fair value based on quoted market prices in active exchange markets at the reporting date, a level 1 measurement. Equity securities are comprised of mutual funds, preferred stock of government-sponsored entities and other equity securities.

 

Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and non-performing categories. The fair values are based primarily on third-party vendor pricing to determine fair values based on the exit price notion.

 

The fair value of performing loans is 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 is 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 or adjusted appraised value of the collateral, a Level 2 or Level 3 measurement.

 

Loans Held-for-Sale The Company records loans held for sale at fair value based on quoted prices from third party sale analysis, existing sale agreements, or appraisal reports adjusted by sales commission assumption, a Level 3 measurement.

 

FHLB Stock - These securities can only be redeemed or sold at their par value and only to the respective issuing government-supported institution or to another member institution. Management considers these non-marketable equity securities to be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value.     

 

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

 

Advances from 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 is derived from third party models with observable market data, 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 is 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 counterparties. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The fair value of off-balance-sheet financial instruments is based on the assumptions that a market participant would use, a Level 3 measurement.

 

Fair value is estimated in accordance with ASC Topic 825. Fair value estimates are 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 are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

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The following table sets forth the carrying and notional amounts and estimated fair value of financial instruments as of September 30, 2019 and December 31, 2018:

 

   

September 30, 2019

   

December 31, 2018

 
   

Carrying

           

Carrying

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 
   

(In thousands)

 

Financial Assets

                               

Cash and due from banks

  $ 257,189     $ 257,189     $ 225,333     $ 225,333  

Short-term investments

    567,957       567,957       374,957       374,957  

Securities available-for-sale

    1,427,438       1,427,438       1,242,509       1,242,509  

Loans held-for-sale

    36,778       36,778              

Loans, net

    14,601,565       15,004,114       13,871,832       13,928,162  

Equity securities

    32,862       32,862       25,098       25,098  

Investment in Federal Home Loan Bank stock

    17,250       17,250       17,250       17,250  

Warrants

    31       31       184       184  

 

   

Notional

           

Notional

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Foreign exchange contracts

  $ 70,955     $ 965     $ 86,875     $ 397  

Interest rate swaps

    139,466       1,697       467,410       7,810  

 

                                 
   

Carrying

           

Carrying

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Financial Liabilities

                               

Deposits

  $ 14,658,269     $ 14,703,977     $ 13,702,340     $ 13,754,028  

Advances from Federal Home Loan Bank

    600,000       603,014       530,000       529,500  

Other borrowings

    38,369       31,844       35,756       34,031  

Long-term debt

    160,386       113,409       189,448       132,615  

 

                                 
   

Notional

           

Notional

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Option contracts

  $ 1,172     $ 6     $ 1,215     $ 6  

Foreign exchange contracts

    121,769       2,435       94,977       1,763  

Interest rate swaps

    581,496       17,734       265,166       1,543  

 

                                 
   

Notional

           

Notional

         
   

Amount

   

Fair Value

   

Amount

   

Fair Value

 

Off-Balance Sheet Financial Instruments

                               

Commitments to extend credit

  $ 3,097,207     $ (9,291 )   $ 2,691,579     $ (8,843 )

Standby letters of credit

    264,059       (2,537 )     245,087       (2,662 )

Other letters of credit

    29,230       (28 )     35,759       (30 )

Bill of lading guarantees

    743             730        

 

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The following tables set forth the level in the fair value hierarchy for the estimated fair values of financial instruments as of September 30, 2019, and December 31, 2018.

 

   

As of September 30, 2019

 
   

Estimated

                         
   

Fair Value

                         
   

Measurements

   

Level 1

   

Level 2

   

Level 3

 
   

(In thousands)

 

Financial Assets

                               

Cash and due from banks

  $ 257,189     $ 257,189     $     $  

Short-term investments

    567,957       567,957              

Securities available-for-sale

    1,427,438             1,427,438        

Loans held-for-sale

    36,778                   36,778  

Loans, net

    15,004,114                   15,004,114  

Equity securities

    32,862       32,862              

Investment in Federal Home Loan Bank stock

    17,250             17,250        

Warrants

    31                   31  

Financial Liabilities

                               

Deposits

    14,703,977                   14,703,977  

Advances from Federal Home Loan Bank

    603,014             603,014        

Other borrowings

    31,844                   31,844  

Long-term debt

    113,409             113,409        

 

   

As of December 31, 2018

 
   

Estimated

                         
   

Fair Value

                         
   

Measurements

   

Level 1

   

Level 2

   

Level 3

 
   

(In thousands)

 

Financial Assets

                               

Cash and due from banks

  $ 225,333     $ 225,333     $     $  

Short-term investments

    374,957       374,957              

Securities available-for-sale

    1,242,509       124,751       1,117,758        

Loans, net

    13,928,162                   13,928,162  

Equity securities

    25,098       25,098              

Investment in Federal Home Loan Bank stock

    17,250             17,250        

Warrants

    184                   184  

Financial Liabilities

                               

Deposits

    13,754,028                   13,754,028  

Advances from Federal Home Loan Bank

    529,500             529,500        

Other borrowings

    34,031                   34,031  

Long-term debt

    132,615             132,615        

 

 

15. 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.  

 

As of September 30, 2019, 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.

 

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16. Financial Derivatives

 

It is our policy not to speculate on the future direction of interest rates. However, from time to time, we may enter 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 our assets or liabilities and against risk in specific transactions. In such instances, we may enter into interest rate swap contracts or other types of financial derivatives. 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 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 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. Fair value is determined using third-party models with observable market data. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivatives are reflected in current earnings, together with changes in the fair value of the related hedged item if there is a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged. If there is not a highly effective correlation between changes in the fair value of the interest rate swap and changes in the fair value of the underlying asset or liability that is intended to be hedged, then only the changes in the fair value of the interest rate swaps are reflected in the Company’s Consolidated Financial Statements.

 

The Company offers various interest rate derivative contracts to its customers. When derivative transactions are executed with its customers, the derivative contracts are offset by paired trades with third-party financial institutions including with central counterparties (“CCP”). Certain derivative contracts entered with CCPs are settled-to-market daily to the extent the CCP’s rulebooks legally characterize the variation margin as settlement. Derivative contracts are intended to allow borrowers to lock in attractive intermediate and long-term fixed rate financing while not increasing the interest rate risk to the Company. These transactions are generally not linked to specific Company assets or liabilities on the Condensed Consolidated Balance Sheets or to forecasted transactions in a hedging relationship and, therefore, are economic hedges. The contracts are marked to market at each reporting period. The changes in fair values of the derivative contracts traded with third-party financial institutions are expected to be largely comparable to the changes in fair values of the derivative transactions executed with customers throughout the terms of these contracts, except for the credit valuation adjustment component.  The Company records credit valuation adjustments on derivatives to properly reflect the variances of credit worthiness between the Company and the counterparties, considering the effects of enforceable master netting agreements and collateral arrangements.

 

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In May 2014, the Bancorp entered into interest rate swap contracts in the notional amount of $119.1 million for a period of ten years. The objective of these interest rate swap contracts, which were designated as hedging instruments in cash flow hedges, was to hedge the quarterly interest payments on the Bancorp’s $119.1 million of Junior Subordinated Debentures that had been issued to five trusts, throughout the ten-year period beginning in June 2014 and ending in June 2024, from the risk of variability of these payments resulting from changes in the three-month LIBOR interest rate. The Bancorp pays a weighted average fixed interest rate of 2.61% and receives a variable interest rate of the three-month LIBOR at a weighted average rate of 2.37%. The notional amount of cash flow interest rate swaps was $119.1 million as of both September 30, 2019 and December 31, 2018, and their unrealized loss of $4.4 million and $241 thousand, net of taxes, was included in other comprehensive income as of September 30, 2019 and December 31, 2018, respectively. The amount of periodic net settlement of interest rate swaps included in interest expense was $78 thousand and $83 thousand for the three months ended September 30, 2019 and 2018, respectively. The amount of periodic net settlement of interest rate swaps included in interest expense was a net interest expense of $41 thousand and a net interest expense of $480 thousand for the nine months ended September 30, 2019 and 2018, respectively. As of September 30, 2019, and 2018, the ineffective portion of these interest rate swaps was not significant.

 

As of September 30, 2019, the Bank’s outstanding interest rate swap contracts had a notional amount of $584.0 million for various terms from three to ten years. The Bank entered into these interest rate swap contracts that are matched to individual fixed-rate commercial real estate loans in the Bank’s loan portfolio. These contracts have been designated as hedging instruments to hedge the risk of changes in the fair value of the underlying commercial real estate loans due to changes in interest rates. The swap contracts are structured so that the notional amounts reduce over time to match the contractual amortization of the underlying loan and allow prepayments with the same pre-payment penalty amounts as the related loan. The Bank pays a weighted average fixed rate of 4.71% and receives a variable rate of the one-month LIBOR rate plus a weighted average spread of 261 basis points, or at a weighted average rate of 5.01%. As of September 30, 2019, and December 31, 2018, the notional amount of fair value interest rate swaps was $584.0 million and $613.4 million, respectively, with net unrealized losses of $9.8 million and net unrealized gains of $6.6 million, respectively, included in other non-interest income. The amount of periodic net settlement of interest rate swaps increased interest income by $205 thousand and $96 thousand for the three months ended September 30, 2019 and 2018, respectively. The amount of periodic net settlement of interest rate swaps increased interest income by $1.4 million and decreased interest income by $132 thousand for the nine months ended September 30, 2019 and 2018, respectively. As of September 30, 2019, and 2018, the ineffective portion of these interest rate swaps was not significant.

 

Interest rate swap contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have a strong credit profile and be approved by the Company’s Board of Directors. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. The Bancorp’s interest rate swaps have been assigned by the counterparties to a derivative clearing organization and daily margin is indirectly maintained with the derivative clearing organization. Cash posted as collateral by the Bancorp related to derivative contracts totaled $9.1 million as of September 30, 2019 and $1.8 million as of December 31, 2018.

 

The Company from time to time enters into foreign exchange forward contracts with various counterparties to mitigate the risk of fluctuations in foreign currency exchange rates for foreign exchange certificates of deposit or foreign exchange 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 and foreign exchange 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. As of September 30, 2019, the notional amount of option contracts totaled $1.2 million with a net negative fair value of $6 thousand. As of September 30, 2019, spot, forward, and swap contracts in the total notional amount of $71.0 million had a positive fair value of $965 thousand. Spot, forward, and swap contracts in the total notional amount of $121.8 million had a negative fair value of $2.4 million at September 30, 2019. As of December 31, 2018, the notional amount of option contracts totaled $1.2 million with a net negative fair value of $6 thousand. As of December 31, 2018, spot, forward, and swap contracts in the total notional amount of $86.9 million had a positive fair value of $397 thousand. Spot, forward, and swap contracts in the total notional amount of $95.0 million had a negative fair value of $1.8 million at December 31, 2018.

 

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17. Balance Sheet Offsetting

 

Certain financial instruments, including resell and repurchase agreements, securities lending arrangements and derivatives, may be eligible for offset in the Condensed Consolidated Balance Sheets and/or subject to master netting arrangements or similar agreements. The Company’s securities sold with agreements to repurchase and derivative transactions with upstream financial institution counterparties are generally executed under International Swaps and Derivative Association master agreements that 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 September 30, 2019, and December 31, 2018, are set forth in the following table:

 

                           

Gross Amounts Not Offset in the

 
                            Balance Sheet  
   

Gross

Amounts

Recognized

   

Gross Amounts

Offset in the

Balance Sheet

   

Net Amounts

Presented in the

Balance Sheet

   

Financial

Instruments

   

Collateral

Posted

   

Net Amount

 

 

 

(In thousands)

 
September 30, 2019      

Assets:

                                               

Derivatives

  $ 1,697     $     $ 1,697     $     $     $ 1,697  
                                                 

Liabilities:

                                               

Derivatives

  $ 17,734     $     $ 17,734     $     $ (22,198 )   $ (4,464 )
                                                 

December 31, 2018

                                               

Assets:

                                               

Derivatives

  $ 7,810     $     $ 7,810     $     $     $ 7,810  
                                                 

Liabilities:

                                               

Derivatives

  $ 1,543     $     $ 1,543     $     $ (1,543 )   $  

 

 

18. Revenue from Contracts with Customers

 

On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers - Topic 606 and all subsequent ASUs that modified ASC 606, Revenue from Contracts with Customers. The Company adopted ASC 606 using the modified retrospective method applied to those contracts that were not completed as of January 1, 2018. The new standard did not materially impact the timing or measurement of the Company’s revenue recognition as it is consistent with the Company’s existing accounting for contracts within the scope of the new standard. There was no cumulative effect adjustment to retained earnings as a result of adopting this new standard.

 

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The following is a summary of revenue from contracts with customers that are in-scope and not in-scope under ASC 606:

 

   

Three months Ended September 30,

   

Nine months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands)

 

Non-interest income, in-scope:

                               

Fees and service charges on deposit accounts

  $ 1,892     $ 2,027     $ 5,940     $ 6,421  

Wealth management fees

    2,049       1,528       6,258       4,252  

Other service fees(1)

    3,645       3,376       10,593       10,140  

Total noninterest income

    7,586       6,931       22,791       20,813  
                                 

Noninterest income, not in-scope(2)

    2,802       904       13,312       99  

Total noninterest income

  $ 10,388     $ 7,835     $ 36,103     $ 20,912  

 

(1)  Other service fees comprise of fees related to letters of credit, wire fees, fees on foreign exchange transactions and other immaterial individual revenue streams.

(2)  These amounts primarily represent revenue from contracts with customers that are out of the scope of ASC 606.

 

The major revenue streams by fee type that are within the scope of ASC 606 presented in the above tables are described in additional detail below:

 

Fees and Services Charges on Deposit Accounts

 

Fees and service charges on deposit accounts include charges for analysis, overdraft, cash checking, ATM, and safe deposit activities executed by our deposit clients, as well as interchange income earned through card payment networks for the acceptance of card based transactions. Fees earned from our deposit clients are governed by contracts that provide for overall custody and access to deposited funds and other related services and can be terminated at will by either party. Fees received from deposit clients for the various deposit activities are recognized as revenue by the Company once the performance obligations are met. The adoption of ASU 2014-09 had no impact to the recognition of fees and service charges on deposit accounts.

 

Wealth Management Fees

 

The Company employs financial consultants to provide investment planning services for customers including wealth management services, asset allocation strategies, portfolio analysis and monitoring, investment strategies, and risk management strategies. The fees the Company earns are variable and are generally received monthly by the Company. The Company recognizes revenue for the services performed at quarter end based on actual transaction details received from the broker dealer the Company engages.

 

Practical Expedients and Exemptions

 

The Company applies the practical expedient in ASC 606-10-50-14 and does not disclose the value of unsatisfied performance obligations as the Company’s contracts with customers generally have a term that is less than one year, are open-ended with a cancellation period that is less than one year, or allow the Company to recognize revenue in the amount to which the Company has the right to invoice.

 

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In addition, given the short term nature of the contracts, the Company also applies the practical expedient in ASC 606-10-32-18 and does not adjust the consideration from customers for the effects of a significant financing component, if at contract inception the period between when the entity transfers the goods or services and when the customer pays for that good or service is one year or less.

 

 

19. Stockholders’ Equity

 

Total equity was $2.25 billion as of September 30, 2019, an increase of $124.0 million, from $2.12 billion as of December 31, 2018, primarily due to net income of $211.8 million, increases in other comprehensive income of $17.2 million, and proceeds from dividend reinvestment of $2.5 million, and partially offset by common stock cash dividends of $74.4 million and repurchases of the Company’s common stock of $36.3 million.

 

Activity in accumulated other comprehensive income, net of tax, and reclassification out of accumulated other comprehensive income for the three months and nine months ended September 30, 2019, and September 30, 2018, was as follows:

 

   

Three months ended September 30, 2019

   

Three months ended September 30, 2018

 
   

Pre-tax

   

Tax expense/

(benefit)

   

Net-of-tax

   

Pre-tax

   

Tax expense/

(benefit)

   

Net-of-tax

 

 

 

(In thousands)

 
Beginning balance, gain/(loss), net of tax      

Securities available-for-sale

            $ 2,209                     $ (24,084 )

Cash flow hedge derivatives

              (3,567 )                     1,163  

Total

                  $ (1,358 )                   $ (22,921 )
                                                 

Net unrealized gains/(losses) arising during the period

                                               

Securities available-for-sale

  $ 1,750     $ 517     $ 1,233     $ (3,603 )   $ (1,065 )   $ (2,538 )

Cash flow hedge derivatives

    (1,126 )     (333 )     (793 )     2,365       699       1,666  

Total

  $ 624     $ 184     $ 440     $ (1,238 )   $ (366 )   $ (872 )
                                                 

Reclassification adjustment for net losses in net income

                                               

Securities available-for-sale

    121       36       85       14       4       10  

Cash flow hedge derivatives

                                   

Total

    121       36       85       14       4       10  
                                                 

Total other comprehensive income/(loss)

                                               

Securities available-for-sale

  $ 1,871     $ 553     $ 1,318     $ (3,589 )   $ (1,061 )   $ (2,528 )

Cash flow hedge derivatives

    (1,126 )     (333 )     (793 )     2,365       699       1,666  

Total

  $ 745     $ 220     $ 525     $ (1,224 )   $ (362 )   $ (862 )
                                                 

Ending balance, gain/(loss), net of tax

                                               

Securities available-for-sale

            $ 3,527                     $ (26,612 )

Cash flow hedge derivatives

              (4,360 )                     2,829  

Total

                  $ (833 )                   $ (23,783 )

 

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Nine months ended September 30, 2019

   

Nine months ended September 30, 2018

 
   

Pre-tax

   

Tax expense/

(benefit)

   

Net-of-tax

   

Pre-tax

   

Tax expense/

(benefit)

   

Net-of-tax

 

 

 

(In thousands)

 
Beginning balance, loss, net of tax                                          

Securities available-for-sale

            $ (17,765 )                   $ (1,060 )

Cash flow hedge derivatives

              (241 )                     (1,451 )

Total

                  $ (18,006 )                   $ (2,511 )
                                                 
Reclassification adjustment for stranded tax effects of Tax Cuts and Jobs Act (1)                                                

Securities available-for-sale

  $     $     $     $     $ 200     $ (200 )

Cash flow hedge derivatives

                            315       (315 )

Total

  $     $     $     $     $ 515     $ (515 )
                                                 

Reclassification adjustment for equity securities (2)

                                               

Equity securities

  $     $     $     $ (12,151 )   $ (3,592 )   $ (8,559 )
                                                 

Net unrealized gains/(losses) arising during the period

                                               

Securities available-for-sale

  $ 30,119     $ 8,903     $ 21,216     $ (23,854 )   $ (7,051 )   $ (16,803 )

Cash flow hedge derivatives

    (5,848 )     (1,729 )     (4,119 )     6,523       1,928       4,595  

Total

  $ 24,271     $ 7,174     $ 17,097     $ (17,331 )   $ (5,123 )   $ (12,208 )
                                                 

Reclassification adjustment for net losses in net income

                                               

Securities available-for-sale

    108       32       76       14       4       10  

Cash flow hedge derivatives

                                   

Total

    108       32       76       14       4       10  
                                                 

Total other comprehensive income/(loss)

                                               

Securities available-for-sale

  $ 30,227     $ 8,935     $ 21,292     $ (23,840 )   $ (7,047 )   $ (16,793 )

Cash flow hedge derivatives

    (5,848 )     (1,729 )     (4,119 )     6,523       1,928       4,595  

Total

  $ 24,379     $ 7,206     $ 17,173     $ (17,317 )   $ (5,119 )   $ (12,198 )
                                                 

Ending balance, gain/(loss), net of tax

                                               

Securities available-for-sale

            $ 3,527                     $ (26,612 )

Cash flow hedge derivatives

              (4,360 )                     2,829  

Total

                  $ (833 )                   $ (23,783 )

 

(1

These amounts were recorded as of January 1, 2018 as a result of the adoption of ASU 2018-2.

(2

This amount was recorded as of January 1, 2018 as a result of the adoption of ASU 2016-1.

 

 

20. Stock Repurchase Program

 

In May 2019, the Company completed the October 2018 stock repurchase program with the repurchase of 1,182,060 shares in total for approximately $45.0 million at an average cost of $38.07 per share of the Company’s common stock.

 

Thereafter, on May 7, 2019, the Company announced that its Board of Directors adopted a new stock repurchase program to buy back up to $50.0 million of the Company’s common stock. As of September 30, 2019, the Company repurchased 741,934 shares for approximately $26.4 million, at an average cost of $35.59 per share, and may repurchase up to an additional $23.6 million of its common stock under the May 2019 stock repurchase program.

 

 

21. Subsequent Events

 

The Company has evaluated the effect of events that have occurred subsequent to September 30, 2019, through the date of issuance of the Condensed Consolidated Financial Statements, and, based on such evaluation, the Company believes that there have been no material events during such period that would require recognition in the Condensed Consolidated Financial Statements or disclosure in the Notes to the Condensed Consolidated Financial Statements.

 

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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion is 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, 2018.

 

Critical Accounting Policies

 

The discussion and analysis of the Company’s financial condition 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 the Condensed Consolidated Financial Statements. Actual results may differ from these estimates under different assumptions or conditions.

 

Critical accounting policies involve significant judgments, assumptions and uncertainties and are essential to understanding the Company’s results of operations and financial condition. Management of the Company considers the following to be critical accounting policies:

 

Accounting for the allowance for loan losses involves significant judgments and assumptions by management, which have a material impact on, among other things, 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, 2018.

 

Highlights

 

 

Total loans, including loans held for sale, increased $171.8 million, or 4.9% annualized, to $14.8 billion for the quarter.

 

Total deposits increased $295.3 million, or 8.6% annualized, to $14.7 billion for the quarter.

 

Quarterly Statement of Operations Review

 

Net Income

 

Net income for the quarter ended September 30, 2019, was $72.8 million, an increase of $3.0 million, or 4.3%, compared to net income of $69.8 million for the same quarter a year ago. Diluted earnings per share for the quarter ended September 30, 2019 was $0.91 compared to $0.85 for the same quarter a year ago.

 

Return on average stockholders’ equity was 12.98% and return on average assets was 1.65% for the quarter ended September 30, 2019, compared to a return on average stockholders’ equity of 13.19% and a return on average assets of 1.72% for the same quarter a year ago.

 

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Financial Performance

 

   

Three months ended

 
   

September 30, 2019

   

September 30, 2018

 

Net income (in millions)

  $ 72.8     $ 69.8  

Basic earnings per common share

  $ 0.91     $ 0.86  

Diluted earnings per common share

  $ 0.91     $ 0.85  

Return on average assets

    1.65 %     1.72 %

Return on average total stockholders' equity

    12.98 %     13.19 %

Efficiency ratio

    41.67 %     43.14 %

 

Net Interest Income Before Provision for Credit Losses

 

Net interest income before provision for credit losses increased $1.9 million, or 1.3%, to $147.0 million during the third quarter of 2019, compared to $145.1 million during the same quarter a year ago. The increase was due primarily to a $3.1 million increase in interest recoveries and prepayment penalties, offset in part by an increase in interest expense from time deposits.

 

The net interest margin was 3.56% for the third quarter of 2019 compared to 3.83% for the third quarter of 2018 and 3.58% for the second quarter of 2019.

 

For the third quarter of 2019, the yield on average interest-earning assets was 4.80%, the cost of funds on average interest-bearing liabilities was 1.65%, and the cost of interest-bearing deposits was 1.60%. In comparison, for the third quarter of 2018, the yield on average interest-earning assets was 4.67%, the cost of funds on average interest-bearing liabilities was 1.15%, and the cost of interest-bearing deposits was 1.05%. The increase in the yield on average interest-earning assets resulted primarily from the higher interest recoveries and prepayment penalties discussed above. The net interest spread, defined as the difference between the yield on average interest-earning assets and the cost of funds on average interest-bearing liabilities, was 3.15% for the quarter ended September 30, 2019, compared to 3.52% for the same quarter a year ago.

 

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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 September 30, 2019, and 2018. Average outstanding amounts included in the table are daily averages.

 

   

Interest-Earning Assets and Interest-Bearing Liabilities

 
   

Three months ended September 30,

 
   

2019

   

2018

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 
   

Balance

   

Expense

   

Rate (1)(2)

   

Balance

   

Expense

   

Rate (1)(2)

 
   

(Dollars in thousands)

 

Interest-earning assets:

                                               

Total loans and leases (1)

  $ 14,662,847     $ 187,827       5.08 %   $ 13,434,018     $ 168,179       4.97 %

Investment securities

    1,498,569       8,687       2.30       1,399,031       7,546       2.14  

Federal Home Loan Bank stock

    17,250       301       6.92       17,250       303       6.95  

Interest-bearing deposits

    188,772       1,016       2.14       178,434       838       1.86  

Total interest-earning assets

    16,367,438       197,831       4.80       15,028,733       176,866       4.67  

Non-interest earning assets:

                                               

Cash and due from banks

    204,974                       196,693                  

Other non-earning assets

    1,037,937                       1,036,279                  

Total non-interest earning assets

    1,242,911                       1,232,972                  

Less: Allowance for loan losses

    (125,399 )                     (124,579 )                

Deferred loan fees

    (1,574 )                     (2,777 )                

Total assets

  $ 17,483,376                     $ 16,134,349                  
                                                 

Interest-bearing liabilities:

                                               

Interest-bearing demand accounts

  $ 1,281,629     $ 589       0.18 %   $ 1,396,436     $ 694       0.20 %

Money market accounts

    2,028,039       5,684       1.11       2,234,139       4,435       0.79  

Savings accounts

    726,763       354       0.19       780,412       345       0.18  

Time deposits

    7,623,238       40,378       2.10       5,997,268       22,135       1.46  

Total interest-bearing deposits

    11,659,669       47,005       1.60       10,408,255       27,609       1.05  
                                                 

Securities sold under agreements to repurchase

                      16,304       124       3.02  

Other borrowings

    362,698       1,878       2.05       307,298       1,829       2.36  

Long-term debt

    165,023       1,948       4.68       194,136       2,220       4.54  

Total interest-bearing liabilities

    12,187,390       50,831       1.65       10,925,993       31,782       1.15  
                                                 

Non-interest bearing liabilities:

                                               

Demand deposit

    2,805,582                       2,877,646                  

Other liabilities

    263,813                       232,924                  

Total equity

    2,226,591                       2,097,786                  

Total liabilities and equity

  $ 17,483,376                     $ 16,134,349                  
                                                 

Net interest spread

                    3.15 %                     3.52 %

Net interest income

          $ 147,000                     $ 145,084          

Net interest margin

                    3.56 %                     3.83 %

 

(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.

 

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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 Volume and Rate(1)  
    Three months ended September 30,  
    2019-2018  
    Increase/(Decrease) in  
    Net Interest Income Due to:  
   

Changes in

Volume

   

Changes in

Rate

   

Total

Change

 
   

(In thousands)

 
Interest-earning assets:                        

Loans and leases

  $ 15,669     $ 3,979     $ 19,648  

Investment securities

    556       584       1,140  

Federal Home Loan Bank stock

          (2 )     (2 )

Deposits with other banks

    51       128       179  

Total changes in interest income

    16,276       4,689       20,965  
                         

Interest-bearing liabilities:

                       

Interest-bearing demand accounts

    (55 )     (50 )     (105 )

Money market accounts

    (435 )     1,683       1,248  

Savings accounts

    (24 )     33       9  

Time deposits

    7,004       11,239       18,243  

Securities sold under agreements to repurchase

    (62 )     (62 )     (124 )

Other borrowed funds

    303       (253 )     50  

Long-term debt

    (341 )     69     $ (272 )

Total changes in interest expense

    6,390       12,659       19,049  

Changes in net interest income

  $ 9,886     $ (7,970 )   $ 1,916  

 

  (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.

 

 

Provision/(reversal) for credit losses

 

The Company recorded a reversal for credit losses of $2.0 million in the third quarter of 2019 compared to a reversal for credit losses of $1.5 million in the third quarter of 2018, based on our management’s review of the appropriateness of the allowance for loan losses at September 30, 2019 and September 30, 2018, respectively. The following table summarizes the charge-offs and recoveries for the periods indicated:

 

   

Three months ended September 30,

   

Nine months ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands)

 

Charge-offs:

                               

Commercial loans

  $ 3,356     $ 122     $ 6,300     $ 629  

Real estate loans (1)

                      390  

Total charge-offs

    3,356       122       6,300       1,019  

Recoveries:

                               

Commercial loans

    212       187       1,609       1,250  

Construction loans

    3,378       44       4,612       132  

Real estate loans (1)

    5,023       2,949       5,596       4,315  

Total recoveries

    8,613       3,180       11,817       5,697  

Net recoveries

  $ (5,257 )   $ (3,058 )   $ (5,517 )   $ (4,678 )

 

  (1) 

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

 

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Non-Interest Income

 

Non-interest income, which includes revenues from depository service fees, letters of credit commissions, equity securities gains (losses), wire transfer fees, and other sources of fee income, was $10.4 million for the third quarter of 2019, an increase of $2.6 million, or 33.3%, compared to $7.8 million for the third quarter of 2018. The increase was primarily due to an increase of $1.5 million in the valuation of interest rate swap contracts and an increase of $0.8 million from the sale of residential mortgages, when compared to the same quarter a year ago.

 

Non-Interest Expense

 

Non-interest expense decreased $0.4 million, or 0.6%, to $65.6 million in the third quarter of 2019, compared to $66.0 million in the same quarter a year ago. The decrease was primarily due to a $4.1 million decrease in the amortization of low income housing and alternative energy partnerships, which was partially offset by a $1.4 million increase in salary and employee benefits and a $1.2 million increase in marketing expense, when compared to the same quarter a year ago. The efficiency ratio was 41.7% in the third quarter of 2019 compared to 43.1% for the same quarter a year ago.

 

Income Taxes

 

The effective tax rate for the third quarter of 2019 was 22.4% compared to 21.1% for the third quarter of 2018. The income tax expense for the third quarter of 2019 included a $1.4 million adjustment to reflect the impact of the delay in installation of solar systems and $0.8 million adjustment for lower than expected low income housing tax credits. The effective tax rate for both quarters includes the impact of low-income housing and alternative energy investment tax credits.

 

Year-to-Date Statement of Operations Review

 

Net income for the nine months ended September 30, 2019, was $211.8 million, an increase of $4.6 million, or 2.2%, compared to net income of $207.2 million for the same period a year ago. Diluted earnings per share was $2.64 compared to $2.53 per share for the same period a year ago. The net interest margin for the nine months ended September 30, 2019, was 3.61% compared to 3.80% for the same period a year ago.

 

Return on average stockholders’ equity was 12.94% and return on average assets was 1.65% for the nine months ended September 30, 2019, compared to a return on average stockholders’ equity of 13.56% and a return on average assets of 1.75% for the same period a year ago. The efficiency ratio for the nine months ended September 30, 2019, was 43.87% compared to 43.05% for the same period a year ago.

 

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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 nine months ended September 30, 2019, and 2018. Average outstanding amounts included in the table are daily averages.

 

   

Interest-Earning Assets and Interest-Bearing Liabilities

 
   

Nine months ended September 30,

 
   

2019

   

2018

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 
   

Balance

   

Expense

   

Rate (1)(2)

   

Balance

   

Expense

   

Rate (1)(2)

 
   

(Dollars in thousands)

 

Interest-earning assets:

                                               

Total loans and leases (1)

  $ 14,374,397     $ 548,395       5.10 %   $ 13,126,693     $ 478,128       4.87 %

Investment securities

    1,404,046       24,454       2.33       1,357,818       21,212       2.09  

Federal Home Loan Bank stock

    17,268       903       6.99       18,975       1,079       7.60  

Interest-bearing deposits

    245,971       4,289       2.33       281,883       3,667       1.74  

Total interest-earning assets

    16,041,682       578,041       4.82       14,785,369       504,086       4.56  

Non-interest earning assets:

                                               

Cash and due from banks

    198,835                       209,456                  

Other non-earning assets

    1,038,009                       996,466                  

Total non-interest earning assets

    1,236,844                       1,205,922                  

Less: Allowance for loan losses

    (123,854 )                     (123,591 )                

Deferred loan fees

    (1,476 )                     (3,117 )                

Total assets

  $ 17,153,196                     $ 15,864,583                  
                                                 

Interest-bearing liabilities:

                                               

Interest-bearing demand accounts

  $ 1,285,180     $ 1,773       0.18 %   $ 1,394,743     $ 2,003       0.19 %

Money market accounts

    1,933,898       14,754       1.02       2,230,365       11,674       0.70  

Savings accounts

    725,257       1,064       0.20       807,402       1,216       0.20  

Time deposit

    7,421,255       113,992       2.05       5,833,807       56,593       1.30  

Total interest-bearing deposits

    11,365,590       131,583       1.55       10,266,317       71,486       0.93  
                                                 

Securities sold under agreements to repurchase

                      66,300       1,446       2.92  

Other borrowings

    392,483       6,676       2.27       287,771       4,231       1.97  

Long-term debt

    172,567       6,087       4.72       194,136       6,465       4.45  

Total interest-bearing liabilities

    11,930,640       144,346       1.62       10,814,524       83,628       1.03  
                                                 

Non-interest bearing liabilities:

                                               

Demand deposits

    2,790,367                       2,796,831                  

Other liabilities

    244,568                       210,391                  

Total equity

    2,187,621                       2,042,837                  

Total liabilities and equity

  $ 17,153,196                     $ 15,864,583                  
                                                 

Net interest spread

                    3.20 %                     3.53 %

Net interest income

          $ 433,695                     $ 420,458          

Net interest margin

                    3.61 %                     3.80 %

 

(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.

 

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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 Volume and Rate(1)  
    Nine months ended September 30,  
    2019-2018  
    Increase/(Decrease) in  
    Net Interest Income Due to:  
   

Changes in

Volume

   

Changes in

Rate

   

Total

Change

 
   

(In thousands)

 

Interest-earning assets:

                       

Loans and leases

  $ 46,884     $ 23,383     $ 70,267  

Investment securities

    741       2,501       3,242  

Federal Home Loan Bank stock

    (93 )     (83 )     (176 )

Deposits with other banks

    (285 )     907       622  

Total changes in interest income

    47,247       26,708       73,955  
                         

Interest-bearing liabilities:

                       

Interest-bearing demand accounts

    (153 )     (77 )     (230 )

Money market accounts

    (914 )     3,994       3,080  

Savings accounts

    (121 )     (30 )     (151 )

Time deposits

    18,257       39,141       57,398  

Securities sold under agreements to repurchase

    (723 )     (723 )     (1,446 )

Other borrowed funds

    1,708       736       2,444  

Long-term debt

    (580 )     203       (377 )

Total changes in interest expense

    17,474       43,244       60,718  

Changes in net interest income

  $ 29,773     $ (16,536 )   $ 13,237  

 

(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.

 

Balance Sheet Review

 

Assets

 

Total assets were $18.0 billion as of September 30, 2019, an increase of $1.2 billion, or 7.1%, from $16.8 billion as of December 31, 2018, primarily due to loan growth and increases in investment securities offset in part by decreases in short-term investments.

 

Securities Available for Sale

 

Securities available-for-sale represented 7.9% of total assets as of September 30, 2019, compared to 7.4% of total assets as of December 31, 2018. Securities available-for-sale were $1.4 billion as of September 30, 2019, compared to $1.2 billion as of December 31, 2018.

 

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The following tables set forth the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of securities available-for-sale as of September 30, 2019, and December 31, 2018:

 

   

September 30, 2019

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. government agency entities

  $ 92,477     $ 750     $ 273     $ 92,954  

U.S. government sponsored entities

    350,000             2,301       347,699  

Mortgage-backed securities

    880,406       7,714       1,385       886,735  

Collateralized mortgage obligations

    683             18       665  

Corporate debt securities

    98,865       533       13       99,385  

Total

  $ 1,422,431     $ 8,997     $ 3,990     $ 1,427,438  

 

   

December 31, 2018

 
           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

         
   

Cost

   

Gains

   

Losses

   

Fair Value

 
   

(In thousands)

 

Securities Available-for-Sale

                               

U.S. treasury securities

  $ 124,801     $     $ 50     $ 124,751  

U.S. government agency entities

    6,066             195       5,871  

U.S. government sponsored entities

    400,000             11,638       388,362  

Mortgage-backed securities

    670,874       960       15,089       656,745  

Collateralized mortgage obligations

    1,005             28       977  

Corporate debt securities

    64,985       818             65,803  

Total

  $ 1,267,731     $ 1,778     $ 27,000     $ 1,242,509  

 

For additional information, see Note 7 to the Company’s unaudited Condensed Consolidated Financial Statements.

 

Securities available-for-sale having a carrying value of $20.8 million as of September 30, 2019, and $28.5 million as of December 31, 2018, were pledged to secure public deposits, other borrowings and treasury tax and loan.

 

Equity Securities

 

The adoption of ASU 2016-01 resulted in approximately $8.6 million being reclassified from accumulated other comprehensive income to retained earnings, representing an increase to retained earnings as of January 1, 2018. The Company recognized a net gain of $0.4 million for the three months ended September 30, 2019, due to the increase in fair value of equity investments with readily determinable fair values compared to a net gain of $0.4 million for the three months ended September 30, 2018. The Company recognized a net gain of $7.8 million for the nine months ended September 30, 2019, due to the increase in fair value of equity investments with readily determinable fair values compared to a net loss of $4.6 million for the nine months ended September 30, 2018. Equity securities were $32.9 million and $25.1 million as of September 30, 2019 and December 31, 2018, respectively.

 

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Loans

 

Gross loans, including loans held for sale, were $14.8 billion at September 30, 2019, an increase of $769.5 million, or 5.5%, from $14.0 billion at December 31, 2018. The increase was primarily due to increases of $353.7 million, or 9.6%, in residential mortgage loans, including loans held for sale, $411.4 million, or 6.1%, in commercial mortgage loans, $65.3 million, or 26.1%, in home equity loans, and $12.4 million, or 2.1%, in real estate construction loans, offset by a decrease of $73.9 million, or 2.7%, in commercial loans. The loan balances and composition at September 30, 2019, compared to December 31, 2018 are set forth below:

 

   

September 30, 2019

   

% of Gross

Loans

   

December 31, 2018

   

% of Gross

Loans

   

% Change

 
   

(Dollars in thousands)

 
                                         

Commercial loans

  $ 2,668,061       18.1 %   $ 2,741,965       19.6 %     (2.7% )

Equity lines

    315,252       2.1       249,967       1.8       26.1  

Commercial mortgage loans

    7,135,599       48.4       6,724,200       48.0       6.1  

Residential mortgage loans

    4,010,739       27.2       3,693,853       26.4       8.6  

Real estate construction loans

    593,816       4.0       581,454       4.2       2.1  

Installment and other loans

    5,087       0.0       4,349       0.0       17.0  

Gross loans

  $ 14,728,554       100 %   $ 13,995,788       100 %     5.2 %

Allowance for loan losses

    (125,908 )             (122,391 )             2.9  

Unamortized deferred loan fees

    (1,081 )             (1,565 )             (30.9 )

Total loans, net

  $ 14,601,565             $ 13,871,832               5.3 %
                                         

Loans held for sale

  $ 36,778             $               100.0 %

 

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 to seek to identify problem loans. From time to time during the ordinary course of business, management may become aware of borrowers that may not be able to meet the contractual requirements of their loan agreements. Such loans generally 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 0.3% at September 30, 2019, and December 31, 2018. Total non-performing assets increased $0.9 million, or 1.5%, to $59.2 million at September 30, 2019, compared to $58.3 million at December 31, 2018, primarily due to an increase of $5.4 million, or 12.9%, in non-accrual loans, offset in part by a decrease of $1.3 million, or 10.6%, in other real estate owned and a decrease of $3.1 million, or 81.9%, in accruing loans past due 90 days or more.

 

As a percentage of gross loans, excluding loans held for sale, plus OREO, our non-performing assets was 0.40% as of September 30, 2019, compared to 0.42% as of December 31, 2018. The non-performing loan portfolio coverage ratio, defined as the allowance for credit losses to non-performing loans, decreased to 272.5% as of September 30, 2019, from 273.4% as of December 31, 2018.

 

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The following table sets forth the changes in non-performing assets and troubled debt restructurings (“TDRs”) as of September 30, 2019, compared to December 31, 2018, and to September 30, 2018:

 

   

September 30, 2019

   

December 31, 2018

   

% Change

   

September 30, 2018

   

% Change

 
   

(Dollars in thousands)

 

Non-performing assets

                                       

Accruing loans past due 90 days or more

  $ 683     $ 3,773       (82 )   $ 6,681       (90 )

Non-accrual loans:

                                       

Construction loans

    4,629       4,872       (5 )     4,922       (6 )

Commercial mortgage loans

    12,330       10,611       16       13,172       (6 )

Commercial loans

    22,970       18,805       22       17,118       34  

Residential mortgage loans

    7,271       7,527       (3 )     7,199       1  

Total non-accrual loans

  $ 47,200     $ 41,815       13     $ 42,411       11  

Total non-performing loans

    47,883       45,588       5       49,092       (2 )

Other real estate owned

    11,329       12,674       (11 )     8,741       30  

Total non-performing assets

  $ 59,212     $ 58,262       2     $ 57,833       2  

Accruing troubled debt restructurings

  $ 41,647     $ 65,071       (36 )   $ 74,598       (44 )
                                         

Allowance for loan losses

  $ 125,908     $ 122,391       3     $ 123,457       2  
                                         

Total gross loans outstanding, at period-end (1)

  $ 14,728,554     $ 13,995,788       5     $ 13,647,646       8  
                                         

Allowance for loan losses to non-performing loans, at period-end (2)

    262.95 %     268.47 %             251.48 %        

Allowance for loan losses to gross loans, at period-end (1)

    0.85 %     0.87 %             0.90 %        

 

(1) 

Excludes loans held for sale at period-end.

(2) 

Excludes non-accrual loans held for sale at period-end.

 

Non-accrual Loans

 

At September 30, 2019, total non-accrual loans were $47.2 million, an increase of $5.4 million, or 12.9%, from $41.8 million at December 31, 2018, and an increase of $4.8 million, or 11.3%, from $42.4 million at September 30, 2018. 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, less cost to sell. 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 of these loans, based on recent appraisals, on a quarterly basis and adjust the allowance accordingly. Non-accrual loans also include those TDRs that do not qualify for accrual status.

 

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

 

   

September 30, 2019

   

December 31, 2018

 
   

Real

           

Real

         
   

Estate (1)

   

Commercial

   

Estate (1)

   

Commercial

 
   

(In thousands)

 

Type of Collateral

                               

Single/multi-family residence

  $ 7,774     $ 7,105     $ 11,366     $ 8,016  

Commercial real estate

    16,456             11,452        

Personal property (UCC)

          15,865       192       10,789  

Total

  $ 24,230     $ 22,970     $ 23,010     $ 18,805  

 

(1) 

Real estate includes commercial mortgage loans, real estate construction loans, residential mortgage loans and equity lines.  

 

   

September 30, 2019

   

December 31, 2018

 
   

Real

           

Real

         
   

Estate (1)

   

Commercial

   

Estate (1)

   

Commercial

 
   

(In thousands)

 

Type of Business

                               

Real estate development

  $ 16,751     $     $ 9,826     $  

Wholesale/Retail

    657       9,008       5,784       14,078  

Import/Export

          8,962             4,727  

Other

    6,822       5,000       7,400        

Total

  $ 24,230     $ 22,970     $ 23,010     $ 18,805  

 

(1) 

Real estate includes commercial mortgage loans, real estate construction loans, residential mortgage loans and equity lines.  

 

Impaired Loans

 

We consider a loan to be impaired when it is probable that we 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 our receipt of information otherwise indicating that full collection of principal is doubtful, or when the loan has been restructured in a TDRs. Those loans with a balance less than our defined selection criteria, generally a loan amount less than $500 thousand, 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 generally obtain an appraisal to determine the amount of impairment at the date that the loan becomes impaired. The appraisals are generally based on “as is” or bulk sale valuations. To ensure that appraised values remain current, we generally obtain an updated appraisal every twelve months from qualified independent appraisers. 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 generally 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.

 

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Table of Contents

 

As of September 30, 2019, recorded investment in impaired loans totaled $88.8 million and was comprised of non-accrual loans of $47.2 million and accruing TDRs of $41.6 million. As of December 31, 2018, recorded investment in impaired loans totaled $106.9 million and was comprised of non-accrual loans of $41.8 million and accruing TDRs of $65.1 million. For impaired loans, the amounts previously charged off represent 1.9% as of September 30, 2019, and 9.3% as of December 31, 2018, of the contractual balances for impaired loans. As of September 30, 2019, $24.2 million, or 51.3%, of the $47.2 million of non-accrual loans were secured by real estate compared to $23.0 million, or 55.0%, of the $41.8 million of non-accrual loans that were secured by real estate as of December 31, 2018. The Bank generally seeks to obtain current appraisals, sales contracts, or other available market price information intended to provide updated factors in evaluating potential loss.

 

As of September 30, 2019, $1.5 million of the $125.9 million allowance for loan losses was allocated for impaired loans and $124.4 million was allocated to the general allowance. As of December 31, 2018, $3.8 million of the $122.4 million allowance for loan losses was allocated for impaired loans and $118.6 million was allocated to the general allowance.

 

The allowance for loan losses to non-performing loans was 263.0% as of September 30, 2019, compared to 268.5% as of December 31, 2018, primarily due to an increase in the non-accrual loans. Non-accrual loans also include those TDRs that do not qualify for accrual status.

 

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

 

   

September 30, 2019

   

December 31, 2018

 
   

Unpaid

Principal

Balance

   

Recorded Investment

   

Allowance

   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

 
   

(In thousands)

 
                                                 

With no allocated allowance

                                               

Commercial loans

  $ 24,711     $ 20,492     $     $ 32,015     $ 30,368     $  

Real estate construction loans

    5,776       4,629             5,776       4,873        

Commercial mortgage loans

    11,663       11,517             34,129       24,409        

Residential mortgage loans and equity lines

    6,808       6,770             5,685       5,665        

Subtotal

  $ 48,958     $ 43,408     $     $ 77,605     $ 65,315     $  
                                                 

With allocated allowance

                                               

Commercial loans

  $ 13,251     $ 13,234     $ 744     $ 6,653     $ 6,570     $ 1,837  

Commercial mortgage loans

    26,356       26,288       536       27,099       27,063       877  

Residential mortgage loans and equity lines

    7,011       5,917       221       8,934       7,938       1,088  

Subtotal

  $ 46,618     $ 45,439     $ 1,501     $ 42,686     $ 41,571     $ 3,802  

Total impaired loans

  $ 95,576     $ 88,847     $ 1,501     $ 120,291     $ 106,886     $ 3,802  

 

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Loan Interest Reserves 

 

In accordance with customary banking practice, we originate construction loans and land development loans where interest on the loan is disbursed from pre-established interest reserves included in the total original loan commitment. Our construction loans 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 generally 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 50% in the case of land to 85% in the case of one to four family residential construction projects.

 

As of September 30, 2019, construction loans of $555.3 million were disbursed with pre-established interest reserves of $66.7 million, compared to $524.4 million with pre-established interest reserves of $65.2 million at December 31, 2018.  The balance for construction loans with interest reserves that have been extended was $146.3 million with pre-established interest reserves of $4.2 million at September 30, 2019, compared to $88.8 million with pre-established interest reserves of $3.9 million at December 31, 2018.  Land loans of $46.5 million were disbursed with pre-established interest reserves of $1.5 million at September 30, 2019, compared to $24.1 million of land loans disbursed with pre-established interest reserves of $770 thousand at December 31, 2018.  The balance for land loans with interest reserves that have been extended was $1.7 million at September 30, 2019 with pre-established interest reserves of $2 thousand, compared to $5.6 million in land loans with pre-established interest reserves of $71 thousand at December 31, 2018. 

 

At September 30, 2019 and December 31, 2018, the Bank had no loans on non-accrual status with available interest reserves.  At September 30, 2019 and December 31, 2018, $4.6 million and $4.9 million of non-accrual non-residential construction loans had been originated with pre-established interest reserves, respectively.  While we typically expect loans with interest reserves to be repaid in full according to the original contractual terms, some loans may require one or more extensions beyond the original maturity before full repayment.  Typically, these extensions are required due to construction delays, delays in the sale or lease of the property, or some combination of these two factors.

 

Loan Concentration

 

Most of the Company’s business activities are with customers located in the high-density Asian-populated areas of Southern and Northern California; New York City, New York; Dallas and Houston, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; Edison, New Jersey; Rockville, Maryland; and Las Vegas, Nevada. The Company also has loan customers in 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. The Company generally expects loans 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 that exceeded 10% of total loans as of September 30, 2019, or as of December 31, 2018.

 

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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) 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-six months. Total loans for construction, land development, and other land represented 34% of the Bank’s total risk-based capital as of September 30, 2019, and 33% as of December 31, 2018. Total CRE loans represented 277% of total risk-based capital as of September 30, 2019, and 268% as of December 31, 2018 and were below the Bank’s internal limit for CRE loans of 400% of total capital at both dates.

 

Allowance for Credit Losses

 

The Bank maintains the allowance for credit losses at a level that the Bank considers appropriate 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 it believes is designed to identify impaired and potential problem loans, and to permit periodic evaluation of impairment and the appropriate level of the allowance for credit losses in a timely manner.

 

In addition, the Bank’s Board of Directors has established a written credit policy that includes a credit review and control system that the Board of Directors believes should be effective in ensuring that the Bank maintains an appropriate allowance for credit losses. The Board of Directors provides oversight for the allowance evaluation process, including quarterly evaluations, and determines whether the allowance is appropriate to absorb losses in the credit portfolio. The determination of the amount of the allowance for credit losses and the provision for credit losses are based on management’s current judgment about the credit quality of the loan portfolio and take 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 business judgment based on the information available, the ultimate appropriateness of the allowance is dependent upon a variety of factors, many of which are beyond the Bank’s control, including but not limited to the performance of the Bank’s loan portfolio, the economy and market conditions, 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 $125.9 million and the allowance for off-balance sheet unfunded credit commitments was $4.6 million at September 30, 2019, which represented the amount believed by management to be appropriate to absorb credit losses inherent in the loan portfolio, including unfunded credit commitments. The $125.9 million allowance for loan losses at September 30, 2019, increased $3.5 million, or 2.9%, from $122.4 million at December 31, 2018. The allowance for loan losses represented 0.85% of period-end gross loans, excluding loans held for sale, and 263.0% of non-performing loans at September 30, 2019. The comparable ratios were 0.87% of period-end gross loans, excluding loans held for sale, and 268.5% of non-performing loans at December 31, 2018.

 

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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:

 

   

Three months ended September 30,

   

Nine months ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(In thousands)

 

Allowance for loan losses

                               

Balance at beginning of period

  $ 122,651     $ 121,899     $ 122,391     $ 123,279  

Reversal for credit losses

    (2,000 )     (1,500 )     (2,000 )     (4,500 )

Charge-offs:

                               

Commercial loans

    (3,356 )     (122 )     (6,300 )     (629 )

Real estate loans

                      (390 )

Total charge-offs

    (3,356 )     (122 )     (6,300 )     (1,019 )

Recoveries:

                               

Commercial loans

    212       187       1,609       1,250  

Construction loans

    3,378       44       4,612       132  

Real estate loans

    5,023       2,949       5,596       4,315  

Total recoveries

    8,613       3,180       11,817       5,697  

Balance at end of period

  $ 125,908     $ 123,457     $ 125,908     $ 123,457  
                                 

Reserve for off-balance sheet credit commitments

                               

Balance at beginning of period

  $ 4,550     $ 3,088     $ 2,250     $ 4,588  

Provision for credit losses

                2,300       (1,500 )

Balance at end of period

  $ 4,550     $ 3,088     $ 4,550     $ 3,088  
                                 

Average loans outstanding during the period (1)

  $ 14,654,644     $ 13,434,018     $ 14,371,633     $ 13,126,693  

Total gross loans outstanding, at period-end (1)

  $ 14,728,554     $ 13,647,646     $ 14,728,554     $ 13,647,646  

Total non-performing loans, at period-end (2)

  $ 47,883     $ 49,092     $ 47,883     $ 49,092  

Ratio of net (recoveries)/charge-offs to average loans outstanding during the period (1)

    (0.14% )     (0.09% )     (0.05% )     (0.05% )

Provision for credit losses to average loans outstanding during the period (1)

    (0.05% )     (0.04% )     0.00 %     (0.06% )

Allowance for credit losses to non-performing loans, at period-end (2)

    272.45 %     257.77 %     272.45 %     257.77 %

Allowance for credit losses to gross loans, at period-end (1)

    0.89 %     0.93 %     0.89 %     0.93 %

 

(1) 

Excludes loans held for sale.

(2) 

Excludes non-accrual loans held for sale.

 

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 19 segments: two commercial segments, ten commercial real estate segments, one residential construction segment, one non-residential construction segment, 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 take into account, among other things, 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, 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 check for appropriate classification.

 

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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 average gross loans as of the dates indicated:

 

   

September 30, 2019

   

December 31, 2018

 
           

Percentage of

           

Percentage of

 
           

Loans in Each

           

Loans in Each

 
           

Category

           

Category

 
           

to Average

           

to Average

 
   

Amount

   

Gross Loans

   

Amount

   

Gross Loans

 
   

(In thousands)

 

Type of Loan:

                               

Commercial loans

  $ 58,549       19.0 %   $ 54,978       19.1 %

Real estate construction loans

    21,698       4.0       19,626       4.5  

Commercial mortgage loans

    33,467       48.0       33,487       49.5  

Residential mortgage loans and equity lines

    12,169       29.0       14,282       26.9  

Installment and other loans

    25             18        

Total loans

  $ 125,908       100 %   $ 122,391       100 %

 

 

The allowance allocated to commercial loans increased $3.5 million, or 6.5%, to $58.5 million at September 30, 2019, from $55.0 million at December 31, 2018. The increase is due primarily to an increase in the allowance for trade finance loans as a result of the additional tariffs imposed on imports from China during the nine months ended September 30, 2019.

 

The allowance allocated to real estate construction loans increased $2.1 million, or 10.7%, to $21.7 million at September 30, 2019 from $19.6 million at December 31, 2018. The increase is due primarily to an increase in non-residential construction loan volume during the nine months ended September 30, 2019.

 

The allowance allocated to commercial mortgage loans remained flat at $33.5 million at September 30, 2019, from December 31, 2018.

 

The allowance allocated for residential mortgage loans decreased by $2.1 million, or 14.7%, to $12.2 million as of September 30, 2019, from $14.3 million at December 31, 2018. The decrease is due primarily to decreases in the environmental reserve factors during the nine months ended September 30, 2019.

 

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Deposits

 

Total deposits were $14.7 billion at September 30, 2019, an increase of $955.9 million, or 7.0%, from $13.7 billion at December 31, 2018. The following table sets forth the deposit mix as of the dates indicated:

 

   

September 30, 2019

   

December 31, 2018

 
   

Amount

   

Percentage

   

Amount

   

Percentage

 

 

 

(Dollars in thousands)

 
Deposits      

Non-interest-bearing demand deposits

  $ 2,939,924       20.1 %   $ 2,857,443       20.8 %

Interest bearing demand deposits

    1,282,267       8.7       1,365,763       10.0  

Money market deposits

    2,095,328       14.3       2,027,404       14.8  

Savings deposits

    721,547       4.9       738,656       5.4  

Time deposits

    7,619,203       52.0       6,713,074       49.0  

Total deposits

  $ 14,658,269       100.0 %   $ 13,702,340       100.0 %

 

The following table sets forth the maturity distribution of time deposits at September 30, 2019:

 

   

At September 30, 2019

 
   

Time Deposits -

under $100,000

   

Time Deposits -

$100,000 and over

   

Total Time

Deposits

 
   

(Dollars in thousands)

 

Less than three months

  $ 354,460     $ 1,224,622     $ 1,579,082  

Three to six months

    796,141       1,871,436       2,667,577  

Six to twelve months

    795,014       1,850,702       2,645,716  

Over one year

    189,495       537,333       726,828  

Total

  $ 2,135,110     $ 5,484,093     $ 7,619,203  
                         

Percent of total deposits

    14.6 %     37.4 %     52.0 %

 

Borrowings

 

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

 

Borrowings from the FHLB - As of September 30, 2019, over-night borrowings from the FHLB were $330 million at an average rate of 2.08%, compared to $200 million at an average rate of 2.56% as of December 31, 2018. Advances from the FHLB were $270 million at an average rate of 2.15% as of September 30, 2019 and $330 million at an average rate of 2.42% as of December 31, 2018. As of September 30, 2019, FHLB advances of $50 million will mature in December 2019, $75 million in May 2021, $50 million in June 2021, $75 million in July 2021, and $20 million in May 2023.

 

Other Borrowings - The Company owes a residual payable balance of $7.6 million to Bank SinoPac Co. related to the Company’s acquisition of SinoPac Bancorp, the parent of Far East National Bank. The remaining balance of $7.0 million, due in July 2020, has an interest rate of 3.60% (three-month LIBOR rate plus 150 basis points) as of September 30, 2019.

 

Long-term Debt - On October 12, 2017, the Bank entered into a term loan agreement of $75.0 million with U.S. Bank. The loan has a floating rate of one-month LIBOR plus 175 basis points. As of September 30, 2019, the term loan has a remaining balance of $41.3 million and an interest rate of 3.875% compared to 4.125% at December 31, 2018. The principal amount of the long-term debt from U.S. Bank is due and payable in consecutive quarterly installments of $4.7 million each on the last day of each calendar quarter commencing December 31, 2018, with the final installment due and payable on October 12, 2020. We used the U.S. Bank loan proceeds to fund a portion of our acquisition of SinoPac Bancorp.

 

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At September 30, 2019, Junior Subordinated Notes totaled $119.1 million with a weighted average interest rate of 4.29%, compared to $119.1 million with a weighted average rate of 4.96% at December 31, 2018. The Junior Subordinated Notes have a stated maturity term of 30 years. The trusts are not consolidated with the Company in accordance with an accounting pronouncement that took effect in December 2003.

 

Off-Balance-Sheet Arrangements and Contractual Obligations

 

The following table summarizes the Company’s contractual obligations to make future payments as of September 30, 2019. 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

  $ 6,892,375     $ 689,224     $ 37,592     $ 12     $ 7,619,203  

Advances from the Federal Home Loan Bank

    380,000       200,000       20,000             600,000  

Other borrowings

    7,602                   30,767       38,369  

Long-term debt

    18,750       22,500             119,136       160,386  

Operating leases

    2,326       16,217       11,857       9,532       39,932  

Total contractual obligations and other commitments

  $ 7,301,053     $ 927,941     $ 69,449     $ 159,447     $ 8,457,890  

 

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 Condensed 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 seek to 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.

 

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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.

 

Capital Resources

 

Total equity was $2.25 billion as of September 30, 2019, an increase of $124.0 million, from $2.12 billion as of December 31, 2018, primarily due to net income of $211.8 million, increases in other comprehensive income of $17.2 million, and proceeds from dividend reinvestment of $2.5 million, and partially offset by common stock cash dividends of $74.4 million and repurchases of the Company’s common stock of $36.3 million.

 

The following table summarizes changes in total equity for the nine months ended September 30, 2019:

 

   

Nine months ended

 
   

September 30, 2019

 
   

(In thousands)

 

Net income

  $ 211,758  

Proceeds from shares issued through the Dividend Reinvestment Plan

    2,522  

RSUs distributed

    1  

Shares withheld related to net share settlement of RSUs

    (2,300 )

Stock issued to directors

    749  

Purchase of treasury stock

    (36,301 )

Share-based compensation

    4,848  

Cash dividends paid to common stockholders

    (74,422 )

Other comprehensive income

    17,173  

Net increase in total equity

  $ 124,028  

 

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.

 

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The following tables set forth actual and required capital ratios as of September 30, 2019 and December 31, 2018 for Bancorp and the Bank under the Basel III Capital Rules. The Basel III Capital Rules became fully phased-in on January 1, 2019. The minimum required capital amounts presented as of December 31, 2018 include the minimum required capital levels applicable as of that date as well as the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules became fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. See the 2018 Form 10-K for a more detailed discussion of the Basel III Capital Rules.

 

   

Actual

   

Minimum Capital

Required - Basel III

   

Required to be Considered

Well Capitalized

 
   

Capital Amount

   

Ratio

   

Capital Amount

   

Ratio

   

Capital Amount

   

Ratio

 

 

 

(Dollars in thousands)

 
September 30, 2019                                                
                                                 

Common Equity Tier 1 to Risk-Weighted Assets

                                         

Cathay General Bancorp

  $ 1,846,200       12.41     $ 1,041,619       7.00     $ 967,218       6.50  

Cathay Bank

    1,949,520       13.13       1,039,708       7.00       965,443       6.50  
                                                 

Tier 1 Capital to Risk-Weighted Assets

                                               

Cathay General Bancorp

    1,846,200       12.41       1,264,824       8.50       1,190,422       8.00  

Cathay Bank

    1,949,520       13.13       1,262,502       8.50       1,188,237       8.00  
                                                 

Total Capital to Risk-Weighted Assets

                                               

Cathay General Bancorp

    2,092,158       14.06       1,562,429       10.50       1,488,028       10.00  

Cathay Bank

    2,079,978       14.00       1,559,561       10.50       1,485,297       10.00  
                                                 

Leverage Ratio

                                               

Cathay General Bancorp

    1,846,200       10.81       683,193       4.00       853,991       5.00  

Cathay Bank

    1,949,520       11.43       682,062       4.00       852,578       5.00  

 

   

Actual

   

Minimum Capital

Required - Basel III

   

Required to be Considered

Well Capitalized

 
   

Capital Amount

   

Ratio

   

Capital Amount

   

Ratio

   

Capital Amount

   

Ratio

 

 

 

(Dollars in thousands)

 
December 31, 2018                                                
                                                 

Common Equity Tier 1 to Risk-Weighted Assets

                                         

Cathay General Bancorp

  $ 1,736,854       12.43     $ 890,524       6.375     $ 907,985       6.50  

Cathay Bank

    1,904,820       13.66       889,287       6.375       906,724       6.50  
                                                 

Tier 1 Capital to Risk-Weighted Assets

                                               

Cathay General Bancorp

    1,736,854       12.43       1,100,059       7.875       1,117,520       8.00  

Cathay Bank

    1,904,820       13.66       1,098,531       7.875       1,115,968       8.00  
                                                 

Total Capital to Risk-Weighted Assets

                                               

Cathay General Bancorp

    1,976,995       14.15       1,379,439       9.875       1,396,900       10.00  

Cathay Bank

    2,029,462       14.55       1,377,523       9.875       1,394,961       10.00  
                                                 

Leverage Ratio

                                               

Cathay General Bancorp

    1,736,854       10.83       641,755       4.00       802,146       5.00  

Cathay Bank

    1,904,820       11.89       640,807       4.00       800,983       5.00  

 

As of September 30, 2019, capital levels at Bancorp and the Bank exceed all capital adequacy requirements under the fully phased-in Basel III Capital Rules. Based on the ratios presented above, capital levels as of September 30, 2019 at Bancorp and the Bank exceed the minimum levels necessary to be considered “well capitalized.”

 

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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, if any, will depend on our earnings, financial condition, capital requirements and other factors, and will be determined by our Board of Directors. The terms of our Junior Subordinated Notes also limit our ability to pay dividends. We increased the common stock dividend from $0.21 per share in the fourth quarter of 2016, to $0.24 per share in the fourth quarter of 2017, and to $0.31 per share in the fourth quarter of 2018.

 

The Company declared a cash dividend of $0.31 per share on 79,683,166 shares outstanding on September 3, 2019, for distribution to holders of our common stock on September 13, 2019, $0.31 per share on 79,850,454 shares outstanding on June 3, 2019, for distribution to holders of our common stock on June 13, 2019, and $0.31 per share on 80,537,962 shares outstanding on March 4, 2019, for distribution to holders of our common stock on March 14, 2019. The Company paid total cash dividends of $74.4 million in the first nine months of 2019.

 

Financial Derivatives

 

It is our policy not to speculate on the future direction of interest rates. However, from time to time, we may enter 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 our assets or liabilities and against risk in specific transactions. In such instances, we may enter into interest rate swap contracts or other types of financial derivatives. 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 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 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. Fair value is determined using third-party models with observable market data. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivatives are reflected in current earnings, together with changes in the fair value of the related hedged item if there is a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged. If there is not a highly effective correlation between changes in the fair value of the interest rate swap and changes in the fair value of the underlying asset or liability that is intended to be hedged, then only the changes in the fair value of the interest rate swaps are reflected in the Company’s consolidated financial statements.

 

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The Company offers various interest rate derivative contracts to its customers. When derivative transactions are executed with its customers, the derivative contracts are offset by paired trades with third-party financial institutions including with central counterparties (“CCP”). Certain derivative contracts entered with CCPs are settled-to-market daily to the extent the CCP’s rulebooks legally characterize the variation margin as settlement. Derivative contracts are intended to allow borrowers to lock in attractive intermediate and long-term fixed rate financing while not increasing the interest rate risk to the Company. These transactions are generally not linked to specific Company assets or liabilities on the Condensed Consolidated Balance Sheets or to forecasted transactions in a hedging relationship and, therefore, are economic hedges. The contracts are marked to market at each reporting period. The changes in fair values of the derivative contracts traded with third-party financial institutions are expected to be largely comparable to the changes in fair values of the derivative transactions executed with customers throughout the terms of these contracts, except for the credit valuation adjustment component.  The Company records credit valuation adjustments on derivatives to properly reflect the variances of credit worthiness between the Company and the counterparties, considering the effects of enforceable master netting agreements and collateral arrangements.

 

In May 2014, the Bancorp entered into interest rate swap contracts in the notional amount of $119.1 million for a period of ten years. The objective of these interest rate swap contracts, which were designated as hedging instruments in cash flow hedges, was to hedge the quarterly interest payments on the Bancorp’s $119.1 million of Junior Subordinated Debentures that had been issued to five trusts, throughout the ten-year period beginning in June 2014 and ending in June 2024, from the risk of variability of these payments resulting from changes in the three-month LIBOR interest rate. The Bancorp pays a weighted average fixed interest rate of 2.61% and receives a variable interest rate of the three-month LIBOR at a weighted average rate of 2.37%. The notional amount of cash flow interest rate swaps was $119.1 million as of both September 30, 2019 and December 31, 2018, and their unrealized loss of $4.4 million and $241 thousand, net of taxes, was included in other comprehensive income as of September 30, 2019 and December 31, 2018, respectively. The amount of periodic net settlement of interest rate swaps included in interest expense was $78 thousand and $83 thousand for the three months ended September 30, 2019 and 2018, respectively. The amount of periodic net settlement of interest rate swaps included in interest expense was a net interest expense of $41 thousand and a net interest expense of $480 thousand for the nine months ended September 30, 2019 and 2018, respectively. As of September 30, 2019, and 2018, the ineffective portion of these interest rate swaps was not significant.

 

As of September 30, 2019, the Bank’s outstanding interest rate swap contracts had a notional amount of $584.0 million for various terms from three to ten years. The Bank entered into these interest rate swap contracts that are matched to individual fixed-rate commercial real estate loans in the Bank’s loan portfolio. These contracts have been designated as hedging instruments to hedge the risk of changes in the fair value of the underlying commercial real estate loans due to changes in interest rates. The swap contracts are structured so that the notional amounts reduce over time to match the contractual amortization of the underlying loan and allow prepayments with the same pre-payment penalty amounts as the related loan. The Bank pays a weighted average fixed rate of 4.71% and receives a variable rate of the one-month LIBOR rate plus a weighted average spread of 261 basis points, or at a weighted average rate of 5.01%. As of September 30, 2019, and December 31, 2018, the notional amount of fair value interest rate swaps was $584.0 million and $613.4 million, respectively with net unrealized losses of $9.8 million and net unrealized gains of $6.6 million, respectively, included in other non-interest income. The amount of periodic net settlement of interest rate swaps increased interest income by $205 thousand and $96 thousand for the three months ended September 30, 2019 and 2018, respectively. The amount of periodic net settlement of interest rate swaps increased interest income by $1.4 million and decreased interest income by $132 thousand for the nine months ended September 30, 2019 and 2018, respectively. As of September 30, 2019, and 2018, the ineffective portion of these interest rate swaps was not significant.

 

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Interest rate swap contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have a strong credit profile and be approved by the Company’s Board of Directors. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. The Bancorp’s interest rate swaps have been assigned by the counterparties to a derivative clearing organization and daily margin is indirectly maintained with the derivative clearing organization. Cash posted as collateral by the Bancorp related to derivative contracts totaled $9.1 million as of September 30, 2019 and $1.8 million as of December 31, 2018.

 

The Company from time to time enters into foreign exchange forward contracts with various counterparties to mitigate the risk of fluctuations in foreign currency exchange rates for foreign exchange certificates of deposit or foreign exchange 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 and foreign exchange 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. As of September 30, 2019, the notional amount of option contracts totaled $1.2 million with a net negative fair value of $6 thousand. As of September 30, 2019, spot, forward, and swap contracts in the total notional amount of $71.0 million had a positive fair value of $965 thousand. Spot, forward, and swap contracts in the total notional amount of $121.8 million had a negative fair value of $2.4 million at September 30, 2019. As of December 31, 2018, the notional amount of option contracts totaled $1.2 million with a net negative fair value of $6 thousand. As of December 31, 2018, spot, forward, and swap contracts in the total notional amount of $86.9 million had a positive fair value of $397 thousand. Spot, forward, and swap contracts in the total notional amount of $95.0 million had a negative fair value of $1.8 million at December 31, 2018.

 

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. As of September 30, 2019, our average monthly liquidity ratio (defined as net cash plus short-term and marketable securities to net deposits and short-term liabilities) was 12.7% compared to 12.0% as of December 31, 2018.

 

The Bank is a shareholder of the FHLB, which enables the Bank to have access to lower-cost FHLB financing when necessary. At September 30, 2019, the Bank had an approved credit line with the FHLB of San Francisco totaling $4.4 billion. Total advances from the FHLB of San Francisco were $600.0 million and standby letter of credits issued by the FHLB on the Company’s behalf were $368.1 million as of September 30, 2019. These borrowings bear fixed rates and are secured by the Bank’s loans. See Note 11 to the Condensed Consolidated Financial Statements. At September 30, 2019, the Bank pledged $22.7 million of its commercial loans to the Federal Reserve Bank’s Discount Window under the Borrower-in-Custody program. The Bank had borrowing capacity of $24.3 million from the Federal Reserve Bank Discount Window at September 30, 2019.

 

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Liquidity can also be provided through the sale of liquid assets, which consist of federal funds sold, securities purchased under agreements to resell, and securities available-for-sale. At September 30, 2019, investment securities totaled $1.4 billion, with $20.8 million pledged as collateral for borrowings and other commitments. The remaining $1.4 billion was available as additional liquidity or to be pledged as collateral for additional borrowings.

 

Approximately 90% of our time deposits mature within one year or less as of September 30, 2019. 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 runoff experience, we expect the outflow will not be significant and can be replenished through our normal growth in deposits. Management believes all the above-mentioned sources will provide adequate liquidity during the next twelve months for the Bank to meet its operating needs.

 

The business activities of Bancorp consist primarily of the operation of the Bank and limited activities in other investments. The Bank paid dividends to Bancorp totaling $176.5 million and $94.8 million during the first nine months of 2019 and 2018, respectively.

 

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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 but not limited to economic, market 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 can be 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 seeks to reduce the risk of a significant decrease in net interest income caused by a change in interest rates.

 

We have established a tolerance level in our policy to define and limit net interest income volatility to a change of plus or minus 5% 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 limit the loss in the net economic value of our portfolio of assets and liabilities to zero when the hypothetical rate change is plus or minus 200 basis points.

 

The table below shows the estimated impact of changes in interest rates on net interest income and market value of equity as of September 30, 2019:

 

     

Net Interest

   

Market Value

 
     

Income

   

of Equity

 

Change in Interest Rate (Basis Points)

   

Volatility (1)

   

Volatility (2)

 

+200

      7.2       1.1  

+100

      3.6       1.0  
-100       -6.5       -0.2  
-200       -17.0       3.8  

 

(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 the net portfolio value of the Company in a stable  interest rate environment versus the net portfolio value in the various rate scenarios.

 

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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 third quarter of 2019 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

Item 1.     LEGAL PROCEEDINGS.

 

From time to time, Bancorp and its subsidiaries are parties to litigation that arise in the ordinary course of business or otherwise are incidental to various aspects of its operations. Based upon information available to the Company and its review of any such litigation with counsel, management believes that the liability relating to such litigation, if any, would not be expected to have a material adverse impact on the Company’s consolidated financial condition, results of operations or liquidity taken as a whole.

 

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Item 1A.     RISK FACTORS.

 

The Company is not aware of any material change to the risk factors as previously disclosed in Part I, Item 1A, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors disclosed in Part I, Item 1A, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, which could materially and adversely affect the Company’s business, financial condition, results of operations and stock price. The risk factors disclosed in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties, including those not presently known to the Company or that the Company presently believes not to be material, could also materially and adversely affect the Company’s business, financial condition, and results of operations and stock price.

 

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 (July 1, 2019 - July 31, 2019)

    0     $ 0       0     $ 28,286,005  

Month #2 (August 1, 2019 - August 31, 2019)

    135,000     $ 34.76       135,000     $ 23,593,308  

Month #3 (September 1, 2019 - September 30, 2019)

    0     $ 0       0     $ 23,593,308  

Total

    135,000     $ 34.76       135,000     $ 23,593,308  

 

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.”

 

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Item 3.     DEFAULTS UPON SENIOR SECURITIES.

 

Not applicable.

 

Item 4.     MINE SAFETY DISCLOSURES.

 

Not applicable.

 

Item 5.     OTHER INFORMATION.

 

None.

 

Item 6.     EXHIBITS.

 

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

 

Exhibit 31.2

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

 

Exhibit 32.1

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

 

Exhibit 32.2

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

 

Exhibit 101.INS

XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document*

 

Exhibit 101.SCH

Inline XBRL Taxonomy Extension Schema Document*

 

Exhibit 101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase Document*

 

Exhibit 101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document*

 

Exhibit 101.LAB

Inline XBRL Taxonomy Extension Label Linkbase Document*

 

Exhibit 101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase Document*

 

Exhibit 104 Cover Page Interactive Data File - the cover page XBRL tags are embedded within the Inline XBRL document*

 

 

____________________

+ Filed herewith.

 

++ Furnished herewith.

 

*

Filed electronically herewith. 

 

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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: November 8, 2019    
     
  /s/ Pin Tai                                      
  Pin Tai  
  Chief Executive Officer  
     
     
     
Date: November 8, 2019    
     
  /s/ Heng W. Chen                          
  Heng W. Chen  
  Executive Vice President and  
  Chief Financial Officer  

 

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