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EAST WEST BANCORP INC - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

Mark One

 

x

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

 

For the quarterly period ended June 30, 2013

 

or

 

¨

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

 

For the transition period from                  to

 

Commission file number 000-24939

 

EAST WEST BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4703316

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

135 N. Los Robles Ave, 7th Floor, Pasadena, California 91101

(Address of principal executive offices) (Zip Code)

 

(626) 768-6000

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

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

 

Number of shares outstanding of the issuer’s common stock on the latest practicable date: 137,742,433 shares of common stock as of July 31, 2013.

 

 

 


 


Table of Contents

 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

4

 

 

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited)

4

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

9

 

 

 

 

 

Item 2.

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

63

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

89

 

 

 

 

 

Item 4.

Controls and Procedures

89

 

 

 

 

PART II - OTHER INFORMATION

90

 

 

 

Item 1.

Legal Proceedings

90

 

 

 

 

 

Item 1A.

Risk Factors

90

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

90

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

90

 

 

 

 

 

Item 4.

Mine Safety Disclosures

90

 

 

 

 

 

Item 5.

Other Information

91

 

 

 

 

 

Item 6.

Exhibits

91

 

 

 

 

SIGNATURE

 

91

 

2


 


Table of Contents

 

Forward-Looking Statements

 

Certain matters discussed in this Quarterly Report contain or incorporate statements that we believe are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Exchange Act”), and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking language, such as “will likely result,” “may,” “are expected to,” “is anticipated,” “estimate,” “forecast,” “projected,” “intends to,” or may include other similar words or phrases, such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs, such as “will,” “would,” “should,” “could,” “might,” “can,” or similar verbs. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including, but not limited to, those described in the documents incorporated by reference. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us.

 

There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to:

 

·                                          our ability to manage the loan portfolio acquired from FDIC-assisted acquisitions within the limits of the loss protection provided by the FDIC;

·                                          changes in our borrowers’ performance on loans;

·                                          changes in the commercial and consumer real estate markets;

·                                          changes in our costs of operation, compliance and expansion;

·                                          changes in the U.S. economy, including inflation;

·                                          changes in government interest rate policies;

·                                          changes in laws or the regulatory environment;

·                                          changes in the economy of and monetary policy in the People’s Republic of China;

·                                          changes in critical accounting policies and judgments;

·                                          changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies;

·                                          changes in the equity and debt securities markets;

·                                          changes in competitive pressures on financial institutions;

·                                          effect of additional provision for loan losses;

·                                          fluctuations of our stock price;

·                                          success and timing of our business strategies;

·                                          impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity;

·                                          impact of the European debt crisis;

·                                          impact of potential federal tax increases and spending cuts;

·                                          impact of adverse judgments or settlements in litigation against the Company;

·                                          changes in our ability to receive dividends from our subsidiaries; and

·                                          political developments, wars or other hostilities that may disrupt or increase volatility in securities or otherwise affect economic conditions.

 

For a more detailed discussion of some of the factors that might cause such differences, see the Company’s 2012 Form 10-K under the heading “ITEM 1A. RISK FACTORS” and the information set forth under “RISK FACTORS” in this Form 10-Q. The Company does not undertake, and specifically disclaims any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

 

3


 


Table of Contents

 

PART I — FINANCIAL INFORMATION

 

EAST WEST BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

1,050,214

 

$

1,323,106

 

Short-term investments

 

330,438

 

366,378

 

Securities purchased under resale agreements

 

1,450,000

 

1,450,000

 

Investment securities available-for-sale, at fair value (with amortized cost of $2,704,652 at June 30, 2013 and $2,599,018 at December 31, 2012)

 

2,667,172

 

2,607,029

 

Loans held for sale

 

245,026

 

174,317

 

Loans receivable, excluding covered loans (net of allowance for loan losses of $233,480 at June 30, 2013 and $229,382 at December 31, 2012)

 

13,264,215

 

11,710,190

 

Covered loans (net of allowance for loan losses of $9,629 at June 30, 2013 and $5,153 at December 31, 2012)

 

2,504,315

 

2,935,595

 

Total loans receivable, net

 

15,768,530

 

14,645,785

 

FDIC indemnification asset

 

219,942

 

316,313

 

Other real estate owned, net

 

21,433

 

32,911

 

Other real estate owned covered, net

 

29,836

 

26,808

 

Total other real estate owned

 

51,269

 

59,719

 

Investment in Federal Home Loan Bank stock, at cost

 

86,139

 

107,275

 

Investment in Federal Reserve Bank stock, at cost

 

48,111

 

48,003

 

Investment in affordable housing partnerships

 

176,588

 

185,645

 

Premises and equipment, net

 

111,762

 

107,517

 

Accrued interest receivable

 

109,822

 

94,837

 

Due from customers on acceptances

 

21,573

 

28,612

 

Premiums on deposits acquired, net

 

51,501

 

56,285

 

Goodwill

 

337,438

 

337,438

 

Cash surrender value of life insurance policies

 

111,531

 

110,133

 

Other assets

 

471,350

 

517,718

 

TOTAL

 

$

23,308,406

 

$

22,536,110

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Customer deposit accounts:

 

 

 

 

 

Noninterest-bearing

 

$

5,128,894

 

$

4,535,877

 

Interest-bearing

 

14,153,313

 

13,773,477

 

Total deposits

 

19,282,207

 

18,309,354

 

Federal Home Loan Bank advances

 

314,022

 

312,975

 

Securities sold under repurchase agreements

 

995,000

 

995,000

 

Other borrowings

 

 

20,000

 

Bank acceptances outstanding

 

21,573

 

28,612

 

Long-term debt

 

137,178

 

137,178

 

Accrued expenses and other liabilities

 

300,475

 

350,869

 

Total liabilities

 

21,050,455

 

20,153,988

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES (Note 12)

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Preferred stock, $0.001 par value, 5,000,000 shares authorized; Series A, non-cumulative convertible, 200,000 shares issued; no shares outstanding as of June 30, 2013 and 85,710 shares outstanding in 2012.

 

 

83,027

 

Common stock, $0.001 par value, 200,000,000 shares authorized; 162,999,534 and 157,160,193 shares issued in 2013 and 2012, respectively; 137,705,407 and 140,294,092 shares outstanding in 2013 and 2012, respectively

 

163

 

157

 

Additional paid in capital

 

1,558,415

 

1,464,739

 

Retained earnings

 

1,252,812

 

1,151,828

 

Treasury stock, at cost – 25,294,127 shares in 2013 and 16,866,101 shares in 2012

 

(531,761

)

(322,298

)

Accumulated other comprehensive (loss) income, net of tax

 

(21,678

)

4,669

 

Total stockholders’ equity

 

2,257,951

 

2,382,122

 

TOTAL

 

$

23,308,406

 

$

22,536,110

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



Table of Contents

 

EAST WEST BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

INTEREST AND DIVIDEND INCOME

 

 

 

 

 

 

 

 

 

Loans receivable, including fees

 

$

234,290

 

$

238,036

 

$

451,449

 

$

459,075

 

Investment securities

 

9,594

 

16,913

 

19,804

 

38,145

 

Securities purchased under resale agreements

 

5,435

 

4,758

 

10,964

 

9,072

 

Investment in Federal Home Loan Bank stock

 

1,021

 

167

 

1,550

 

387

 

Investment in Federal Reserve Bank stock

 

721

 

714

 

1,441

 

1,427

 

Due from banks and short-term investments

 

4,292

 

5,774

 

8,568

 

12,306

 

Total interest and dividend income

 

255,353

 

266,362

 

493,776

 

520,412

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Customer deposit accounts

 

15,738

 

19,177

 

32,592

 

39,341

 

Federal funds purchased

 

 

 

 

2

 

Federal Home Loan Bank advances

 

1,047

 

1,353

 

2,086

 

3,495

 

Securities sold under repurchase agreements

 

10,217

 

11,591

 

20,746

 

23,313

 

Long-term debt

 

707

 

1,084

 

1,417

 

2,186

 

Total interest expense

 

27,709

 

33,205

 

56,841

 

68,337

 

 

 

 

 

 

 

 

 

 

 

Net interest income before provision for loan losses

 

227,644

 

233,157

 

436,935

 

452,075

 

Provision for loan losses, excluding covered loans

 

8,277

 

16,595

 

7,515

 

33,074

 

Provision for (reversal of) loan losses on covered loans

 

723

 

(1,095

)

5,812

 

526

 

Net interest income after provision for loan losses

 

218,644

 

217,657

 

423,608

 

418,475

 

 

 

 

 

 

 

 

 

 

 

NONINTEREST (LOSS) INCOME

 

 

 

 

 

 

 

 

 

Impairment loss on investment securities

 

 

 

 

(5,165

)

Less: Noncredit-related impairment loss recorded in other comprehensive income

 

 

 

 

5,066

 

Net impairment loss on investment securities recognized in earnings

 

 

 

 

(99

)

Decrease in FDIC indemnification asset and receivable

 

(47,905

)

(40,345

)

(79,804

)

(45,763

)

Branch fees

 

8,119

 

7,821

 

15,773

 

15,484

 

Net gain on sales of investment securities

 

5,345

 

71

 

10,922

 

554

 

Net gain on sale of fixed assets

 

228

 

37

 

352

 

73

 

Letters of credit fees and commissions

 

5,426

 

4,538

 

10,488

 

8,813

 

Foreign exchange income

 

3,649

 

563

 

5,985

 

2,359

 

Ancillary loan fees

 

2,634

 

2,188

 

4,686

 

4,196

 

Income from life insurance policies

 

900

 

959

 

1,868

 

1,949

 

Net (loss) gain on sales of loans

 

(354

)

6,375

 

(260

)

11,554

 

Other operating income

 

9,604

 

6,138

 

15,537

 

10,965

 

Total noninterest (loss) income

 

(12,354

)

(11,655

)

(14,453

)

10,085

 

 

 

 

 

 

 

 

 

 

 

NONINTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

42,026

 

42,863

 

87,757

 

89,272

 

Occupancy and equipment expense

 

13,706

 

13,057

 

27,514

 

26,575

 

Amortization of investments in affordable housing partnerships and other investments

 

5,064

 

4,425

 

9,347

 

8,891

 

Amortization of premiums on deposits acquired

 

2,375

 

2,838

 

4,784

 

5,711

 

Deposit insurance premiums and regulatory assessments

 

3,875

 

3,323

 

7,657

 

7,315

 

Loan related expenses

 

3,573

 

4,175

 

7,157

 

8,656

 

Other real estate owned (gain on sale) expense

 

(1,188

)

4,486

 

(2,172

)

15,351

 

Legal expense

 

5,467

 

4,150

 

9,911

 

11,323

 

Prepayment penalty for FHLB advances

 

 

2,336

 

 

3,657

 

Data processing

 

2,200

 

2,197

 

4,637

 

4,661

 

Deposit related expenses

 

1,516

 

1,657

 

3,090

 

3,084

 

Consulting expense

 

1,003

 

1,568

 

1,457

 

3,035

 

Other operating expenses

 

14,803

 

14,533

 

29,636

 

28,840

 

Total noninterest expense

 

94,420

 

101,608

 

190,775

 

216,371

 

 

 

 

 

 

 

 

 

 

 

INCOME BEFORE PROVISION FOR INCOME TAXES

 

111,870

 

104,394

 

218,380

 

212,189

 

PROVISION FOR INCOME TAXES

 

37,855

 

33,837

 

72,274

 

73,549

 

NET INCOME

 

74,015

 

70,557

 

146,106

 

138,640

 

PREFERRED STOCK DIVIDENDS

 

1,714

 

1,714

 

3,428

 

3,428

 

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

 

$

72,301

 

$

68,843

 

$

142,678

 

$

135,212

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER SHARE AVAILABLE TO COMMON STOCKHOLDERS

 

 

 

 

 

 

 

 

 

BASIC

 

$

0.52

 

$

0.48

 

$

1.03

 

$

0.93

 

DILUTED

 

$

0.52

 

$

0.47

 

$

1.03

 

$

0.92

 

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING

 

 

 

 

 

 

 

 

 

BASIC

 

137,536

 

142,107

 

137,592

 

143,727

 

DILUTED

 

137,816

 

147,786

 

141,573

 

149,414

 

 

 

 

 

 

 

 

 

 

 

DIVIDENDS DECLARED PER COMMON SHARE

 

$

0.15

 

$

0.10

 

$

0.30

 

$

0.20

 

 

See accompanying notes to condensed consolidated financial statements.

 

5



Table of Contents

 

EAST WEST BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net income

 

$

74,015

 

$

70,557

 

$

146,106

 

$

138,640

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized (loss) gain on investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

Unrealized holding (losses) gains arising during period

 

(24,770

)

1,002

 

(20,029

)

21,272

 

Reclassification adjustment for net gains included in net income

 

(3,100

)

(41

)

(6,335

)

(321

)

Noncredit-related impairment loss on securities

 

 

 

 

(2,938

)

Unrealized gains (losses) on other investments

 

7

 

(6

)

17

 

4

 

Reclassification adjustment for net gains included in net income

 

 

 

 

 

Other comprehensive (loss) income

 

(27,863

)

955

 

(26,347

)

18,017

 

COMPREHENSIVE INCOME

 

$

46,152

 

$

71,512

 

$

119,759

 

$

156,657

 

 

See accompanying notes to condensed consolidated financial statements.

 

6



Table of Contents

 

EAST WEST BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(In thousands, except share data)

(Unaudited)

 

 

 

 

 

Additional

 

 

 

Additional

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Paid In

 

 

 

Paid In

 

 

 

 

 

Other

 

 

 

 

 

 

 

Capital

 

 

 

Capital

 

 

 

 

 

Comprehensive

 

Total

 

 

 

Preferred

 

Preferred

 

Common

 

Common

 

Retained

 

Treasury

 

Income (Loss),

 

Stockholders’

 

 

 

Stock

 

Stock

 

Stock

 

Stock

 

Earnings

 

Stock

 

Net of Tax

 

Equity

 

BALANCE, JANAURY 1, 2012

 

$

 

$

83,027

 

$

157

 

$

1,443,883

 

$

934,617

 

$

(116,001

)

$

(33,940

)

$

2,311,743

 

Net income

 

 

 

 

 

 

 

 

 

138,640

 

 

 

 

 

138,640

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

18,017

 

18,017

 

Stock compensation costs

 

 

 

 

 

 

 

7,773

 

 

 

 

 

 

 

7,773

 

Tax benefit from stock compensation plans, net

 

 

 

 

 

 

 

157

 

 

 

 

 

 

 

157

 

Issuance of 274,430 shares of common stock pursuant to various stock compensation plans and agreements

 

 

 

 

 

 

 

2,678

 

 

 

 

 

 

 

2,678

 

Cancellation of 108,662 shares of common stock due to forfeitures of issued restricted stock

 

 

 

 

 

 

 

1,870

 

 

 

(1,870

)

 

 

 

63,636 shares of restricted stock surrendered due to employee tax liability

 

 

 

 

 

 

 

 

 

 

 

(1,396

)

 

 

(1,396

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

(3,428

)

 

 

 

 

(3,428

)

Common stock dividends

 

 

 

 

 

 

 

 

 

(29,294

)

 

 

 

 

(29,294

)

Purchase of 6,784,227 shares of treasury stock pursuant to the Stock Repurchase Program

 

 

 

 

 

 

 

 

 

 

 

(149,950

)

 

 

(149,950

)

BALANCE, JUNE 30, 2012

 

$

 

$

83,027

 

$

157

 

$

1,456,361

 

$

1,040,535

 

$

(269,217

)

$

(15,923

)

$

2,294,940

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, JANAURY 1, 2013

 

$

 

$

83,027

 

$

157

 

$

1,464,739

 

$

1,151,828

 

$

(322,298

)

$

4,669

 

$

2,382,122

 

Net income

 

 

 

 

 

 

 

 

 

146,106

 

 

 

 

 

146,106

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(26,347

)

(26,347

)

Stock compensation costs

 

 

 

 

 

 

 

5,898

 

 

 

 

 

 

 

5,898

 

Tax benefit from stock compensation plans, net

 

 

 

 

 

 

 

2,803

 

 

 

 

 

 

 

2,803

 

Issuance of 245,261 shares of common stock pursuant to various stock compensation plans and agreements

 

 

 

 

 

 

 

1,150

 

 

 

 

 

 

 

1,150

 

Cancellation of 44,793 shares of common stock due to forfeitures of issued restricted stock

 

 

 

 

 

 

 

804

 

 

 

(804

)

 

 

 

356,426 shares of restricted stock surrendered due to employee tax liability

 

 

 

 

 

 

 

 

 

 

 

(8,667

)

 

 

(8,667

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

(3,428

)

 

 

 

 

(3,428

)

Common stock dividends

 

 

 

 

 

 

 

 

 

(41,694

)

 

 

 

 

(41,694

)

Conversion of 85,710 shares of Series A preferred stock into 5,594,080 shares of common stock

 

 

 

(83,027

)

6

 

83,021

 

 

 

 

 

 

 

 

Purchase of 8,026,807 shares of treasury stock pursuant to the Stock Repurchase Program

 

 

 

 

 

 

 

 

 

 

 

(199,992

)

 

 

(199,992

)

BALANCE, JUNE 30, 2013

 

$

 

$

 

$

163

 

$

1,558,415

 

$

1,252,812

 

$

(531,761

)

$

(21,678

)

$

2,257,951

 

 

See accompanying notes to condensed consolidated financial statements.

 

7



Table of Contents

 

EAST WEST BANCORP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2013

 

2012

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

146,106

 

$

138,640

 

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

 

 

 

 

 

Depreciation and amortization

 

46,785

 

39,711

 

(Accretion) of discount and amortization of premiums, net

 

(104,247

)

(96,885

)

Decrease in FDIC indemnification asset and receivable

 

79,804

 

45,763

 

Stock compensation costs

 

5,898

 

7,773

 

Deferred tax expense (benefit)

 

320

 

(19,868

)

Provision for loan losses

 

13,327

 

33,600

 

Impairment on other real estate owned

 

2,153

 

10,541

 

Net gain on sales of investment securities, loans and other assets

 

(16,512

)

(14,854

)

Prepayment penalty for Federal Home Loan Bank advances, net

 

 

3,657

 

Originations and purchases of loans held for sale

 

(71,572

)

(34,716

)

Proceeds from sales of loans held for sale

 

6,272

 

 

Net proceeds from FDIC shared-loss agreements

 

42,494

 

63,077

 

Net change in accrued interest receivable and other assets

 

55,158

 

(67,820

)

Net change in accrued expenses and other liabilities

 

(43,579

)

(43,142

)

Other net operating activities

 

(4,671

)

(2,007

)

Total adjustments

 

11,630

 

(75,170

)

Net cash provided by operating activities

 

157,736

 

63,470

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Net (increase) decrease in:

 

 

 

 

 

Loans

 

(679,359

)

184,443

 

Short-term investments

 

35,940

 

(192,880

)

Federal funds sold

 

 

(30,000

)

Purchases of:

 

 

 

 

 

Securities purchased under resale agreements

 

(300,000

)

(200,000

)

Investment securities available-for-sale

 

(699,650

)

(482,500

)

Loans receivable

 

(466,715

)

(239,272

)

Premises and equipment

 

(10,328

)

(3,405

)

Investments in affordable housing partnerships

 

(16,683

)

(34,128

)

Proceeds from sale of:

 

 

 

 

 

Investment securities available-for-sale

 

325,721

 

1,097,270

 

Loans receivable

 

55,129

 

58,205

 

Loans held for sale originated for investment

 

 

199,435

 

Other real estate owned

 

38,677

 

59,814

 

Premises and equipment

 

352

 

11

 

Repayments, maturities and redemptions of investment securities available-for-sale

 

262,074

 

606,704

 

Paydowns, maturities and termination of securities purchased under resale agreements

 

300,000

 

311,434

 

Redemption of Federal Home Loan Bank stock

 

21,136

 

12,674

 

Other net investing activities

 

(108

)

(236

)

Net cash (used in) provided by investing activities

 

(1,133,814

)

1,347,569

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Net increase (decrease) in:

 

 

 

 

 

Deposits

 

972,853

 

(110,498

)

Short-term borrowings

 

(20,000

)

(25,208

)

Proceeds from:

 

 

 

 

 

Issuance of common stock pursuant to various stock plans and agreements

 

1,150

 

2,678

 

Payment for:

 

 

 

 

 

Repayment of FHLB advances

 

 

(57,616

)

Modification of Federal Home Loan Bank advances

 

 

(37,678

)

Repurchase of shares of treasury stock pursuant to the Stock Repurchase Plan

 

(199,992

)

(149,950

)

Cash dividends

 

(44,961

)

(32,642

)

Other net financing activities

 

(5,864

)

(1,239

)

Net cash provided by (used in) financing activities

 

703,186

 

(412,153

)

Effect of exchange rate changes on cash and cash equivalents

 

 

(457

)

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

(272,892

)

998,429

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

1,323,106

 

1,431,185

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

1,050,214

 

$

2,429,614

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

58,336

 

$

73,938

 

Income tax payments, net of refunds

 

92,096

 

185,729

 

Noncash investing and financing activities:

 

 

 

 

 

Loans transferred to loans held for sale, net

 

19,125

 

21,317

 

Transfers to other real estate owned

 

29,782

 

54,478

 

Conversion of preferred stock to common stock

 

83,027

 

 

Loans to facilitate sales of other real estate owned and short sales

 

139

 

850

 

Loans to facilitate sales of loans

 

 

638

 

 

See accompanying notes to condensed consolidated financial statements.

 

8


 


Table of Contents

 

EAST WEST BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

NOTE 1 — BASIS OF PRESENTATION

 

The condensed consolidated financial statements include the accounts of East West Bancorp, Inc. (referred to herein on an unconsolidated basis as “East West” and on a consolidated basis as the “Company”) and its wholly-owned subsidiaries, East West Bank and subsidiaries (“East West Bank” or the “Bank”) and East West Insurance Services, Inc. Intercompany transactions and accounts have been eliminated in consolidation. East West also has seven wholly-owned subsidiaries that are statutory business trusts (the “Trusts”). In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, the Trusts are not consolidated into the accounts of East West Bancorp, Inc.

 

The interim condensed consolidated financial statements, presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), are unaudited and reflect all adjustments that, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. All adjustments are of a normal and recurring nature. Results for the three months and six months ended June 30, 2013 are not necessarily indicative of results that may be expected for any other interim period or for the year as a whole. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. Events subsequent to the condensed consolidated balance sheet date have been evaluated through the date the financial statements are issued for inclusion in the accompanying financial statements. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

Certain prior year balances have been reclassified to conform to current year presentation.

 

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES

 

Recent Accounting Standards

 

In October 2012, the FASB issued ASU 2012-06, Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution. ASU 2012-06 clarifies the applicable guidance for subsequently measuring an indemnification asset recognized as a result of a government-assisted acquisition of a financial institution. The standard instructs that when a reporting entity recognizes an indemnification asset, it should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement. The amended guidance is effective for interim and annual periods beginning on or after December 15, 2012. The adoption of this guidance did not have a material effect on the Company’s condensed consolidated financial statements, as the Company had applied this methodology prior to the issuance of this ASU.

 

In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU 2013-01 clarifies that the scope of ASU 2011-01 applies to derivatives, repurchase agreements, and securities lending transactions to the extent that they are (1) offset in the financial statements or (2) subject to an enforceable master netting arrangement or similar agreement. The amended guidance is effective for interim and annual periods beginning on or after January 1, 2013. The adoption of this guidance did not have a material effect on the Company’s condensed consolidated financial statements. The Company did include additional disclosure in the notes to the condensed consolidated financial statements to comply with the requirements of the ASU.

 

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Table of Contents

 

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 enhances the reporting of reclassifications out of accumulated other comprehensive income by requiring entities to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. The amendments are effective for interim and annual periods beginning on or after December 15, 2012. The adoption of this guidance did not have a material effect on the Company’s condensed consolidated financial statements. The Company did include additional disclosure in the notes to the condensed consolidated financial statements to comply with the requirements of the ASU.

 

In July 2013, the FASB issued ASU 2013-10, Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes. ASU 2013-10 permits the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate (“LIBOR”). ASU 2013-10 is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013.  The Company does not expect the adoption of this guidance to have a material effect on the Company’s condensed consolidated financial statements.

 

NOTE 3 — FAIR VALUE

 

Fair value is defined as the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market and income approaches. Based on these approaches, the Company utilizes certain assumptions that market participants would use in pricing the asset or liability. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy noted below. The hierarchy is based on the quality and reliability of the information used to determine fair values. The hierarchy gives the highest priority to quoted prices available in active markets and the lowest priority to data lacking transparency. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

 

·                                          Level 1 — Quoted prices for identical instruments that are highly liquid, observable and actively traded in over-the-counter markets. Level 1 financial instruments typically include U.S. Treasury securities.

 

·                                          Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable and can be corroborated by market data. Level 2 financial instruments typically include U.S. Government debt and agency mortgage-backed securities, municipal securities, corporate debt securities, single issuer trust preferred securities, equity swap agreements, foreign exchange options and interest rate swaps.

 

10



Table of Contents

 

·                                          Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value is not solely based on observable market inputs and requires management judgment or estimation. This category typically includes pooled trust preferred securities, impaired loans, other real estate owned (“OREO”) and derivatives payable.

 

The Company records investment securities available-for-sale, equity swap agreements, derivative liabilities, foreign exchange options, interest rate swaps and short-term foreign exchange contracts at fair value on a recurring basis. Certain other assets such as impaired loans, other real estate owned, loans held for sale, goodwill, premiums on acquired deposits and other investments are recorded at fair value on a nonrecurring basis. Nonrecurring fair value measurements typically involve assets that are periodically evaluated for impairment and for which any impairment is recorded in the period in which the remeasurement is performed.

 

In determining the appropriate hierarchy levels, the Company performs a detailed analysis of assets and liabilities that are subject to fair value disclosure. The following tables present both financial and nonfinancial assets and liabilities that are measured at fair value on a recurring and nonrecurring basis. These assets and liabilities are reported on the condensed consolidated balance sheets at their fair values as of June 30, 2013 and December 31, 2012. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. There were no transfers for assets measured on a recurring basis in and out of Levels 1 and 3 or Levels 2 and 3 during the first six months of 2013 and 2012.

 

11



Table of Contents

 

 

 

Assets (Liabilities) Measured at Fair Value on a Recurring Basis

 

 

 

as of June 30, 2013

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(In thousands)

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

515,762

 

$

515,762

 

$

 

$

 

U.S. Government agency and U.S. Government sponsored enterprise debt securities

 

250,255

 

 

250,255

 

 

U.S. Government agency and U.S. Government sponsored enterprise mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Commercial mortgage-backed securities

 

134,248

 

 

134,248

 

 

Residential mortgage-backed securities

 

996,517

 

 

996,517

 

 

Municipal securities

 

229,273

 

 

229,273

 

 

Other residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Investment grade

 

15,202

 

 

15,202

 

 

Other commercial mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Investment grade

 

51,297

 

 

51,297

 

 

Corporate debt securities:

 

 

 

 

 

 

 

 

 

Investment grade

 

448,211

 

 

448,211

 

 

Non-investment grade

 

15,640

 

 

10,123

 

5,517

 

Other securities

 

10,767

 

 

10,767

 

 

Total investment securities available-for-sale

 

$

2,667,172

 

$

515,762

 

$

2,145,893

 

$

5,517

 

Foreign exchange options

 

$

5,460

 

$

 

$

5,460

 

$

 

Interest rate swaps

 

22,353

 

 

22,353

 

 

Short-term foreign exchange contracts

 

2,896

 

 

2,896

 

 

Derivative liabilities

 

(33,667

)

 

(30,410

)

(3,257

)

 

 

 

Assets (Liabilities) Measured at Fair Value on a Recurring Basis

 

 

 

as of December 31, 2012

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

 

 

December 31,

 

Assets

 

Inputs

 

Inputs

 

 

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(In thousands)

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

460,677

 

$

460,677

 

$

 

$

 

U.S. Government agency and U.S. Government sponsored enterprise debt securities

 

197,855

 

 

197,855

 

 

U.S. Government agency and U.S. Government sponsored enterprise mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Commercial mortgage-backed securities

 

180,665

 

 

180,665

 

 

Residential mortgage-backed securities

 

1,144,085

 

 

1,144,085

 

 

Municipal securities

 

167,093

 

 

167,093

 

 

Other commercial mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Investment grade

 

17,084

 

 

17,084

 

 

Corporate debt securities:

 

 

 

 

 

 

 

 

 

Investment grade

 

411,983

 

 

411,983

 

 

Non-investment grade

 

17,417

 

 

12,617

 

4,800

 

Other securities

 

10,170

 

 

10,170

 

 

Total investment securities available-for-sale

 

$

2,607,029

 

$

460,677

 

$

2,141,552

 

$

4,800

 

Foreign exchange options

 

$

5,011

 

$

 

$

5,011

 

$

 

Interest rate swaps

 

36,943

 

 

36,943

 

 

Short-term foreign exchange contracts

 

896

 

 

896

 

 

Derivative liabilities

 

(42,060

)

 

(39,008

)

(3,052

)

 

12



Table of Contents

 

Assets measured at fair value on a nonrecurring basis using significant unobservable inputs include certain impaired loans and OREO. The inputs and assumptions for nonrecurring Level 3 fair value measurements for impaired loans and OREO include adjustments to external and internal appraisals for change in the market , assumptions by appraiser embedded into appraisals, probability weighting of brokered price opinions, and management’s adjustments for other relevant factors and market trends.

 

 

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

 

 

as of and for the Three Months Ended June 30, 2013

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

Total Gains

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

(Losses) for the

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

Three Months Ended

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

June 30,

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

2013

 

 

 

(In thousands)

 

Non-covered impaired loans:

 

 

 

 

 

 

 

 

 

 

 

Total residential

 

$

22,012

 

$

 

$

 

$

22,012

 

$

(838

)

Total commercial real estate

 

35,349

 

 

 

35,349

 

(1,320

)

Total commercial and industrial

 

9,203

 

 

 

9,203

 

674

 

Total consumer

 

372

 

 

 

372

 

4

 

Total non-covered impaired loans

 

$

66,936

 

$

 

$

 

$

66,936

 

$

(1,480

)

Non-covered OREO

 

$

435

 

$

 

$

 

$

435

 

$

(18

)

Covered OREO (1)

 

$

7,500

 

$

 

$

 

$

7,500

 

$

(1,000

)

 

 

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

 

 

as of and for the Three Months Ended June 30, 2012

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

Total Gains

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

(Losses) for the

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

Three Months Ended

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

June 30,

 

 

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

2012

 

 

 

(In thousands)

 

Non-covered impaired loans:

 

 

 

 

 

 

 

 

 

 

 

Total residential

 

$

14,824

 

$

 

$

 

$

14,824

 

$

(2,240

)

Total commercial real estate

 

16,517

 

 

 

16,517

 

(4,315

)

Total commercial and industrial

 

15,616

 

 

 

15,616

 

(9,705

)

Total consumer

 

372

 

 

 

372

 

(264

)

Total non-covered impaired loans

 

$

47,329

 

$

 

$

 

$

47,329

 

$

(16,524

)

Non-covered OREO

 

$

4,625

 

$

 

$

 

$

4,625

 

$

(1,820

)

Covered OREO (1)

 

$

6,544

 

$

 

$

 

$

6,544

 

$

(1,241

)

 


(1)             Covered OREO results from the WFIB and UCB FDIC-assisted acquisitions for which the Company entered into shared-loss agreements with the FDIC whereby the FDIC will reimburse the Company for 80% of eligible losses. As such, the Company’s liability for losses is 20% of the $1.0 million in losses, or $200 thousand, and 20% of the $1.2 million in losses, or $248 thousand, for the three months ended June 30, 2013 and 2012, respectively.

 

13



Table of Contents

 

 

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

 

 

as of and for the Six Months Ended June 30, 2013

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

Total Gains

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

(Losses) for the

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

Six Months Ended

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

June 30,

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

2013

 

 

 

(In thousands)

 

Non-covered impaired loans:

 

 

 

 

 

 

 

 

 

 

 

Total residential

 

$

19,971

 

$

 

$

 

$

19,971

 

$

(1,274

)

Total commercial real estate

 

30,397

 

 

 

30,397

 

(3,422

)

Total commercial and industrial

 

9,723

 

 

 

9,723

 

(1,492

)

Total consumer

 

293

 

 

 

293

 

(112

)

Total non-covered impaired loans

 

$

60,384

 

$

 

$

 

$

60,384

 

$

(6,300

)

Non-covered OREO

 

$

13,238

 

$

 

$

 

$

13,238

 

$

(1,403

)

Covered OREO (1)

 

$

11,030

 

$

 

$

 

$

11,030

 

$

(1,126

)

 

 

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

 

 

as of and for the Six Months Ended June 30, 2012

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

Total Gains

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

(Losses) for the

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

Six Months Ended

 

 

 

June 30,

 

Assets

 

Inputs

 

Inputs

 

June 30,

 

 

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

2012

 

 

 

(In thousands)

 

Non-covered impaired loans:

 

 

 

 

 

 

 

 

 

 

 

Total residential

 

$

18,466

 

$

 

$

 

$

18,466

 

$

(2,789

)

Total commercial real estate

 

26,789

 

 

 

26,789

 

(4,316

)

Total commercial and industrial

 

16,097

 

 

 

16,097

 

(10,281

)

Total consumer

 

379

 

 

 

379

 

(321

)

Total non-covered impaired loans

 

$

61,731

 

$

 

$

 

$

61,731

 

$

(17,707

)

Non-covered OREO

 

$

8,674

 

$

 

$

 

$

8,674

 

$

(2,675

)

Covered OREO (1)

 

$

17,712

 

$

 

$

 

$

17,712

 

$

(7,689

)

Loans held for sale

 

$

 

$

 

$

 

$

 

$

(4,730

)

 


(1)             Covered OREO results from the WFIB and UCB FDIC-assisted acquisitions for which the Company entered into shared-loss agreements with the FDIC whereby the FDIC will reimburse the Company for 80% of eligible losses. As such, the Company’s liability for losses is 20% of the $1.1 million in losses, or $225 thousand, and 20% of the $7.7 million in losses, or $1.5 million, for the six months ended June 30, 2013 and 2012, respectively.

 

14


 


Table of Contents

 

At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3. The following tables provide a reconciliation of the beginning and ending balances for major asset and liability categories measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months and six months ended June 30, 2013 and 2012:

 

 

 

Investment Securities
Available-for-Sale

 

 

 

 

 

Corporate Debt
Securities

 

 

 

 

 

Non-Investment Grade

 

Derivatives Payable

 

 

 

(In thousands)

 

Opening balance, April 1, 2013

 

$

5,284

 

$

(3,233

)

Total gains or (losses) for the period: (1)

 

 

 

 

 

Included in earnings

 

 

(24

)

Included in other comprehensive income (unrealized) (2)

 

239

 

 

Purchases, issues, sales, settlements (3)

 

 

 

 

 

Purchases

 

 

 

Issues

 

 

 

Sales

 

 

 

Settlements

 

(6

)

 

Transfer from investment grade to non-investment grade

 

 

 

Transfers in and/or out of Level 3

 

 

 

Closing balance, June 30, 2013

 

$

5,517

 

$

(3,257

)

Changes in unrealized losses included in earnings relating to assets and liabilities held at the end of June 30, 2013

 

$

 

$

24

 

 

 

 

Investment Securities
Available-for-Sale

 

 

 

 

 

Corporate Debt
Securities

 

 

 

 

 

Non-Investment Grade

 

Derivatives Payable

 

 

 

(In thousands)

 

Opening balance, April 1, 2012

 

$

2,247

 

$

(3,122

)

Total gains or (losses) for the period: (1)

 

 

 

 

 

Included in earnings

 

 

308

 

Included in other comprehensive income (unrealized) (2)

 

105

 

 

Purchases, issues, sales, settlements (3)

 

 

 

 

 

Purchases

 

 

 

Issues

 

 

 

Sales

 

 

 

Settlements

 

70

 

 

Transfer from investment grade to non-investment grade

 

 

 

Transfers in and/or out of Level 3

 

 

 

Closing balance, June 30, 2012

 

$

2,422

 

$

(2,814

)

Changes in unrealized gains included in earnings relating to assets and liabilities held at the end of June 30, 2012

 

$

 

$

(308

)

 


(1)             Total gains or losses represent the total realized and unrealized gains and losses recorded for Level 3 assets and liabilities. Realized gains or losses are reported in the condensed consolidated statements of income.

 

(2)             Unrealized gains or losses on investment securities are reported in accumulated other comprehensive income (loss), net of tax, in the condensed consolidated statements of comprehensive income.

 

(3)             Purchases, issuances, sales, and settlements represent Level 3 assets and liabilities that were either purchased, issued, sold, or settled during the period. The amounts are recorded at their end of period fair values.

 

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Table of Contents

 

 

 

Investment Securities
Available-for-Sale

 

 

 

 

 

Corporate Debt
Securities

 

 

 

 

 

Non-Investment Grade

 

Derivatives Payable

 

 

 

(In thousands)

 

Beginning balance, January 1, 2013

 

$

4,800

 

$

(3,052

)

Total gains or (losses) for the period: (1)

 

 

 

 

 

Included in earnings

 

 

(205

)

Included in other comprehensive income (unrealized) (2)

 

788

 

 

Purchases, issues, sales, settlements (3)

 

 

 

 

 

Purchases

 

 

 

Issues

 

 

 

Sales

 

 

 

Settlements

 

(71

)

 

Transfer from investment grade to non-investment grade

 

 

 

Transfers in and/or out of Level 3

 

 

 

Closing balance, June 30, 2013

 

$

5,517

 

$

(3,257

)

Changes in unrealized losses included in earnings relating to assets and liabilities held at the end of June 30, 2013

 

$

 

$

205

 

 

 

 

Investment Securities
Available-for-Sale

 

 

 

 

 

Corporate Debt
Securities

 

 

 

 

 

Non-Investment Grade

 

Derivatives Payable

 

 

 

(In thousands)

 

Beginning balance, January 1, 2012

 

$

2,235

 

$

(2,634

)

Total gains or (losses) for the period: (1)

 

 

 

 

 

Included in earnings

 

(99

)

(180

)

Included in other comprehensive income (unrealized) (2)

 

330

 

 

Purchases, issues, sales, settlements (3)

 

 

 

 

 

Purchases

 

 

 

Issues

 

 

 

Sales

 

 

 

Settlements

 

(44

)

 

Transfer from investment grade to non-investment grade

 

 

 

Transfers in and/or out of Level 3

 

 

 

Closing balance, June 30, 2012

 

$

2,422

 

$

(2,814

)

Changes in unrealized losses included in earnings relating to assets and liabilities held at the end of June 30, 2012

 

$

99

 

$

180

 

 


(1)             Total gains or losses represent the total realized and unrealized gains and losses recorded for Level 3 assets and liabilities. Realized gains or losses are reported in the condensed consolidated statements of income.

 

(2)             Unrealized gains or losses on investment securities are reported in accumulated other comprehensive income (loss), net of tax, in the condensed consolidated statements of comprehensive income.

 

(3)             Purchases, issuances, sales, and settlements represent Level 3 assets and liabilities that were either purchased, issued, sold, or settled during the period. The amounts are recorded at their end of period fair values.

 

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Table of Contents

 

Valuation Methodologies

 

Investment Securities Available-for-Sale — The fair values of available-for-sale investment securities are generally determined by prices obtained from independent external pricing service providers who have experience in valuing these securities or by comparison to the average of at least two quoted market prices obtained from independent external brokers. In obtaining such valuation information from third parties, the Company has reviewed the methodologies used to develop the resulting fair values.

 

The Company’s Level 3 available-for-sale securities include four pooled trust preferred securities. The fair values of these investment securities represent less than 1% of the total available-for-sale investment securities. The fair values of the pooled trust preferred securities have traditionally been based on the average of at least two quoted market prices obtained from independent external brokers since broker quotes in an active market are given the highest priority. As a result of the continued illiquidity in the pooled trust preferred securities market, it is the Company’s view that current broker prices (which are typically non-binding) on certain pooled trust preferred securities are based on forced liquidation or distressed sale values in very inactive markets that are not representative of the fair value of these securities. As such, the Company considered what weight, if any, to place on transactions that are not orderly when estimating fair value.

 

For the pooled trust preferred securities, the fair value was derived based on discounted cash flow analyses (the income method) prepared by management. In order to determine the appropriate discount rate used in calculating fair values derived from the income method for the pooled trust preferred securities, the Company has made assumptions using an exit price approach related to the implied rate of return which have been adjusted for general changes in market rates, estimated changes in credit risk and liquidity risk premium, specific nonperformance, and default experience in the collateral underlying the securities. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for credit risk and liquidity risk. The actual Level 3 unobservable assumption rates used as of June 30, 2013 include: a constant prepayment rate of 0% for year 1-5 and 1% thereafter, a constant default rate of 1.2% for year 1-5 and 0.75% thereafter, and a recovery assumption of 0% for existing deferrals/defaults and 15% for future deferrals with a recovery lag of 60 months. Losses arising during the period, if any, are recognized in noninterest income.

 

Derivative Liabilities — The Company’s derivative liabilities include derivatives payable that fall within Level 3 and all other derivative liabilities which fall within Level 2. The derivatives payable are recorded in conjunction with certain certificates of deposit (“host instrument”). These CDs pay interest based on changes in either the Chinese currency Renminbi (“RMB”) or the Hang Seng China Enterprises Index (“HSCEI”), as designated, and are included in interest-bearing deposits on the condensed consolidated balance sheets. CDs paying interest based on changes in the HSCEI matured during the fourth quarter of 2012. The fair value of these embedded derivatives is based on the income approach. The payable is divided by the portion under FDIC insurance coverage and the non-insured portion. For the FDIC insured portion the Company applied a risk premium comparable to an agency security risk premium. For the non-insured portion, the Company considered its own credit risk in determining the valuation by applying a risk premium based on our institutional credit rating, which resulted in a $2.2 million adjustment to the valuation of the derivative liabilities for the six months ended June 30, 2013. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. The valuation of the derivatives payable falls within Level 3 of the fair value hierarchy since the significant inputs used in deriving the fair value of these derivative contracts are not directly observable. The actual Level 3 unobservable input used as of June 30, 2013 was a credit risk adjustment with a range of 1.27% to 1.42%. The Level 2 derivative liabilities are mostly comprised of the offsetting interest rate swaps with other counterparties. Refer to “Interest Rate Swaps” within this footnote for complete discussion.

 

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Table of Contents

 

Equity Swap Agreements — The Company has entered into equity swap agreements to hedge against market fluctuations in a promotional equity index certificate of deposit product offered to bank customers. This deposit product has a term of 5 years and matured during the fourth quarter of 2012. It paid interest based on the performance of the HSCEI. The fair value of these equity swap agreements is based on the income approach. The fair value is based on the change in the value of the HSCEI and the volatility of the call option over the life of the individual swap agreement. The option value is derived based on the volatility, the interest rate and the time remaining to maturity of the call option. The valuation of equity swap agreements falls within Level 2 of the fair value hierarchy due to the observable nature of the inputs used in deriving the fair value of these derivative contracts. The fair value of the derivative contracts is provided by a third party.

 

Foreign Exchange Options — The Company has entered into foreign exchange option contracts with major investment firms. The settlement amount is determined based upon the performance of the Chinese currency RMB relative to the U.S. Dollar (“USD”) over the 5-year term of the contract. The performance amount is computed based on the average quarterly value of the RMB per the USD as compared to the initial value. The fair value of the derivative contract is provided by third parties and is determined based on the change in the RMB and the volatility of the option over the life of the agreement. The option value is derived based on the volatility of the option, interest rate, currency rate and time remaining to maturity. The Company’s consideration of the counterparty’s credit risk resulted in a nominal adjustment to the valuation of the foreign exchange options for the six months ended June 30, 2013. The valuation of the option contract falls within Level 2 of the fair value hierarchy due to the observable nature of the inputs used in deriving the fair value of this derivative contract.

 

Interest Rate Swaps — The Company has entered into pay-fixed, receive-variable swap contracts with institutional counterparties to hedge against interest rate swap products offered to bank customers. This product allows borrowers to lock in attractive intermediate and long-term interest rates by entering into a pay-fixed, receive-variable swap contract with the Company, resulting in the customer obtaining a synthetic fixed rate loan. The Company has also entered into pay-variable, receive-fixed swap contracts with institutional counterparties to hedge against certificates of deposit issued. This product allows the Company to lock in attractive floating rate funding. The fair value of the interest rate swap contracts is based on a discounted cash flow approach. The Company’s consideration of the counterparty’s credit risk resulted in a $0.2 million adjustment to the valuation of the interest rate swaps for the six months ended June 30, 2013. The valuation of the interest rate swap falls within Level 2 of the fair value hierarchy due to the observable nature of the inputs used in deriving the fair value of this derivative contract.

 

Short-term Foreign Exchange Contracts — The Company entered into short-term foreign exchange contracts to purchase/sell foreign currencies at set rates in the future. These contracts economically hedge against foreign exchange rate fluctuations. The Company enters into contracts with institutional counterparties to hedge against foreign exchange products offered to bank customers. These products allow customers to hedge the foreign exchange risk of their deposits and loans denominated in foreign currencies. The Company does not assume any foreign exchange rate risk as the contract with the customer and the contract with the institutional party mirror each other. The fair value is determined at each reporting period based on the change in the foreign exchange rate. Given the short-term nature of the contracts, the counterparties’ credit risks are considered nominal and resulted in no adjustments to the valuation of the short-term foreign exchange contracts for the six months ended June 30, 2013. The valuation of the contract falls within Level 2 of the fair value hierarchy due to the observable nature of the inputs used in deriving the fair value of this derivative contract.

 

Impaired Loans — The Company’s impaired loans are generally measured using the fair value of the underlying collateral, which is determined based on the most recent valuation information received. The fair values may be adjusted as needed based on factors such as the Company’s historical knowledge and changes in market conditions from the time of valuation. Impaired loans fall within Level 3 of the fair value hierarchy as values are measured at fair value based on the most recent valuation information received on the underlying collateral and may include adjustments by the Company for historical knowledge and for changes in market conditions.

 

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Table of Contents

 

Other Real Estate Owned — The Company’s OREO represents properties acquired through foreclosure or through full or partial satisfaction of loans and are recorded at estimated fair value less cost to sell at the time of foreclosure and at the lower of cost or estimated fair value less cost to sell subsequent to acquisition. The fair values of OREO properties are based on third party appraisals, broker price opinions or accepted written offers. These valuations are reviewed and approved by the Company’s appraisal department, credit review department, or OREO department and may include adjustments by the Company for historical knowledge and for changes in market conditions. OREO properties are classified as Level 3 assets in the fair value hierarchy.

 

Loans Held for Sale — The Company’s loans held for sale are carried at the lower of cost or market value. These loans are currently comprised of mostly student loans. For these loans, the fair value of loans held for sale is derived from current market prices and comparative current sales. For the remainder of the loans held for sale, which fall within Level 2, the fair value is derived from third party sale analysis, existing sale agreements, or appraisal reports on the loans’ underlying collateral. As such, the Company records any fair value adjustments on a nonrecurring basis.

 

Fair Value of Financial Instruments

 

The carrying amounts and fair values of the Company’s financial instruments as of June 30, 2013 and December 31, 2012 were as follows: