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EAST WEST BANCORP INC - Quarter Report: 2013 March (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 March 31, 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 o

 

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 o

 

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

¨

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: 136,174,881 shares of common stock as of April 30, 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

56

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

80

 

 

 

Item 4.

Controls and Procedures

80

 

 

 

PART II - OTHER INFORMATION

81

 

 

 

Item 1.

Legal Proceedings

81

 

 

 

Item 1A.

Risk Factors

81

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

81

 

 

 

Item 3.

Defaults Upon Senior Securities

81

 

 

 

Item 4.

Mine Safety Disclosures

81

 

 

 

Item 5.

Other Information

82

 

 

 

Item 6.

Exhibits

82

 

 

 

SIGNATURE

82

 

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 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)

 

 

 

March 31,

 

December 31,

 

 

 

2013

 

2012

 

ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

1,736,865

 

$

1,323,106

 

Short-term investments

 

379,029

 

366,378

 

Securities purchased under resale agreements

 

1,400,000

 

1,450,000

 

Investment securities available-for-sale, at fair value (with amortized cost of $2,578,384 at March 31, 2013 and $2,599,018 at December 31, 2012)

 

2,588,993

 

2,607,029

 

Loans held for sale

 

226,635

 

174,317

 

Loans receivable, excluding covered loans (net of allowance for loan losses of $228,796 at March 31, 2013 and $229,382 at December 31, 2012)

 

12,119,903

 

11,710,190

 

Covered loans (net of allowance for loan losses of $10,110 at March 31, 2013 and $5,153 at December 31, 2012)

 

2,752,269

 

2,935,595

 

Total loans receivable, net

 

14,872,172

 

14,645,785

 

FDIC indemnification asset

 

276,834

 

316,313

 

Other real estate owned, net

 

32,324

 

32,911

 

Other real estate owned covered, net

 

28,567

 

26,808

 

Total other real estate owned

 

60,891

 

59,719

 

Investment in Federal Home Loan Bank stock, at cost

 

96,795

 

107,275

 

Investment in Federal Reserve Bank stock, at cost

 

48,036

 

48,003

 

Investment in affordable housing partnerships

 

181,928

 

185,645

 

Premises and equipment, net

 

109,485

 

107,517

 

Accrued interest receivable

 

103,392

 

94,837

 

Due from customers on acceptances

 

22,662

 

28,612

 

Premiums on deposits acquired, net

 

53,875

 

56,285

 

Goodwill

 

337,438

 

337,438

 

Cash surrender value of life insurance policies

 

110,860

 

110,133

 

Other assets

 

496,065

 

517,718

 

TOTAL

 

$

23,101,955

 

$

22,536,110

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Customer deposit accounts:

 

 

 

 

 

Noninterest-bearing

 

$

4,838,523

 

$

4,535,877

 

Interest-bearing

 

14,097,179

 

13,773,477

 

 

 

 

 

 

 

Total deposits

 

18,935,702

 

18,309,354

 

Federal Home Loan Bank advances

 

313,494

 

312,975

 

Securities sold under repurchase agreements

 

995,000

 

995,000

 

Other borrowings

 

 

20,000

 

Bank acceptances outstanding

 

22,662

 

28,612

 

Long-term debt

 

137,178

 

137,178

 

Accrued expenses and other liabilities

 

354,800

 

350,869

 

 

 

 

 

 

 

Total liabilities

 

20,758,836

 

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 and 85,710 shares outstanding in 2013 and 2012

 

83,027

 

83,027

 

Common stock, $0.001 par value, 200,000,000 shares authorized; 157,354,024 and 157,160,193 shares issued in 2013 and 2012, respectively; 136,578,350 and 140,294,092 shares outstanding in 2013 and 2012, respectively

 

157

 

157

 

Additional paid in capital

 

1,470,674

 

1,464,739

 

Retained earnings

 

1,201,126

 

1,151,828

 

Treasury stock, at cost – 20,775,674 shares in 2013 and 16,866,101 shares in 2012

 

(418,050

)

(322,298

)

Accumulated other comprehensive income, net of tax

 

6,185

 

4,669

 

Total stockholders’ equity

 

2,343,119

 

2,382,122

 

TOTAL

 

$

23,101,955

 

$

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

 

 

 

March 31,

 

 

 

2013

 

2012

 

INTEREST AND DIVIDEND INCOME

 

 

 

 

 

Loans receivable, including fees

 

$

217,159

 

$

221,039

 

Investment securities

 

10,210

 

21,232

 

Securities purchased under resale agreements

 

5,529

 

4,314

 

Investment in Federal Home Loan Bank stock

 

529

 

220

 

Investment in Federal Reserve Bank stock

 

720

 

713

 

Due from banks and short-term investments

 

4,276

 

6,532

 

 

 

 

 

 

 

Total interest and dividend income

 

238,423

 

254,050

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

Customer deposit accounts

 

16,854

 

20,164

 

Federal funds purchased

 

 

2

 

Federal Home Loan Bank advances

 

1,039

 

2,142

 

Securities sold under repurchase agreements

 

10,529

 

11,722

 

Long-term debt

 

710

 

1,102

 

 

 

 

 

 

 

Total interest expense

 

29,132

 

35,132

 

 

 

 

 

 

 

Net interest income before provision for loan losses

 

209,291

 

218,918

 

(Reversal of) provision for loan losses, excluding covered loans

 

(762

)

16,479

 

Provision for loan losses on covered loans

 

5,089

 

1,621

 

 

 

 

 

 

 

Net interest income after provision for loan losses

 

204,964

 

200,818

 

 

 

 

 

 

 

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

 

(31,899

)

(5,418

)

Branch fees

 

7,654

 

7,662

 

Net gain on sales of investment securities

 

5,577

 

483

 

Letters of credit fees and commissions

 

5,062

 

4,275

 

Foreign exchange income

 

2,336

 

1,796

 

Ancillary loan fees

 

2,052

 

2,008

 

Income from life insurance policies

 

968

 

990

 

Net gain on sales of loans

 

94

 

5,179

 

Other operating income

 

6,057

 

4,864

 

 

 

 

 

 

 

Total noninterest (loss) income

 

(2,099

)

21,740

 

 

 

 

 

 

 

NONINTEREST EXPENSE

 

 

 

 

 

Compensation and employee benefits

 

45,731

 

46,409

 

Occupancy and equipment expense

 

13,808

 

13,518

 

Amortization of investments in affordable housing partnerships and other investments

 

4,283

 

4,466

 

Amortization of premiums on deposits acquired

 

2,409

 

2,873

 

Deposit insurance premiums and regulatory assessments

 

3,782

 

3,992

 

Loan related expenses

 

3,584

 

4,481

 

Other real estate owned (gain on sale) expense

 

(984

)

10,865

 

Legal expense

 

4,444

 

7,173

 

Prepayment penalty for FHLB advances

 

 

1,321

 

Data processing

 

2,437

 

2,464

 

Deposit related expenses

 

1,574

 

1,427

 

Consulting expense

 

454

 

1,467

 

Other operating expenses

 

14,833

 

14,307

 

 

 

 

 

 

 

Total noninterest expense

 

96,355

 

114,763

 

 

 

 

 

 

 

INCOME BEFORE PROVISION FOR INCOME TAXES

 

106,510

 

107,795

 

PROVISION FOR INCOME TAXES

 

34,419

 

39,712

 

 

 

 

 

 

 

NET INCOME

 

72,091

 

68,083

 

 

 

 

 

 

 

PREFERRED STOCK DIVIDENDS

 

1,714

 

1,714

 

 

 

 

 

 

 

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

 

$

70,377

 

$

66,369

 

 

 

 

 

 

 

EARNINGS PER SHARE AVAILABLE TO COMMON STOCKHOLDERS

 

 

 

 

 

BASIC

 

$

0.51

 

$

0.46

 

DILUTED

 

$

0.50

 

$

0.45

 

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING

 

 

 

 

 

BASIC

 

137,648

 

145,347

 

DILUTED

 

143,519

 

151,996

 

 

 

 

 

 

 

DIVIDENDS DECLARED PER COMMON SHARE

 

$

0.15

 

$

0.10

 

 

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

 

 

 

March 31,

 

 

 

2013

 

2012

 

Net income

 

$

72,091

 

$

68,083

 

Other comprehensive income, net of tax:

 

 

 

 

 

Unrealized gain on investment securities available-for-sale:

 

 

 

 

 

Unrealized holding gains arising during period

 

4,741

 

20,270

 

Reclassification adjustment for net gains included in net income

 

(3,235

)

(280

)

Noncredit-related impairment loss on securities

 

 

(2,938

)

Unrealized gains on other investments

 

10

 

10

 

Reclassification adjustment for net gains included in net income

 

 

 

Other comprehensive income

 

1,516

 

17,062

 

COMPREHENSIVE INCOME

 

$

73,607

 

$

85,145

 

 

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

 

 

 

 

 

 

 

 

 

68,083

 

 

 

 

 

68,083

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

17,062

 

17,062

 

Stock compensation costs

 

 

 

 

 

 

 

3,637

 

 

 

 

 

 

 

3,637

 

Tax benefit from stock compensation plans, net

 

 

 

 

 

 

 

29

 

 

 

 

 

 

 

29

 

Issuance of 205,103 shares of common stock pursuant to various stock compensation plans and agreements

 

 

 

 

 

 

 

1,539

 

 

 

 

 

 

 

1,539

 

Cancellation of 47,489 shares of common stock due to forfeitures of issued restricted stock

 

 

 

 

 

 

 

883

 

 

 

(883

)

 

 

 

60,073 shares of restricted stock surrendered due to employee tax liability

 

 

 

 

 

 

 

 

 

 

 

(1,313

)

 

 

(1,313

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

(1,714

)

 

 

 

 

(1,714

)

Common stock dividends

 

 

 

 

 

 

 

 

 

(14,791

)

 

 

 

 

(14,791

)

Purchase of 4,554,827 shares of treasury stock pursuant to the Stock Repurchase Program

 

 

 

 

 

 

 

 

 

 

 

(100,978

)

 

 

(100,978

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, MARCH 31, 2012

 

$

 

$

83,027

 

$

157

 

$

1,449,971

 

$

986,195

 

$

(219,175

)

$

(16,878

)

$

2,283,297

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, JANAURY 1, 2013

 

$

 

$

83,027

 

$

157

 

$

1,464,739

 

$

1,151,828

 

$

(322,298

)

$

4,669

 

$

2,382,122

 

Net income

 

 

 

 

 

 

 

 

 

72,091

 

 

 

 

 

72,091

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

1,516

 

1,516

 

Stock compensation costs

 

 

 

 

 

 

 

2,504

 

 

 

 

 

 

 

2,504

 

Tax benefit from stock compensation plans, net

 

 

 

 

 

 

 

2,602

 

 

 

 

 

 

 

2,602

 

Issuance of 193,831 shares of common stock pursuant to various stock compensation plans and agreements

 

 

 

 

 

 

 

442

 

 

 

 

 

 

 

442

 

Cancellation of 22,050 shares of common stock due to forfeitures of issued restricted stock

 

 

 

 

 

 

 

387

 

 

 

(387

)

 

 

 

344,423 shares of restricted stock surrendered due to employee tax liability

 

 

 

 

 

 

 

 

 

 

 

(8,365

)

 

 

(8,365

)

Preferred stock dividends

 

 

 

 

 

 

 

 

 

(1,714

)

 

 

 

 

(1,714

)

Common stock dividends

 

 

 

 

 

 

 

 

 

(21,079

)

 

 

 

 

(21,079

)

Purchase of 3,543,100 shares of treasury stock pursuant to the Stock Repurchase Program

 

 

 

 

 

 

 

 

 

 

 

(87,000

)

 

 

(87,000

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, MARCH 31, 2013

 

$

 

$

83,027

 

$

157

 

$

1,470,674

 

$

1,201,126

 

$

(418,050

)

$

6,185

 

$

2,343,119

 

 

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)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2013

 

2012

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

72,091

 

$

68,083

 

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

 

 

 

 

 

Depreciation and amortization

 

23,908

 

19,459

 

(Accretion) of discount and amortization of premiums, net

 

(48,390

)

(34,660

)

Decrease in FDIC indemnification asset and receivable

 

31,899

 

5,418

 

Stock compensation costs

 

2,504

 

3,637

 

Deferred tax expense (benefit)

 

312

 

(20,159

)

Provision for loan losses

 

4,327

 

18,100

 

Impairment on other real estate owned

 

1,321

 

7,389

 

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

 

(8,592

)

(7,014

)

Prepayment penalty for Federal Home Loan Bank advances, net

 

 

1,321

 

Originations and purchases of loans held for sale

 

(43,604

)

(15,782

)

Proceeds from sales of loans held for sale

 

6,272

 

 

Net proceeds from FDIC shared-loss agreements

 

33,890

 

39,358

 

Net change in accrued interest receivable and other assets

 

(12,525

)

(27,165

)

Net change in accrued expenses and other liabilities

 

20,557

 

40,427

 

Other net operating activities

 

(3,570

)

(713

)

 

 

 

 

 

 

Total adjustments

 

8,309

 

29,616

 

 

 

 

 

 

 

Net cash provided by operating activities

 

80,400

 

97,699

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Net (increase) decrease in:

 

 

 

 

 

Loans

 

(147,933

)

68,532

 

Short-term investments

 

(12,651

)

(115,742

)

Federal funds sold

 

 

(30,000

)

Purchases of:

 

 

 

 

 

Securities purchased under resale agreements

 

(250,000

)

 

Investment securities available-for-sale

 

(267,882

)

(8,018

)

Loans receivable

 

(106,206

)

(116,486

)

Investments in affordable housing partnerships

 

(8,386

)

(17,850

)

Proceeds from sale of:

 

 

 

 

 

Investment securities available-for-sale

 

196,853

 

260,261

 

Loans receivable

 

22,566

 

27,639

 

Loans held for sale originated for investment

 

 

52,559

 

Other real estate owned

 

22,313

 

22,791

 

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

 

87,889

 

138,650

 

Paydowns, maturities and termination of securities purchased under resale agreements

 

300,000

 

136,434

 

Redemption of Federal Home Loan Bank stock

 

10,480

 

6,391

 

Other net investing activities

 

(4,929

)

(832

)

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

(157,886

)

424,329

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Net increase (decrease) in:

 

 

 

 

 

Deposits

 

626,348

 

(113,801

)

Short-term borrowings

 

(20,000

)

(25,208

)

Proceeds from:

 

 

 

 

 

Issuance of common stock pursuant to various stock plans and agreements

 

442

 

1,539

 

Payment for:

 

 

 

 

 

Repayment of FHLB advances

 

 

(23,003

)

Modification of Federal Home Loan Bank advances

 

 

(37,678

)

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

 

(87,000

)

(100,978

)

Cash dividends

 

(22,782

)

(16,495

)

Other net financing activities

 

(5,763

)

(1,284

)

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

491,245

 

(316,908

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(451

)

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

413,759

 

204,669

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

1,323,106

 

1,431,185

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

1,736,865

 

$

1,635,854

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

28,885

 

$

34,140

 

Income tax payments, net of refunds

 

1,716

 

23,422

 

Noncash investing and financing activities:

 

 

 

 

 

Loans transferred to loans held for sale, net

 

21,855

 

40,800

 

Transfers to other real estate owned

 

23,230

 

39,572

 

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

 

 

400

 

 

See accompanying notes to condensed consolidated financial statements.

 

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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 ended March 31, 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.

 

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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.

 

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, interest rate swaps, impaired loans and other real estate owned (“OREO”).

 

·                                          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 requires significant management judgment or estimation. This category typically includes pooled trust preferred securities, impaired loans and derivatives payable.

 

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Table of Contents

 

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 March 31, 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 in and out of Levels 1 and 3 or Levels 2 and 3 during the first three months of 2013 and 2012.

 

11



Table of Contents

 

 

 

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

 

 

 

as of March 31, 2013

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

 

 

March 31,

 

Assets

 

Inputs

 

Inputs

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(In thousands)

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

470,764

 

$

470,764

 

$

 

$

 

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

 

197,537

 

 

197,537

 

 

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

 

 

 

 

 

 

 

 

 

Commercial mortgage-backed securities

 

145,044

 

 

145,044

 

 

Residential mortgage-backed securities

 

1,035,415

 

 

1,035,415

 

 

Municipal securities

 

206,758

 

 

206,758

 

 

Other commercial mortgage-backed securities:

 

 

 

 

 

 

 

 

Investment grade

 

51,359

 

 

51,359

 

 

Corporate debt securities:

 

 

 

 

 

 

 

 

 

Investment grade

 

453,323

 

 

453,323

 

 

Non-investment grade

 

18,000

 

 

12,716

 

5,284

 

Other securities

 

10,793

 

 

10,793

 

 

 

 

 

 

 

 

 

 

 

 

Total investment securities available-for-sale

 

$

2,588,993

 

$

470,764

 

$

2,112,945

 

$

5,284

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange options

 

$

5,340

 

$

 

$

5,340

 

$

 

Interest rate swaps

 

34,192

 

 

34,192

 

 

Short-term foreign exchange contracts

 

1,303

 

 

1,303

 

 

Derivative liabilities

 

(41,024

)

 

(37,791

)

(3,233

)

 

 

 

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 Non-Recurring Basis

 

 

 

as of and for the Three Months Ended March 31, 2013

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

Total Gains

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

(Losses) for the

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

Three Months Ended

 

 

 

March 31,

 

Assets

 

Inputs

 

Inputs

 

March 31,

 

 

 

2013

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

2013

 

 

 

(In thousands)

 

Non-covered impaired loans:

 

 

 

 

 

 

 

 

 

 

 

Total residential

 

$

12,969

 

$

 

$

12,969

 

$

 

$

(440

)

Total commercial real estate

 

23,382

 

 

23,382

 

 

(2,115

)

Total commercial and industrial

 

2,566

 

 

1,432

 

1,134

 

(2,258

)

Total consumer

 

665

 

 

665

 

 

(116

)

 

 

 

 

 

 

 

 

 

 

 

 

Total non-covered impaired loans

 

$

39,582

 

$

 

$

38,448

 

$

1,134

 

$

(4,929

)

 

 

 

 

 

 

 

 

 

 

 

 

Non-covered OREO

 

$

13,227

 

$

 

$

13,227

 

$

 

$

(1,385

)

Covered OREO (1)

 

$

3,720

 

$

 

$

3,720

 

$

 

$

(126

)

 

 

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

 

 

as of and for the Three Months Ended March 31, 2012

 

 

 

 

 

Quoted Prices in

 

Significant

 

 

 

Total Gains

 

 

 

Fair Value

 

Active Markets

 

Other

 

Significant

 

(Losses) for the

 

 

 

Measurements

 

for Identical

 

Observable

 

Unobservable

 

Three Months Ended

 

 

 

March 31,

 

Assets

 

Inputs

 

Inputs

 

March 31,

 

 

 

2012

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

2012

 

 

 

(In thousands)

 

Non-covered impaired loans:

 

 

 

 

 

 

 

 

 

 

 

Total residential

 

$

5,564

 

$

 

$

5,564

 

$

 

$

(1,903

)

Total commercial real estate

 

21,073

 

 

21,073

 

 

(1,343

)

Total commercial and industrial

 

3,316

 

 

 

3,316

 

(984

)

Total consumer

 

7

 

 

7

 

 

(57

)

 

 

 

 

 

 

 

 

 

 

 

 

Total non-covered impaired loans

 

$

29,960

 

$

 

$

26,644

 

$

3,316

 

$

(4,287

)

 

 

 

 

 

 

 

 

 

 

 

 

Non-covered OREO

 

$

8,195

 

$

 

$

8,195

 

$

 

$

(855

)

Covered OREO (1)

 

$

25,585

 

$

 

$

25,585

 

$

 

$

(6,449

)

Loans held for sale

 

$

4,600

 

$

 

$

4,600

 

$

 

$

(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 $126 thousand in losses, or $25 thousand, and 20% of the $6.4 million in losses, or $1.3 million, for the three months ended March 31, 2013 and 2012, respectively.

 

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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 ended March 31, 2013 and 2012:

 

 

 

Investment Securities
Available-for-Sale

 

 

 

 

 

Corporate Debt
Securities

 

 

 

 

 

Non-Investment Grade

 

Derivatives Payable

 

 

 

(In thousands)

 

Opening balance, January 1, 2013

 

$

4,800

 

$

(3,052

)

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

 

 

 

 

 

Included in earnings

 

 

(181

)

Included in other comprehensive income (unrealized) (2)

 

549

 

 

Purchases, issues, sales, settlements (3)

 

 

 

 

 

Purchases

 

 

 

Issues

 

 

 

Sales

 

 

 

Settlements

 

(65

)

 

Transfer from investment grade to non-investment grade

 

 

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

 

 

 

Closing balance, March 31, 2013

 

$

5,284

 

$

(3,233

)

Changes in unrealized losses included in earnings relating to assets and liabilities held at the end of March 31, 2013

 

$

 

$

181

 

 

 

 

Investment Securities
Available-for-Sale

 

 

 

 

 

Corporate Debt
Securities

 

 

 

 

 

Non-Investment Grade

 

Derivatives Payable

 

 

 

(In thousands)

 

 

 

 

 

 

 

Opening balance, January 1, 2012

 

$

2,235

 

$

(2,634

)

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

 

 

 

 

 

Included in earnings

 

(99

)

(488

)

Included in other comprehensive loss (unrealized) (2)

 

225

 

 

Purchases, issues, sales, settlements (3)

 

 

 

 

 

Purchases

 

 

 

Issues

 

 

 

Sales

 

 

 

Settlements

 

(114

)

 

Transfer from investment grade to non-investment grade

 

 

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

 

 

 

Closing balance, March 31, 2012

 

$

2,247

 

$

(3,122

)

Changes in unrealized losses included in earnings relating to assets and liabilities held at the end of March 31, 2012

 

$

99

 

$

488

 

 


(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 March 31, 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 nominal adjustment to the valuation of the derivative liabilities for the three months ended March 31, 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 March 31, 2013 was a credit risk adjustment with a range of 1.17% to 1.25%. 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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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, which has a term of 5 years, which matured during the fourth quarter of 2012, and 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 the valuation of the foreign exchange options for the three months ended March 31, 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 $0.4 million adjustment to the valuation of the interest rate swaps for the three months ended March 31, 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 three months ended March 31, 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 2 or Level 3 of the fair value hierarchy as appropriate. Level 2 values are measured at fair value based on the most recent valuation information received on the underlying collateral. Level 3 values, additionally include adjustments by the Company for historical knowledge and for changes in market conditions.

 

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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. OREO properties are classified as Level 2 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 March 31, 2013 and December 31, 2012 were as follows:

 

 

 

March 31, 2013

 

December 31, 2012

 

 

 

Carrying

 

 

 

Carrying

 

 

 

 

 

Amount or

 

 

 

Amount or

 

 

 

 

 

Notional

 

Estimated

 

Notional

 

Estimated

 

 

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

 

 

(In thousands)

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,736,865

 

$

1,736,865

 

$

1,323,106

 

$

1,323,106

 

Short-term investments

 

379,029

 

379,029

 

366,378

 

366,378

 

Securities purchased under resale agreements

 

1,400,000

 

1,392,927

 

1,450,000

 

1,442,302

 

Investment securities available-for-sale

 

2,588,993

 

2,588,993

 

2,607,029

 

2,607,029

 

Loans held for sale

 

226,635

 

233,843

 

174,317

 

180,349

 

Loans receivable, net

 

14,872,172

 

14,818,860

 

14,645,785

 

14,743,218

 

Investment in Federal Home Loan Bank stock

 

96,795

 

96,795

 

107,275

 

107,275

 

Investment in Federal Reserve Bank stock

 

48,036

 

48,036

 

48,003

 

48,003

 

Accrued interest receivable

 

103,392

 

103,392

 

94,837

 

94,837

 

Foreign exchange options

 

85,614

 

5,340

 

85,614

 

5,011

 

Interest rate swaps

 

1,244,393

 

34,192

 

1,190,793

 

36,943

 

Short-term foreign exchange contracts

 

138,940

 

1,303

 

112,459

 

896

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Customer deposit accounts:

 

 

 

 

 

 

 

 

 

Demand, savings and money market deposits

 

12,901,076

 

12,901,076

 

12,187,740

 

12,187,740

 

Time deposits

 

6,034,626

 

6,016,426

 

6,121,614

 

6,115,530

 

Federal Home Loan Bank advances

 

313,494

 

326,527

 

312,975

 

333,060

 

Securities sold under repurchase agreements

 

995,000

 

1,174,984

 

995,000

 

1,173,830

 

Other borrowings

 

 

 

20,000

 

20,000

 

Accrued interest payable

 

11,103

 

11,103

 

10,855

 

10,855

 

Long-term debt

 

137,178

 

88,379

 

137,178

 

83,762

 

Derivative liabilities

 

1,576,769

 

41,024

 

1,392,494

 

42,060

 

 

The following table shows the level in the fair value hierarchy for the estimated fair values of only financial instruments that are not already on the condensed consolidated balance sheets at fair value at March 31, 2013 and December 31, 2012.

 

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March 31, 2013

 

 

 

Estimated

 

 

 

 

 

 

 

 

 

Fair Value

 

 

 

 

 

 

 

 

 

Measurements

 

Level 1

 

Level 2

 

Level 3

 

 

 

(In thousands)

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,736,865

 

$

1,736,865

 

$

 

$

 

Short-term investments

 

379,029

 

 

379,029

 

 

Securities purchased under resale agreements

 

1,392,927

 

 

1,392,927

 

 

Loans held for sale

 

233,843

 

 

233,843

 

 

Loans receivable, net

 

14,818,860

 

 

 

14,818,860

 

Investment in Federal Home Loan Bank stock

 

96,795

 

 

96,795

 

 

Investment in Federal Reserve Bank stock

 

48,036

 

 

48,036

 

 

Accrued interest receivable

 

103,392

 

 

103,392

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Customer deposit accounts:

 

 

 

 

 

 

 

 

 

Demand, savings and money market deposits

 

12,901,076

 

 

12,901,076

 

 

Time deposits

 

6,016,426

 

 

 

6,016,426

 

Federal Home Loan Bank advances

 

326,527

 

 

326,527

 

 

Securities sold under repurchase agreements

 

1,174,984

 

 

1,174,984

 

 

Other borrowings

 

 

 

 

 

Accrued interest payable

 

11,103

 

 

11,103

 

 

Long-term debt

 

88,379

 

 

88,379

 

 

 

 

 

December 31, 2012

 

 

 

Estimated

 

 

 

 

 

 

 

 

 

Fair Value

 

 

 

 

 

 

 

 

 

Measurements

 

Level 1

 

Level 2

 

Level 3

 

 

 

(In thousands)

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,323,106

 

$

1,323,106

 

$

 

$

 

Short-term investments

 

366,378

 

 

366,378

 

 

Securities purchased under resale agreements

 

1,442,302

 

 

1,442,302

 

 

Loans held for sale

 

180,349

 

 

180,349

 

 

Loans receivable, net

 

14,743,218

 

 

 

14,743,218

 

Investment in Federal Home Loan Bank stock

 

107,275

 

 

107,275

 

 

Investment in Federal Reserve Bank stock

 

48,003

 

 

48,003

 

 

Accrued interest receivable

 

94,837

 

 

94,837

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Customer deposit accounts:

 

 

 

 

 

 

 

 

 

Demand, savings and money market deposits

 

12,187,740

 

 

12,187,740

 

 

Time deposits

 

6,115,530

 

 

 

6,115,530

 

Federal Home Loan Bank advances

 

333,060

 

 

333,060

 

 

Securities sold under repurchase agreements

 

1,173,830

 

 

1,173,830

 

 

Other borrowings

 

20,000

 

 

20,000

 

 

Accrued interest payable

 

10,855

 

 

10,855

 

 

Long-term debt

 

83,762

 

 

83,762

 

 

 

The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value are explained below:

 

Cash and Cash Equivalents — The carrying amounts approximate fair values due to the short-term nature of these instruments. Due to the short-term nature, the estimated fair value is considered to be within Level 1 of the fair value hierarchy.

 

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Short-Term Investments — The fair values of short-term investments generally approximate their book values due to their short maturities. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Securities Purchased Under Resale Agreements — Securities purchased under resale agreements with original maturities of 90 days or less are included in cash and cash equivalents. The fair value of securities purchased under resale agreements with original maturities of more than 90 days is estimated by discounting the cash flows based on expected maturities or repricing dates utilizing estimated market discount rates. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Investment Securities Available-for-Sale — The fair values of the investment securities available-for-sale are generally determined by reference to the average of at least two quoted market prices obtained from independent external brokers or independent external pricing service providers who have experience in valuing these securities. In obtaining such valuation information from third parties, the Company has reviewed the methodologies used to develop the resulting fair values. For pooled trust preferred securities, fair values are based on discounted cash flow analyses. Due to the unobservable inputs used within the discounted cash flow analysis, the estimate for pooled trust preferred securities is considered to be within Level 3 of the fair value hierarchy. The remainder of the portfolio is classified within Level 1 and Level 2, as discussed earlier in this footnote.

 

Loans Held for Sale — The fair value of loans held for sale is derived from current market prices and comparative current sales or from third party sale analysis, existing sale agreements, or appraisal reports on the loans’ underlying collateral, as applicable. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Loans Receivable, net (includes covered and non-covered loans) — The fair value of loans is determined based on a discounted cash flow approach considered for an entry price value. The discount rate is derived from the associated yield curve plus spreads, and reflects the offering rates in the market for loans with similar financial characteristics. No adjustments have been made for changes in credit within any of the loan portfolios. It is management’s opinion that the allowance for loan losses pertaining to performing and nonperforming loans results in a fair valuation of credit for such loans. Due to the unobservable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 3 of the fair value hierarchy.

 

Investment in Federal Home Loan Bank Stock and Federal Reserve Bank Stock — The carrying amount approximates fair value, as the stock may be sold back to the Federal Home Loan Bank and the Federal Reserve Bank at carrying value. The valuation of these instruments is the carrying amount as these investments can only be sold and purchased from the Federal Home Loan Bank and Federal Reserve Bank respectively. The valuation of these investments is considered to be within Level 2 of the fair value hierarchy, as the restrictions and value of the investments are the same for all financial institutions which are required to hold these investments.

 

Accrued Interest Receivable — The carrying amounts approximate fair values due to the short-term nature of these instruments, as such, due to the observable nature of the inputs used in deriving the estimated fair value, these instruments are considered to be within Level 2 of the fair value hierarchy.

 

Equity Swap Agreements — Equity swap agreements matured during the fourth quarter of 2012. The fair value of the derivative contracts is provided by a third party and is determined based on the change in 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 of the option, interest rate, and time remaining to maturity. We also considered the counterparty’s credit risk in determining the fair value. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

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Foreign Exchange Options — The fair value of the derivative contracts 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, and time remaining to maturity. We also considered the counterparty’s credit risk in determining the fair value. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Interest Rate Swaps — The fair value of the interest rate swap contracts is provided by a third party and is determined based on a discounted cash flow approach. The Company also considered the counterparty’s credit risk in determining the fair value. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Short-term Foreign Exchange Contracts — The fair value of short-term foreign exchange contracts is determined based on the change in foreign exchange rate. We also considered the counterparty’s credit risk in determining the fair value. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Customer Deposit Accounts — The carrying amounts approximate fair value for demand and interest checking deposits, savings deposits, and certain money market accounts as the amounts are payable on demand at the reporting date. Due to the observable nature of the inputs used in deriving the estimated fair value these instruments are considered to be within Level 2 of the fair value hierarchy. For time deposits, the cash flows are based on the contractual runoff and are discounted by the Bank’s current offering rates, plus spread. Due to the unobservable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 3 of the fair value hierarchy.

 

Federal Home Loan Bank Advances — The fair value of Federal Home Loan Bank (“FHLB”) advances is estimated based on the discounted value of contractual cash flows, using rates currently offered by the FHLB of San Francisco for advances with similar remaining maturities at each reporting date. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Securities Sold Under Repurchase Agreements — For securities sold under repurchase agreements with original maturities of 90 days or less, the carrying amounts approximate fair values due to the short-term nature of these instruments. At March 31, 2013 and December 31, 2012, most of the securities sold under repurchase agreements are long-term in nature and the fair values of securities sold under repurchase agreements are calculated by discounting future cash flows based on expected maturities or repricing dates, utilizing estimated market discount rates, and taking into consideration the call features of each instrument. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Other Borrowings — The carrying amounts approximate fair values due to the short-term nature of these instruments, as such, due to the observable nature of the inputs used in deriving the estimated fair value, these instruments are considered to be within Level 2 of the fair value hierarchy.

 

Accrued Interest Payable — The carrying amounts approximate fair values due to the short-term nature of these instruments, as such, due to the observable nature of the inputs used in deriving the estimated fair value, these instruments are considered to be within Level 2 of the fair value hierarchy.

 

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Long-Term Debt — The fair values of long-term debt are estimated by discounting the cash flows through maturity based on current market rates the Bank would pay for new issuances. Due to the observable nature of the inputs used in deriving the estimated fair value of these instruments, the estimate is considered to be within Level 2 of the fair value hierarchy.

 

Derivatives Liabilities — The Company’s derivative liabilities include “derivatives payable” and all other derivative liabilities. The Company’s derivatives payable are recorded in conjunction with certain certificates of deposit (“host instrument”). These CD’s pay interest based on changes in RMB or the HSCEI, as designated. CDs paying interest based on changes in the HSCEI matured during the fourth quarter of 2012. The fair value of derivatives payable is estimated using the income approach. Additionally, we considered our own credit risk in determining the valuation. The other derivative liabilities are mostly comprised of the off-setting interest rate swaps. The fair value of the interest rate swap contracts is provided by a third party and is determined based on a discounted cash flow approach. The Company also considered the counterparty’s credit risk in determining the fair value. Due to the observable nature of the inputs used in deriving the estimated fair value of the interest rate swaps within derivative liabilities, the estimate is considered to be within Level 2 of the fair value hierarchy. Due to the unobservable nature of the inputs used in deriving the estimated fair value of derivatives payable within derivative liabilities, this estimate is considered to be within Level 3 of the fair value hierarchy.

 

The fair value estimates presented herein are based on pertinent information available to management as of each reporting date. Although we are not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and therefore, current estimates of fair value may differ significantly from the amounts presented herein.

 

NOTE 4 — STOCK-BASED COMPENSATION

 

During the three months ended March 31, 2013, total compensation expense recognized in the condensed consolidated statements of income related to both stock options and restricted stock awards reduced income before taxes by $2.5 million and net income by $1.5 million.

 

During the three months ended March 31, 2012, total compensation expense recognized in the condensed consolidated statements of income related to both stock options and restricted stock awards reduced income before taxes by $3.6 million and net income by $2.1 million.

 

The Company received $442 thousand and $1.5 million during the three months ended March 31, 2013 and March 31, 2012, respectively, in cash proceeds from stock option exercises. The net tax benefit recognized in equity for stock compensation plans was $2.6 million and $29 thousand for the three months ended, March 31, 2013 and March 31, 2012, respectively.

 

As of March 31, 2013, there are 4,115,745 shares available to be issued, subject to the Company’s current 1998 Stock Incentive Plan, as amended.

 

Stock Options

 

The Company issues fixed stock options to certain employees, officers, and directors. Stock options are issued at the current market price on the date of grant with a three-year or four-year vesting period and contractual terms of 7 or 10 years. The Company issues new shares upon the exercise of stock options.

 

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