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, 2014

or

 

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

For the transition period from                      to                     

Commission File Number: 0-10140

 

 

CVB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

 

 

California   95-3629339

(State or other jurisdiction of

Incorporation or organization)

 

(I.R.S. Employer

Identification No.)

701 North Haven Ave., Suite 350  
Ontario, California   91764
(Address of principal executive offices)   (Zip Code)

(909) 980-4030

(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, accelerated filer, non-accelerated filer or smaller reporting company. See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

Number of shares of common stock of the registrant: 105,900,492 outstanding as of April 30, 2014.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION (UNAUDITED)

     3   

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

     41   

CRITICAL ACCOUNTING POLICIES

     41   

OVERVIEW

     41   

ANALYSIS OF THE RESULTS OF OPERATIONS

     43   

RESULTS BY BUSINESS SEGMENTS

     50   

ANALYSIS OF FINANCIAL CONDITION

     52   

ASSET/LIABILITY AND MARKET RISK MANAGEMENT

     66   

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     68   

ITEM 4. CONTROLS AND PROCEDURES

     68   

PART II - OTHER INFORMATION

     68   

ITEM 1. LEGAL PROCEEDINGS

     68   

ITEM 1A. RISK FACTORS

     70   

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

     70   

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     70   

ITEM 4. MINE SAFETY DISCLOSURES

     70   

ITEM 5. OTHER INFORMATION

     70   

ITEM 6. EXHIBITS

     70   

SIGNATURES

     71   

 

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Table of Contents

PART I – FINANCIAL INFORMATION (UNAUDITED)

GENERAL

Forward Looking Statements

Certain statements in this Report on Form 10-Q, including, but not limited to, statements under the heading “Management Discussion and Analysis of Financial Condition and Results of Operations” constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995, including but not limited to, statements about anticipated future operating and financial performance, financial position and liquidity, business prospects, strategic alternatives, business strategies, regulatory policies, competitive outlook, capital and financing needs and availability, acquisition and divestiture opportunities, investment and expenditure plans, plans and objectives of management for future operations, management hiring and retention and other similar forecasts and statements of expectations of assumptions underlying any of the foregoing. Words such as “will likely result, “aims”, “anticipates”, “believes”, “could”, “estimates”, “expects”, “hopes”, “intends”, “may”, “plans”, “projects”, “seeks”, “should”, “will” and variations of these words and similar expressions are intended to identify these forward looking statements, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, local, regional, national and international economic and market conditions and events and the impact they may have on us and our customers; our ability to attract and maintain deposits, borrowings and other sources of liquidity; supply of property inventory and renewed fluctuation or deterioration in values of real estate in California or other jurisdictions where we lend, whether involving residential or commercial property; a prolonged slowdown or decline in construction activity; changes in the financial performance and/or condition of our loan and deposit customers; changes in the levels of performing and nonperforming assets and charge-offs; the cost or effect of acquisitions or divestitures we may make; the effect of changes in laws and regulations (including laws, regulations and judicial decisions concerning financial reform, taxes, bank or holding company capital levels, securities, employment, executive compensation, insurance, compliance and information security) with which we and our subsidiaries must comply; changes in the applicability or costs of deposit insurance; changes in estimates of future reserve requirements and minimum capital requirements based upon the periodic review thereof under relevant legal, regulatory and accounting requirements; inflation, interest rate, securities market and monetary fluctuations; internal and external fraud and cyber-security threats, including theft or loss of Company or customer funds, loss of system functionality or access, or theft or loss of Company or customer data; political instability; acts of war or terrorism, or natural disasters, such as earthquakes, or the effects of pandemic diseases; the timely development and acceptance of new banking products and services (including technology-based services and products) and the perceived overall value of these products and services by users; changes in consumer spending, borrowing and savings habits; the effects of technological changes, the expanding use of technology in banking (including the adoption of mobile banking applications) and product innovation; the ability to retain or increase market share, retain or grow customers and control expenses; changes in the risk or competitive environment among financial and bank entities, holding companies and other financial service providers; continued volatility in the credit and equity markets and its effects on the general economy or local business conditions; the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as by the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other national or international accounting standard setters; changes in our organization, management, compensation and benefit plans, and our ability to retain or expand our management team and our board of directors; the costs and effects of legal, regulatory and compliance changes or developments; the favorable or unfavorable resolution of legal proceedings or regulatory or other governmental inquiries, including, but not limited to, the current investigation by the Securities and Exchange Commission and the related class-action and derivative action lawsuits filed against us; and the results of regulatory examinations or reviews or other government actions. The Company cautions that the foregoing factors are not exclusive. For additional information concerning these factors and other factors which may cause actual results to differ from the results discussed in our forward-looking statements, see the periodic filings the Company makes with the Securities and Exchange Commission, and, in particular, the information set forth in Item 1A herein and in “Item 1A. Risk Factors” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. The Company does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements except as required by law.

 

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Table of Contents
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

(Unaudited)

 

     March 31,
2014
    December 31,
2013
 
ASSETS     

Cash and due from banks

   $ 124,112      $ 88,776   

Interest-earning balances due from Federal Reserve

     297,274        5,917   
  

 

 

   

 

 

 

Total cash and cash equivalents

     421,386        94,693   
  

 

 

   

 

 

 

Interest-earning balances due from depository institutions

     70,000        70,000   

Investment securities available-for-sale, at fair value (with amortized cost of $2,741,367 at March 31, 2014, and $2,679,727 at December 31, 2013)

     2,750,063        2,663,642   

Investment securities held-to-maturity

     1,730        1,777   

Investment in stock of Federal Home Loan Bank (FHLB)

     25,560        32,331   

Non-covered loans held-for-sale

     —          3,667   

Loans and lease finance receivables, excluding covered loans

     3,257,559        3,385,916   

Allowance for loan losses

     (68,725     (75,235
  

 

 

   

 

 

 

Net loans and lease finance receivables

     3,188,834        3,310,681   
  

 

 

   

 

 

 

Covered loans and lease finance receivables, net

     145,313        160,315   

Premises and equipment, net

     31,723        32,831   

Bank owned life insurance

     123,790        123,168   

Accrued interest receivable

     21,775        22,051   

Intangibles

     2,139        2,261   

Goodwill

     55,097        55,097   

FDIC loss sharing asset

     1,370        4,764   

Non-covered other real estate owned

     6,475        6,475   

Covered other real estate owned

     504        504   

Income taxes

     33,819        59,786   

Other assets

     22,940        20,924   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 6,902,518      $ 6,664,967   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Liabilities:

    

Deposits:

    

Noninterest-bearing

   $ 2,688,585      $ 2,562,980   

Interest-bearing

     2,422,201        2,327,651   
  

 

 

   

 

 

 

Total deposits

     5,110,786        4,890,631   

Customer repurchase agreements

     626,802        643,251   

FHLB advances

     199,274        199,206   

Other borrowings

     —          69,000   

Accrued interest payable

     1,083        1,111   

Deferred compensation

     9,956        9,449   

Junior subordinated debentures

     25,774        25,774   

Payable for securities purchased

     75,392        3,533   

Other liabilities

     44,270        51,125   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     6,093,337        5,893,080   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

Stockholders’ Equity:

    

Common stock, authorized, 225,000,000 shares without par; issued and outstanding 106,011,665 at March 31, 2014 and 105,370,170 at December 31, 2013.

     495,935        491,068   

Retained earnings

     308,202        290,149   

Accumulated other comprehensive income, net of tax

     5,044        (9,330
  

 

 

   

 

 

 

Total stockholders’ equity

     809,181        771,887   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 6,902,518      $ 6,664,967   
  

 

 

   

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME

(Dollars in thousands, except per share amounts)

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2014     2013  

Interest income:

    

Loans and leases, including fees

   $ 42,949      $ 41,654   

Accretion on acquired loans

     1,707        4,393   
  

 

 

   

 

 

 

Loans, including fees

     44,656        46,047   

Investment securities:

    

Taxable

     10,279        6,747   

Tax-advantaged

     5,278        5,541   
  

 

 

   

 

 

 

Total investment income

     15,557        12,288   

Dividends from FHLB stock

     604        343   

Federal funds sold

     124        14   

Interest-earning deposits with other institutions

     121        121   
  

 

 

   

 

 

 

Total interest income

     61,062        58,813   

Interest expense:

    

Deposits

     1,186        1,241   

Borrowings

     2,830        2,700   

Junior subordinated debentures

     104        283   
  

 

 

   

 

 

 

Total interest expense

     4,120        4,224   
  

 

 

   

 

 

 

Net interest income before provision for loan losses

     56,942        54,589   

Provision for loan losses

     (7,500     —     
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     64,442        54,589   
  

 

 

   

 

 

 

Noninterest income:

    

Service charges on deposit accounts

     3,828        3,826   

Trust and investment services

     1,925        2,005   

Bankcard services

     778        839   

BOLI income

     638        743   

Gain on sale of loans held-for-sale

     5,330        —     

Gain on sale of securities, net

     —          2,094   

Decrease in FDIC loss sharing asset, net

     (1,707     (4,023

Gain on OREO, net

     5        564   

Other

     701        697   
  

 

 

   

 

 

 

Total noninterest income

     11,498        6,745   
  

 

 

   

 

 

 

Noninterest expense:

    

Salaries and employee benefits

     19,417        17,300   

Occupancy and equipment

     3,725        3,682   

Professional services

     1,791        1,596   

Software licenses and maintenance

     1,065        1,152   

Promotion

     1,266        1,258   

Amortization of intangible assets

     122        438   

OREO expense

     25        330   

Other

     3,746        5,042   
  

 

 

   

 

 

 

Total noninterest expense

     31,157        30,798   
  

 

 

   

 

 

 

Earnings before income taxes

     44,783        30,536   
  

 

 

   

 

 

 

Income taxes

     16,122        8,921   
  

 

 

   

 

 

 

Net earnings

   $ 28,661      $ 21,615   
  

 

 

   

 

 

 

Other comprehensive income (loss):

    

Unrealized gain (loss) on securities arising during the period

   $ 24,781      $ (11,696

Less: Reclassification adjustment for net gain on securities included in net income

     —          (2,094
  

 

 

   

 

 

 

Other comprehensive income (loss), before tax

     24,781        (13,790

Less: Income tax (expense) benefit related to items of other comprehensive income (loss)

     (10,407     5,792   
  

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     14,374        (7,998
  

 

 

   

 

 

 

Comprehensive income

   $ 43,035      $ 13,617   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.27      $ 0.21   

Diluted earnings per common share

   $ 0.27      $ 0.21   

Cash dividends declared per common share

   $ 0.10      $ 0.085   

See accompanying notes to the condensed consolidated financial statements.

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Three Months Ended March 31, 2014 and 2013

(Dollars and shares in thousands)

(Unaudited)

 

     Common
Shares
Outstanding
    Common
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Total  

Balance January 1, 2013

     104,890      $ 484,709      $ 235,010      $ 43,251      $ 762,970   

Repurchase of common stock

     (2     (24         (24

Exercise of stock options

     10        95            95   

Tax benefit from exercise of stock options

       5            5   

Shares issued pursuant to stock-based compensation plan

     5        461            461   

Cash dividends declared on Common ($0.085 per share)

         (8,912       (8,912

Net earnings

         21,615          21,615   

Other comprehensive income

           (7,998     (7,998
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance March 31, 2013

     104,903      $ 485,246      $ 247,713      $ 35,253      $ 768,212   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance January 1, 2014

     105,370      $ 491,068     $ 290,149      $ (9,330 )   $ 771,887   

Repurchase of common stock

     (2     (32 )         (32

Exercise of stock options

     334        3,684           3,684   

Tax benefit from exercise of stock options

       559           559   

Shares issued pursuant to stock-based compensation plan

     310        656           656   

Cash dividends declared on Common ($0.10 per share)

         (10,608       (10,608

Net earnings

         28,661          28,661   

Other comprehensive income

           14,374       14,374   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance March 31, 2014

     106,012      $ 495,935     $ 308,202      $ 5,044     $ 809,181   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Table of Contents

CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2014     2013  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Interest and dividends received

   $ 63,935      $ 59,834   

Service charges and other fees received

     7,237        8,905   

Interest paid

     (4,080     (4,343

Net cash paid to vendors and employees

     (37,955     (34,057

Income taxes paid

     —          (22,200

(Payments to) proceeds from FDIC loss share agreement

     (185     187   
  

 

 

   

 

 

 

Net cash provided by operating activities

     28,952        8,326   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from redemption of FHLB stock

     6,771        5,670   

Proceeds from sale of investment securities

     —          99,155   

Proceeds from repayment of investment securities

     65,093        136,939   

Proceeds from maturity of investment securities

     39,768        6,533   

Purchases of investment securities

     (99,689     (197,690

Net decrease in loan and lease finance receivables

     157,719        83,023   

Proceeds from sales of premises and equipment

     —          5   

Purchase of premises and equipment

     (301     (1,059

Proceeds from sales of other real estate owned

     —          3,443   
  

 

 

   

 

 

 

Net cash provided by investing activities

     169,361        136,019   
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Net increase (decrease) in transaction deposits

     237,238        (85,560

Net decrease in time deposits

     (17,083     (2,266

Repayment of junior subordinated debentures

     —          (20,619

Net decrease in other borrowings

     (69,000     (26,000

Net (decrease) increase in customer repurchase agreements

     (16,449     26,871   

Cash dividends on common stock

     (10,537     —     

Repurchase of common stock

     (32     (24

Proceeds from exercise of stock options

     3,684        95   

Tax benefit related to exercise of stock options

     559        5   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     128,380        (107,498
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     326,693        36,847   

CASH AND CASH EQUIVALENTS, beginning of period

     94,693        98,431   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, end of period

   $ 421,386      $ 135,278   
  

 

 

   

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2014     2013  

RECONCILIATION OF NET EARNINGS TO NET CASH PROVIDED BY OPERATING ACTIVITIES

    

Net earnings

   $ 28,661      $ 21,615   

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

    

Gain on sale of loans held-for-sale

     (5,330     —     

Gain on sale of investment securities

     —          (2,094

Loss on sale of premises and equipment, net

     204        6   

Gain on sale of other real estate owned

     —          (512

Amortization of capitalized prepayment penalty on borrowings

     68        68   

Increase in bank owned life insurance

     (622     (732

Net amortization of premiums and discounts on investment securities

     5,094        6,786   

Accretion of SJB discount

     (1,707     (4,393

Provision for loan losses

     (7,500     —     

Valuation adjustment on other real estate owned

     —          73   

Change in FDIC loss share asset

     1,707        4,023   

(Payments to) proceeds from FDIC loss share agreement

     (185     187   

Stock-based compensation

     656        461   

Depreciation and amortization, net

     354        831   

Change in accrued interest receivable

     276        (630

Change in accrued interest payable

     (28     (187

Change in other assets and liabilities

     7,304        (17,176
  

 

 

   

 

 

 

Total adjustments

     291        (13,289
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 28,952      $ 8,326   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES

    

Securities purchased and not settled

   $ 75,392      $ 4,630   

Transfer of loans to other real estate owned

   $ —        $ 1,303   

See accompanying notes to the condensed consolidated financial statements.

 

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CVB FINANCIAL CORP. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2014 and 2013

(Unaudited)

 

1. BUSINESS

The condensed consolidated financial statements include the accounts of CVB Financial Corp. (referred to herein on an unconsolidated basis as “CVB” and on a consolidated basis as “we”, “our” or the “Company”) and its wholly owned subsidiaries: Citizens Business Bank (the “Bank”) after elimination of all intercompany transactions and balances. The Company has three inactive subsidiaries; CVB Ventures, Inc.; Chino Valley Bancorp; and ONB Bancorp. The Company is also the common stockholder of CVB Statutory Trust III. CVB Statutory Trust III was created in January 2006 to issue trust preferred securities in order to raise capital for the Company. In accordance with ASC 810 Consolidation (previously Financial Accounting Standards Board (“FASB”) Interpretation No. 46R “Consolidation of Variable Interest Entities”), this trust does not meet the criteria for consolidation.

The Company’s primary operations are related to traditional banking activities, including the acceptance of deposits and the lending and investing of money through the operations of the Bank. The Bank also provides automobile and equipment leasing to customers through its Citizens Financial Services Group and trust and investment-related services to customers through its CitizensTrust Division. The Bank’s customers consist primarily of small to mid-sized businesses and individuals located in San Bernardino County, Riverside County, Los Angeles County, Orange County, San Diego County, Madera County, Fresno County, Tulare County and Kern County, California. The Bank operates 37 Business Financial Centers, six Commercial Banking Centers, and three trust office locations. The Company is headquartered in the city of Ontario, California.

On February 18, 2014, CVB and America Bancshares, Inc. announced that they have entered into a definitive Stock Purchase Agreement, pursuant to which American Security Bank (“ASB”), the principal subsidiary of America Bancshares, Inc., will be sold to and merged with Citizens Business Bank, the principal subsidiary of CVB. The transaction is valued at $57.0 million, subject to certain potential adjustments, for all of the outstanding shares of common stock of ASB and will be paid for by CBB using 100% cash. ASB has total assets of approximately $412 million at December 31, 2013 and five branches located in Newport Beach, Laguna Niguel, Corona, Lancaster, and Apple Valley. ASB also has two electronic branch locations in the High Desert area and a loan production office in Ontario, California. ASB is a community/business bank with a primary focus on small to medium-sized businesses and their owners. The transaction is currently scheduled to close on May 15, 2014, subject to regulatory approvals and other customary closing conditions.

 

2. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements and notes thereto have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for Form 10-Q and conform to practices within the banking industry and include all of the information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting. The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results for the full year. These unaudited financial statements should be read in conjunction with the financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments), which are necessary for a fair presentation of financial results for the interim periods presented. A summary of the significant accounting policies consistently applied in the preparation of the accompanying unaudited condensed consolidated financial statements follows.

Reclassification – Certain amounts in the prior periods’ financial statements and related footnote disclosures have been reclassified to conform to the current presentation with no impact on previously reported net income or stockholders’ equity.

 

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Investment Securities — The Company classifies as held-to-maturity those debt securities that the Company has the positive intent and ability to hold to maturity. Securities classified as trading are those securities that are bought and held principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available-for-sale. Securities held-to-maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Trading securities are accounted for at fair value with the unrealized gains and losses being included in current earnings. Available-for-sale securities are accounted for at fair value, with the net unrealized gains and losses, net of income tax effects, presented as a separate component of stockholders’ equity. Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the effective-yield method over the terms of the securities. For mortgage-backed securities (“MBS”), the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. The Company’s investment in the Federal Home Loan Bank of San Francisco (“FHLB”) stock is carried at cost.

At each reporting date, securities are assessed to determine whether there is an other-than-temporary impairment (“OTTI”). Other-than-temporary impairment on investment securities is recognized in earnings when there are credit losses on a debt security for which management does not intend to sell and for which it is more-likely-than-not that the Company will not have to sell prior to recovery of the noncredit impairment. In those situations, the portion of the total impairment that is attributable to the credit loss would be recognized in earnings, and the remaining difference between the debt security’s amortized cost and its fair value would be included in other comprehensive income.

 

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Loans and Lease Finance Receivables — Non-covered loans and lease finance receivables that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, less deferred net loan origination fees. In the ordinary course of business, the Company enters into commitments to extend credit to its customers. To the extent that such commitments are unfunded, the related unfunded amounts are not reflected in the accompanying condensed consolidated financial statements.

The Company receives collateral to support loans, lease finance receivables, and commitments to extend credit for which collateral is deemed necessary. The most significant categories of collateral are real estate, principally commercial and industrial income-producing properties, real estate mortgages, and assets utilized in dairy & livestock and agribusiness, and various personal property assets utilized in commercial and industrial business governed by the Uniform Commercial Code.

Nonrefundable fees and direct costs associated with the origination or purchase of non-covered loans are deferred and netted against outstanding loan balances. The deferred net loan fees and costs are recognized in interest income over the loan term using the effective-yield method.

Interest on non-covered loans and lease finance receivables is credited to income based on the principal amounts of such loans or receivables outstanding. Non-covered loans are considered delinquent when principal or interest payments are past due 30 days or more and generally remain on accrual status between 30 and 89 days past due. Interest income is not recognized on non-covered loans and lease finance receivables when collection of interest is deemed by management to be doubtful. Non-covered loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. In general, the accrual of interest on non-covered loans is discontinued when the loan becomes 90 days past due, or when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered in determining that the full collection of principal and interest is no longer probable include cash flow and liquidity of the borrower or property, the financial position of the guarantors and their willingness to support the loan as well as other factors, and this determination involves significant judgment. When an asset is placed on nonaccrual status, previously accrued but unpaid interest is reversed against income. Subsequent collections of cash are applied as reductions to the principal balance unless the loan is returned to accrual status. Interest is not recognized using a cash-basis method. Nonaccrual loans may be restored to accrual status when principal and interest become current and when the borrower is able to demonstrate payment performance for a sustained period, typically for six months. A nonaccrual loan may return to accrual status sooner based on other significant events or mitigating circumstances. This policy is consistently applied to all classes of non-covered financing receivables.

Troubled Debt Restructurings — Loans are reported as a Troubled Debt Restructuring (“TDR”) if the Company for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. Types of modifications that may be considered concessions, which in turn result in a TDR include, but are not limited to, (i) a reduction of the stated interest rate for the remaining original life of the debt, (ii) an extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk, (iii) a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement, or (iv) a reduction of interest. As a result of these concessions, restructured loans are considered impaired, and the measurement of impairment is based on the Company’s policy for impaired loans. In addition, the Company may provide a concession to the debtor where it offers collateral and the value of such collateral is significant in proportion to the nature of the concession requested, and it substantially reduces the Company’s risk of loss. In such cases, these modifications are not considered a TDR as, in substance, no concession was made as a result of the significant additional collateral obtained.

When determining whether or not a loan modification is a TDR under ASC 310-40, the Company evaluates loan modification requests from borrowers experiencing financial difficulties on a case-by-case basis. Any such modifications granted are unique to the borrower’s circumstances. Because of the Company’s focus on the commercial lending sector, each business customer has unique attributes, which in turn means that modifications of loans to those customers are not easily categorized by type, key features, or other terms, but are evaluated individually based on all relevant facts and circumstances pertaining to the modification request and the borrower’s/guarantor’s financial condition at the time of the request. The evaluation of whether or not a borrower is experiencing financial difficulties will include, among other relevant factors considered by the Company, a review of significant factors such as (i) whether the borrower is in default on any of its debt, (ii) whether the borrower is experiencing payment delinquency, (iii) whether the global cash flows of the borrower and the owner guarantor(s) of the borrower have diminished below what is necessary to service existing debt obligations, (iv) whether the borrowers’ forecasted cash flows will be insufficient to service the debt in future periods or in accordance with the contractual terms of the existing agreement through maturity, (v) whether the borrower is unable to refinance the subject debt from other financing sources with similar terms, and (vi) whether the borrower is in jeopardy as a going-concern and/or considering bankruptcy. In any case, the debtor is presumed to be experiencing financial difficulties if the Company determines it is probable the debtor will default on the original loan if the modification is not granted.

 

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The types of loans subject to modification vary greatly, but during the subject period are concentrated in commercial and industrial loans, dairy and agricultural loans, and term loans to commercial real estate investors. Some examples of key features include payment deferrals and delays, interest rate reductions, and extensions or renewals where the contract rate may or may not be below the market rate of interest for debt with similar characteristics as those of the modified debt. The typical length of the modified terms ranges from three (3) to twelve (12) months; however, all actual modified terms will depend on the facts, circumstances and attributes of the specific borrower requesting a modification. In general, after a careful evaluation of all relevant facts and circumstances taken together, including the nature of any concession, certain modification requests will result in troubled debt restructurings while certain other modifications will not, pursuant to the criteria and judgments as discussed throughout this report. In certain cases, modification requests for delays or deferrals of principal were evaluated and determined to be exempt from TDR reporting because they constituted insignificant delays under ASC 310-40-15.

In situations where the Company has determined that the borrower is experiencing financial difficulties and is evaluating whether a concession is insignificant, and therefore does not result in a troubled debt restructuring, such analysis is based on an evaluation of both the amount and the timing of the restructured payments, including the following factors:

 

  1. Whether the amount of the restructured payments subject to delay is insignificant relative to the unpaid principal balance or collateral value of the debt and will result in an insignificant shortfall in the contractual amount due; and

 

  2. The delay is insignificant relative to any of the following:

 

    The frequency of payments due;

 

    The debt’s original contractual maturity; or

 

    The debt’s original expected duration.

Most modified loans not classified and accounted for as troubled debt restructurings were performing and paying as agreed under their original terms in the six-month period immediately preceding a request for modification. Subsequently, these modified loans have continued to perform under the modified terms and deferrals that amounted to insignificant delays, which in turn is supported by the facts and circumstances of each individual customer and loan as described above. Payment performance continues to be monitored once modifications are made. The Company’s favorable experience regarding “re-defaults” under modified terms, or upon return of the loan to its original terms, indicates that such relief may improve ultimate collection and reduces the Company’s risk of loss.

Impaired Loans — A loan is generally considered impaired when based on current events and information it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan, including a restructured loan, for which there is an insignificant delay relative to the frequency of payments due, and/or the original contractual maturity, is not considered an impaired loan. Generally, impaired loans include loans on nonaccrual status and TDRs.

The Company’s policy is to record a specific valuation allowance, which is included in the allowance for loan losses, or to charge off that portion of an impaired loan that represents the impairment or shortfall amount as determined utilizing one of the three methods described in ASC 310-10-35-22. Impairment on non-collateral dependent restructured loans is measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. The impairment amount, if any, is generally charged off and recorded against the allowance for loan losses at the time impairment is measurable and a probable loss is determined. As a result, most of the TDRs have no specific allowance allocated because, consistent with the Company’s stated practice, any impairment is typically charged off in the period in which it is identified. The Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may also measure impairment based on an observable market price for the loan, or the value of the collateral, for collateral dependent loans. Impairment on collateral dependent restructured loans is measured by determining the amount by which our recorded investment in the impaired loan exceeds the fair value of the collateral less estimated selling costs. The fair value is generally determined by one or more appraisals of the collateral, performed by a Company-approved third-party independent appraiser. The majority of impaired loans that are collateral dependent are charged off down to their estimated fair value of the collateral (less selling costs) at each reporting date based on current appraised value.

Appraisals of the collateral for impaired collateral dependent loans are typically ordered at the time the loan is identified as showing signs of inherent weakness. These appraisals are normally updated at least annually, or more frequently, if there are concerns or indications that the value of the collateral may have changed significantly since the previous appraisal. On an exception basis, a specific valuation allowance is recorded on collateral dependent impaired loans when a current appraisal is not yet available, a recent appraisal is still under review or on single-family mortgage loans if the loans are currently under review for a loan modification. Such valuation allowances are generally based on previous appraisals adjusted for current market conditions, based on preliminary appraisal values that are still being reviewed or for single-family loans under review for modification on an appraisal or indications of comparable home sales from external sources.

 

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Charge-offs of unsecured consumer loans are recorded when the loan reaches 120 days past due or sooner as circumstances indicate. Except for the charge-offs of unsecured consumer loans, the charge-off policy is applied consistently across all portfolio segments. Impaired single-family mortgage loans that have been modified in accordance with the various government modification programs are also measured based on the present value of the expected cash flows discounted at the loan’s pre-modification interest rate. The Company recognizes the change in present value attributable to the passage of time as interest income on such performing single-family mortgage loans and the amount of interest income recognized to date has been insignificant.

Provision and Allowance for Loan Losses — The allowance for loan losses is management’s estimate of probable losses inherent in the loan and lease receivables portfolio. The allowance is increased by the provision for losses and decreased by charge-offs when management believes the uncollectability of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. The determination of the balance in the allowance for loan losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in management’s judgment, is appropriate to provide for probable loan losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past loan loss experience, and such other factors that would deserve current recognition in estimating inherent loan losses.

There are different qualitative risks for the loans in each portfolio segment. The construction and real estate segments’ predominant risk characteristics are the collateral and the geographic location of the property collateralizing the loan as well as the operating cash flow for commercial real estate properties. The commercial and industrial segments’ predominant risk characteristics are the cash flows of the businesses we lend to, the global cash flows and liquidity of the guarantors of such losses, as well as economic and market conditions. The dairy & livestock segment’s predominant risk characteristics are milk and beef prices in the market as well as the cost of feed and cattle. The municipal lease segment’s predominant risk characteristics are the municipality’s general financial condition and tax revenues or if applicable the specific project related financial condition. The consumer, auto and other segments’ predominant risk characteristics are employment and income levels as they relate to consumers and cash flows of the businesses as they relate to equipment and vehicle leases to businesses. The agribusiness segment’s predominant risk characteristics are the supply and demand conditions of the product, production seasonality, the scale of operations and ability to control costs, the availability and cost of water, and operator experience.

The Company’s methodology is consistently applied across all portfolio segments taking into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans. A key factor in the Company’s methodology is the loan risk rating (Pass, Special Mention, Substandard, Doubtful and Loss). Loan risk ratings are updated as facts related to the loan or borrower become available. In addition, all term loans in excess of $1.0 million are subject to an annual internal credit review process where all factors underlying the loan, borrower and guarantors are subject to review which may result in changes to the loan’s risk rating. Periodically, we assess various attributes utilized in adjusting our historical loss factors to reflect our view of current economic conditions. The estimate is reviewed quarterly by the Board of Directors and management and periodically by various regulatory agencies and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.

Our methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers the Bank’s overall loan portfolio. The Bank’s methodology consists of two major phases.

In the first phase, individual loans are reviewed to identify loans for impairment and, if impaired, whether they are collateral-dependent loans. Impairment is measured based on the Company’s policy which requires that impaired loans are individually evaluated for impairment utilizing one of three valuation methods, as prescribed under ASC 310-10. Generally, the Company measures impairment based on the present value of expected cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is a collateral-dependent loan. Impaired loans are deemed collateral-dependent if repayment is expected to be provided solely by the underlying collateral, which includes repayment from the proceeds from the sale of the collateral, cash flow from the continued operation of the collateral, or both, and cash flows to repay the loan from all other available sources are expected to be no more than nominal. If the Company deems the impaired loan to be a collateral-dependent loan, the impairment is measured using the fair value of the collateral. If the Company determines that a loan’s present value of expected cash flows or fair value of the collateral, if the loan is collateral-dependent, is less than the recorded investment in the loan, the Company either recognizes an impairment reserve as a specific allowance, or charges off the impaired balance if it is determined that such amount represents a confirmed loss. Loans determined to be impaired are excluded from the formula allowance that evaluates loans collectively for impairment, as discussed in the second phase below.

The second phase is conducted by evaluating or segmenting the remainder of the loan portfolio into groups or pools of loans with similar characteristics. In this second phase, groups or pools of homogeneous loans are reviewed to determine a portfolio formula allowance. In the case of the portfolio formula allowance, homogeneous portfolios, such as small business loans, consumer loans, agricultural loans, and real estate loans, are aggregated or pooled in determining the appropriate allowance. The risk assessment process in this case emphasizes trends in the different portfolios for delinquency, loss, and other behavioral characteristics of the subject portfolio over a relevant period.

Included in this second phase is our consideration of qualitative factors, including, all known relevant internal and external factors that may affect the collectability of a loan. This includes our estimates of the amounts necessary for concentrations, economic uncertainties, the volatility of the market value of collateral, and other relevant factors. These qualitative factors are used to adjust the historical loan loss rates for each pool of loans to determine the probable loan losses inherent in the portfolio.

Periodically, we assess various attributes utilized in adjusting our historical loss factors to reflect current economic conditions. The methodology is consistently applied across all the portfolio segments taking into account the applicable historical loss rates and the qualitative factors applicable to each pool of loans.

 

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In the fourth quarter ended December 31, 2013, the Bank implemented a change in its methodology to calculate the ALLL. Previously, the Bank used an annual three-year look-back period of historical losses, segmented by loan type, with the loss factors updated annually to include the current year’s loss experience in the fourth quarter of each year. External factors that were considered were the improving credit environment and the stabilizing economy. In determining the look-back period, management considered the period used to develop the historical loss rate should be long enough to capture sufficient loss data. We determined that a rolling twenty quarters look-back period was appropriate as of December 31, 2013 because the most recent three-year period provides insufficient data, with very low loss experience, and in some cases recoveries actually exceed losses within certain loan segments during the three year period. We believe the rolling twenty quarters look-back period is the best indicator of inherent losses within the loan portfolio as many of the economic factors in the early stages of the economic recovery still exist.

Covered Loans — We refer to “covered loans” as those loans that we acquired in the San Joaquin Bank (“SJB”) acquisition for which we will be reimbursed for a substantial portion of any future losses under the terms of the Federal Deposit Insurance Corporation (“FDIC”) loss sharing agreement. We account for loans under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“acquired impaired loan accounting”) when (i) we acquire loans deemed to be impaired when there is evidence of credit deterioration since their origination and it is probable at the date of acquisition that we would be unable to collect all contractually required payments and (ii) as a general policy election for non-impaired loans that we acquire in a distressed bank acquisition. Acquired impaired loans are accounted for individually or in pools of loans based on common risk characteristics. The excess of the loan’s or pool’s scheduled contractual principal and interest payments over all cash flows expected at acquisition is the nonaccretable difference. The remaining amount, representing the excess of the loan’s cash flows expected to be collected over the fair value is the accretable yield (accreted into interest income over the remaining life of the loan or pool).

A provision for loan losses on the covered portfolio will be recorded if there is deterioration in the expected cash flows on covered loans as a result of deteriorated credit quality, compared to those previously estimated without regard to the reimbursement from the FDIC under the FDIC loss sharing agreement. The portion of the loss on covered loans reimbursable from the FDIC is recorded in noninterest income as a (decrease) increase in the FDIC loss sharing asset. Decreases in expected cash flows on the acquired impaired loans as of the measurement date compared to previously estimated are recognized by recording a provision for loan losses on acquired impaired loans. Loans accounted for as part of a pool are measured based on the expected cash flows of the entire pool.

FDIC Loss Sharing Asset On October 16, 2009, the Bank acquired substantially all of the assets and assumed substantially all of the liabilities of San Joaquin Bank (“SJB”) from the FDIC in an FDIC-assisted transaction. The Bank entered into a loss sharing agreement with the FDIC, whereby the FDIC will cover a substantial portion of any future losses on certain acquired assets. The acquired assets subject to the loss sharing agreement are referred to collectively as “covered assets.” Under the terms of such loss sharing agreement, the FDIC will absorb 80% of losses and share in 80% of loss recoveries up to $144.0 million with respect to covered assets, after a first loss amount of $26.7 million. The FDIC will reimburse the Bank for 95% of losses and share in 95% of loss recoveries in excess of $144.0 million with respect to covered assets. The loss sharing agreement is in effect for 5 years for commercial loans and 10 years for single-family residential loans from the October 16, 2009 acquisition date and the loss recovery provisions are in effect for 8 and 10 years, respectively, for commercial and single-family residential loans from the acquisition date.

The FDIC loss sharing asset was initially recorded at fair value which represents the present value of the estimated cash payments from the FDIC for future losses on covered loans. The ultimate collectability of this asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC. The loss estimates used in calculating the FDIC loss sharing asset are determined on the same basis as the loss estimates on the related covered loans and is the present value of the cash flows the Company expects to collect from the FDIC under the loss sharing agreement. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted (or amortized) into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on covered loan performance. Any increases in the cash flows of covered loans over those expected will reduce the FDIC indemnification asset and any decreases in the cash flows of covered loans over those expected will increase the FDIC indemnification asset, with the remaining balance amortized on the same basis as the discount, not to exceed its remaining contract life. These increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.

Goodwill and Intangible Assets Goodwill resulting from business combinations prior to January 1, 2009, represents the excess of the purchase price over the fair value of the net assets of the businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interest in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually, or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed.

 

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Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet. Based on the Company’s annual impairment test, there was zero recorded impairment as of March 31, 2014.

Other intangible assets consist of core deposit intangible assets arising from business combinations and are amortized using an accelerated method over their estimated useful lives.

Fair Value of Financial Instruments We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Investment securities available-for-sale and interest-rate swaps are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a non-recurring basis, such as impaired loans and other real estate owned (“OREO”). These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. Further, we include in Note 8 of the unaudited condensed consolidated financial statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value we disclose the estimate of their fair value.

Earnings per Common Share — The Company calculates earnings per common share (“EPS”) using the two-class method. The two-class method requires the Company to present EPS as if all of the earnings for the period are distributed to common shareholders and any participating securities. All outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends are considered participating securities. The Company grants restricted shares under the 2008 Equity Incentive Plan that qualify as participating securities. Restricted shares issued under this plan are entitled to dividends at the same rate as common stock. A reconciliation of the numerator and the denominator used in the computation of basic and diluted earnings per common share is included in Note 7 of these unaudited condensed consolidated financial statements.

Stock-Based Compensation Consistent with the provisions of ASC 718, “Stock Compensation”, we recognize expense for the grant date fair value of stock options and restricted shares issued to employees, officers and non-employee directors over the their requisite service periods (generally the vesting period). The service periods may be subject to performance conditions.

At March 31, 2014, the Company had three stock-based employee compensation plans. The Company accounts for stock compensation using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured at fair value as of the grant date with compensation costs recognized over the vesting period on a straight-lined basis. Also under this method, unvested stock awards as of January 1, 2006 are recognized over the remaining service period with no change in historical reported earnings.

The fair value of each stock option grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions used at the time of grant impact the fair value of the option calculated under the Black-Scholes option-pricing model, and ultimately, the expense that will be recognized over the life of the option.

The grant date fair value of restricted stock awards is measured at the fair value of the Company’s common stock as if the restricted share was vested and issued on the date of grant.

Additional information is included in Note 17 Stock Option Plan and Restricted Stock Awards, of the Company’s 2013 Annual Report on Form 10-K.

Derivative Financial Instruments All derivative instruments, including certain derivative instruments embedded in other contracts, are recognized on the consolidated balance sheets at fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in “Other Comprehensive Income,” net of deferred taxes, and are subsequently reclassified to earnings when the hedged transaction affects earnings. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item.

Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. Other significant estimates which may be subject to change include fair value determinations and disclosures, impairment of investments, goodwill, loans, determining the amount and realization of the FDIC loss sharing asset, and valuation of deferred tax assets, other intangibles and OREO.

 

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Other Contingencies In the ordinary course of business, the Company becomes involved in litigation. Based upon the Company’s internal records and discussions with legal counsel, the Company records reserves as appropriate, for estimates of the probable outcome of all cases brought against the Company. Except as discussed in Part II – Other Information, Item 1. “Legal Proceedings,” at March 31, 2014, the Company does not have any litigation reserves, and is not aware of any material pending legal action or complaints asserted against the Company.

Recent Accounting Pronouncements— In January 2014, the FASB issued ASU No. 2014-01, “Investments — Equity Method and Joint Ventures (Topic 323) — Accounting for Investments in Qualified Affordable Housing Projects.” This ASU allows reporting entities to make an accounting policy election concerning investments in Low Income Housing Tax Credit (“LIHTC”) programs, that meet specified conditions, to present the net tax benefits (net of the amortization of the cost of the investment) within income tax expense. The cost of LIHTC investments, that meet the specified conditions, may be amortized in proportion to the total expected tax benefits, including the tax credits and other tax benefits, as they are realized on the tax return. This ASU is effective beginning after December 15, 2014. This ASU is required to be applied retrospectively, if investors elect the proportional amortization method. However, if investors have existing LIHTC investments accounted for under the effective-yield method at adoption, they may continue to apply that method for those existing investments. The adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40) — Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure.” This ASU clarifies when a creditor should reclassify mortgage loans collateralized by residential real estate from loans receivable to other real estate owned. ASU 2014-04 defines when an in-substance repossession or foreclosure has occurred and when a creditor is considered to have received physical possession of residential real estate collateralizing a mortgage loan. This ASU is effective for us on January 1, 2015 and can be applied either prospectively or using a modified retrospective transition method, and early adoption is permitted. The adoption of this this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

 

4. INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities are summarized below. The majority of securities held are publicly traded, and the estimated fair values were obtained from an independent pricing service based upon market quotes.

 

     March 31, 2014  
     Amortized
Cost
     Gross
Unrealized
Holding
Gain
     Gross
Unrealized
Holding
Loss
    Fair Value      Total
Percent
 
     (Dollars in thousands)  

Investment securities available-for-sale:

             

Government agency

   $ 335,412       $ 3      $ (18,586   $ 316,829        11.52

Residential mortgage-backed securities

     1,511,226         16,365        (15,415     1,512,176        54.99

CMO’s / REMIC’s - residential

     344,470         7,466        (563     351,373        12.78

Municipal bonds

     545,259         21,588        (2,162     564,685        20.53

Other securities

     5,000         —           —          5,000        0.18
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,741,367       $ 45,422      $ (36,726   $ 2,750,063        100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

     December 31, 2013  
     Amortized
Cost
     Gross
Unrealized
Holding
Gain
     Gross
Unrealized
Holding
Loss
    Fair Value      Total
Percent
 
     (Dollars in thousands)  

Investment securities available-for-sale:

             

Government agency

   $ 350,378       $ 22       $ (23,875   $ 326,525         12.26

Residential mortgage-backed securities

     1,391,631         13,100         (24,788     1,379,943         51.81

CMO’s / REMIC’s - residential

     361,573         6,576         (1,974     366,175         13.75

Municipal bonds

     571,145         18,839         (3,893     586,091         22.00

Other securities

     5,000         —           (92     4,908         0.18
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,679,727       $ 38,537       $ (54,622   $ 2,663,642         100.00
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

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Approximately 79% of the available-for-sale portfolio at March 31, 2014 represents securities issued by the U.S government or U.S. government-sponsored enterprises, with the implied guarantee of payment of principal and interest. All non-agency available-for-sale CMO/REMIC issues held are rated investment grade or better by either Standard & Poor’s or Moody’s, as of March 31, 2014 and December 31, 2013. The Bank has $505,000 in CMO/REMIC’s backed by whole loans issued by private-label companies (nongovernment sponsored).

During the first quarter of 2013, management identified 13 securities with a par value of $94.2 million that were experiencing accelerated prepayment speeds that were causing deterioration in yield. These securities were sold and the Company recognized a net pre-tax gain on sale of $2.1 million. There were no realized gains or losses for the three months ended March 31, 2014.

The tables below show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2014 and December 31, 2013. Management has reviewed individual securities to determine whether a decline in fair value below the amortized cost basis is other-than-temporary.

 

     March 31, 2014  
     Less Than 12 Months      12 Months or Longer      Total  
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Available-for-sale:

                 

Government agency

   $ 143,534       $ 6,842       $ 164,282       $ 11,744       $ 307,816       $ 18,586   

Residential mortgage-backed securities

     542,041         7,062         148,952         8,353         690,993         15,415   

CMO / REMICs - residential

     52,196         539         15,693         24         67,889         563   

Municipal bonds

     16,068         865         28,076         1,297         44,144         2,162   

Other securities

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 753,839       $ 15,308       $ 357,003       $ 21,418       $ 1,110,842       $ 36,726   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     Less Than 12 Months      12 Months or Longer      Total  
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair
Value
     Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Available-for-sale:

                 

Government agency

   $ 267,936       $ 20,514       $ 38,563       $ 3,361       $ 306,499       $ 23,875   

Residential mortgage-backed securities

     851,621         23,313         22,999         1,475         874,620         24,788   

CMO / REMICs - residential

     104,322         1,780         17,747         194         122,069         1,974   

Municipal bonds

     47,116         3,359         10,338         534         57,454         3,893   

Other securities

     4,908         92         —           —           4,908         92   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,275,903       $ 49,058       $ 89,647       $ 5,564       $ 1,365,550       $ 54,622   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following summarizes our analysis of these securities and the unrealized losses. This assessment was based on the following factors: i) the length of the time and the extent to which the fair value has been less than amortized cost; ii) adverse condition specifically related to the security, an industry, or a geographic area and whether or not the Company expects to recover the entire amortized cost, iii) historical and implied volatility of the fair value of the security; iv) the payment structure of the security and the likelihood of the issuer being able to make payments in the future; v) failure of the issuer of the security to make scheduled interest or principal payments, vi) any changes to the rating of the security by a rating agency, and vii) recoveries or additional declines in fair value subsequent to the balance sheet date.

CMO Held-to-Maturity — The Company has one investment security classified as held-to-maturity. This security was issued by Countrywide Financial and is collateralized by Alt-A mortgages. The mortgages are primarily fixed-rate, 30-year loans, originated in

 

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Table of Contents

early 2006 with average FICO scores of 715 and an average LTV of 71% at origination. The security was a senior security in the securitization, was rated triple AAA at origination and was supported by subordinate securities. This security is classified as held-to-maturity as the Bank has both the intent and ability to hold this debt security to maturity. The Bank acquired this security in February 2008 at a price of 98.25%. The significant decline in the fair value of the security first appeared in August 2008 at the time the financial crisis in the markets occurred and the market for securities collateralized by Alt-A mortgages diminished.

As of March 31, 2014, the unrealized loss on this security was zero and the current fair value on the security was 77.24% of the current par value. This Alt-A bond, with a book value of $1.7 million as of March 31, 2014, has had $1.9 million in net impairment losses to date. These losses have been recorded as a reduction to noninterest income. The security is rated non-investment grade. We evaluated the security for an other-than-temporary decline in fair value as of March 31, 2014. The key assumptions include default rates, loss severities and prepayment rates. There were no changes in credit related other-than temporary impairment recognized in earnings for the three months ended March 31, 2014 and 2013.

Government Agency & Government-Sponsored Enterprise— The government agency bonds are backed by the full faith and credit of agencies of the U.S. Government. While the Government-Sponsored Enterprise bonds are not expressly guaranteed by the U.S. Government, they are currently being supported by the U.S. Government under a conservatorship arrangement. As of March 31, 2014, approximately $134.3 million in U.S. government agency bonds are callable. These securities are bullet securities, that is, they have a defined maturity date on which the principal is paid. The contractual term of these investments provides that the Company will receive the face value of the bond at maturity which will equal the amortized cost of the bond. Interest is received throughout the life of the security.

Mortgage-Backed Securities and CMO/REMICs— Almost all of the Company’s available-for-sale mortgage-backed and CMO/REMICs securities are issued by government agencies or government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac. These securities are collateralized or backed by the underlying residential mortgages. All mortgage-backed securities are considered to be rated investment grade with a weighted average life of approximately 4.3 years. Of the total MBS/CMO, 99.97% have the implied guarantee of U.S. government-sponsored agencies and enterprises. The remaining 0.03% are issued by banks. Accordingly, it is expected the securities would not be settled at a price less than the amortized cost of the bonds.

Municipal Bonds—The majority of the Company’s municipal bonds are insured by the largest bond insurance companies with maturities of approximately 8.9 years. The Company diversifies its holdings by owning selections of securities from different issuers and by holding securities from geographically diversified municipal issuers, thus reducing the Company’s exposure to any single adverse event. Because we believe the decline in fair value is attributable to the changes in interest rates and not credit quality and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized costs, which may be at maturity, management does not consider these investments to be other than temporarily impaired at March 31, 2014.

On an ongoing basis, we monitor the quality of our municipal bond portfolio in light of the current financial problems exhibited by certain monoline insurance companies. Many of the securities that would not be rated without insurance are pre-refunded and/or are general obligation bonds. We continue to monitor municipalities, which includes a review of the respective municipalities’ audited financial statements to determine whether there are any audit or performance issues. We use outside brokers to assist us in these analyses. Based on our monitoring of the municipal marketplace, to our knowledge, none of the municipalities are exhibiting financial problems that would lead us to believe that there is an OTTI for any given security.

At March 31, 2014 and December 31, 2013, investment securities having a carrying value of approximately $2.63 billion and $2.60 billion, respectively, were pledged to secure public deposits, short and long-term borrowings, and for other purposes as required or permitted by law.

The amortized cost and fair value of debt securities at March 31, 2014, by contractual maturity, are shown in the table below. Although mortgage-backed securities and CMO/REMICs have contractual maturities through 2043, expected maturities will differ from contractual maturities because borrowers may have the right to prepay such obligations without penalty. Mortgage-backed securities and CMO/REMICs are included in maturity categories based upon estimated prepayment speeds.

 

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Table of Contents
    March 31, 2014  
    Amortized
Cost
    Fair Value     Weighted-
Average
Yield
 
    (Dollars in thousands)  

Available-for-sale:

     

Due in one year or less

  $ 113,183      $ 116,202       3.25

Due after one year through five years

    1,718,930        1,750,370       2.56

Due after five years through ten years

    865,160        840,172       2.14

Due after ten years

    44,094        43,319       3.57
 

 

 

   

 

 

   

Total

  $ 2,741,367      $ 2,750,063       2.47
 

 

 

   

 

 

   

The investment in FHLB stock is periodically evaluated for impairment based on, among other things, the capital adequacy of the FHLB and its overall financial condition. No impairment losses have been recorded through March 31, 2014.

 

5. COVERED ASSETS AND FDIC LOSS SHARING ASSET

FDIC Assisted Acquisition

On October 16, 2009, the Bank acquired SJB and entered into a loss sharing agreements with the FDIC that is more fully discussed in Note 3—Summary of Significant Accounting Policies, included herein. The acquisition has been accounted for under the purchase method of accounting. The assets and liabilities were recorded at their estimated fair values as of the October 16, 2009 acquisition date. The application of the purchase method of accounting resulted in an after-tax gain of $12.3 million which was included in 2009 earnings. The gain is the negative goodwill resulting from the acquired assets and liabilities recognized at fair value.

At March 31, 2014, the remaining discount associated with the SJB loans approximated $11.2 million. Based on the Company’s regular forecast of expected cash flows from these loans, approximately $7.9 million of the related discount is expected to accrete into interest income over the remaining average lives of the respective pools and individual loans, which approximates 4.3 years and 2.0 years, respectively. Due to the decrease in estimated losses to be incurred in the remaining portfolio, the expected reimbursement from the FDIC under the loss sharing agreement decreased. The FDIC loss sharing asset of $1.4 million at March 31, 2014 will continue to be reduced by loss claims submitted to the FDIC with the remaining balance amortized on the same basis as the discount on the related loans, not to exceed its remaining contract life, which expires in October of 2014.

The following table provides a summary of the components of covered loan and lease finance receivables as of March 31, 2014 and December 31, 2013:

 

    March 31, 2014     December 31, 2013  
    (Dollars in thousands)  

Commercial and industrial

  $ 18,582      $ 20,461  

Real estate:

   

Commercial real estate

    132,052        141,141  

Construction

    —          644  

SFR mortgage

    305        313  

Dairy & livestock and agribusiness

    1,054        6,000  

Municipal lease finance receivables

    —          —     

Consumer and other loans

    4,473        4,545  
 

 

 

   

 

 

 

Gross covered loans

    156,466        173,104  

Less: Purchase accounting discount

    (11,153     (12,789 )
 

 

 

   

 

 

 

Gross covered loans, net of discount

    145,313        160,315  

Less: Allowance for covered loan losses

    —          —     
 

 

 

   

 

 

 

Net covered loans

  $ 145,313      $ 160,315  
 

 

 

   

 

 

 

 

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Table of Contents

Credit Quality Indicators

Central to our credit risk management is our loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is reviewed and possibly changed by Credit Management. The risk rating is based primarily on a thorough analysis of each borrower’s financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.

Credit risk ratings are also used by Management in deriving expectations for future cash flows of covered loans, in addition to managing the underlying credit quality and collection efforts for these loans. Changes in credit risk ratings on covered loans assist the Company in establishing assumptions used in estimating expected future cash flows, and do not necessarily represent a need to establish or reverse an allowance for loan losses for these loans.

The following table summarizes covered loans by internal risk ratings as of March 31, 2014 and December 31, 2013:

 

    March 31, 2014     December 31, 2013  
    (Dollars in thousands)  

Pass

  $ 35,744      $ 38,961   

Watch list

    67,079        74,369   

Special mention

    15,411        15,492   

Substandard

    38,193        44,241   

Doubtful & loss

    39        41   
 

 

 

   

 

 

 

Total covered gross loans

  $ 156,466      $ 173,104   
 

 

 

   

 

 

 

Allowance for Loan Losses

The Company’s Credit Management Division is responsible for regularly reviewing the ALLL methodology for covered loans. The ALLL for covered loans is determined separately from non-covered loans, and is based on expectations of future cash flows from the underlying pools of loans or individual loans in accordance with ASC 310-30, as more fully discussed in Note 3—Summary of Significant Accounting Policies. As of March 31, 2014 and December 31, 2013, the Company had zero allowance for loan losses recorded for covered loans.

 

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Table of Contents
6. NON-COVERED LOAN AND LEASE FINANCE RECEIVABLES AND ALLOWANCE FOR LOAN LOSSES

The following tables provide a summary of the components of loan and lease finance receivables:

 

    March 31, 2014     December 31, 2013  
    (Dollars in thousands)  

Commercial and industrial

  $ 490,653      $ 512,792  

Real estate:

   

Commercial real estate

    2,194,051        2,207,515  

Construction

    42,906        47,109  

SFR mortgage

    189,899        189,233  

Dairy & livestock and agribusiness

    212,957        294,292  

Municipal lease finance receivables

    81,041        89,106  

Consumer and other loans

    54,815        55,103  
 

 

 

   

 

 

 

Gross non-covered loans

    3,266,322        3,395,150  

Less: Deferred loan fees, net

    (8,763     (9,234 )
 

 

 

   

 

 

 

Gross loans, net of deferred loan fees

    3,257,559        3,385,916  

Less: Allowance for non-covered loan losses

    (68,725     (75,235 )
 

 

 

   

 

 

 

Net non-covered loans

  $ 3,188,834      $ 3,310,681  
 

 

 

   

 

 

 

As of March 31, 2014, 67.17% of the total non-covered loan portfolio consisted of commercial real estate loans and 1.31% of the total non-covered loan portfolio consisted of construction loans. Substantially all of the Company’s real estate loans and construction loans are secured by real properties located in California. At March 31, 2014, the Company held approximately $1.64 billion of non-covered fixed rate loans.

At March 31, 2014 and December 31, 2013, loans totaling $2.37 billion and $2.31 billion, respectively, were pledged to secure borrowings and available lines of credit from the FHLB and the Federal Reserve Bank.

Non-Covered Loans Held-for-Sale

The following table provides a summary of the activity related to non-covered loans held-for-sale for the three months ended March 31, 2014 and 2013:

 

     For the Three Months
Ended March 31,
 
     2014     2013  
     (Dollars in thousands)  

Balance, beginning of period

   $ 3,667      $ —     

Originations of mortgage loans

     —          —     

Sales of mortgage loans

     —          —     

Transfer of mortgage loans to held-for-investment

     —          —     

Sales of other loans

     (3,667     —     

Transfers of other loans to held-for-sale

     —          —     

Write-down of loans held-for-sale

     —          —     
  

 

 

   

 

 

 

Balance, end of period

   $ —        $ —     
  

 

 

   

 

 

 

 

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Table of Contents

Credit Quality Indicators

Central to our credit risk management is our loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is reviewed and confirmed or changed, as appropriate, by Credit Management. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.

Loans are risk rated into the following categories (Credit Quality Indicators): Pass, Pass Watch List, Special Mention, Substandard, Doubtful and Loss. Each of these groups is assessed for the proper amount to be used in determining the adequacy of our allowance for losses. These categories can be described as follows:

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

Pass Watch List — Pass Watch list loans usually require more than normal management attention. Loans which qualify for the Pass Watch List may involve borrowers with adverse financial trends, higher debt/equity ratios, or weaker liquidity positions, but not to the degree of being considered a defined weakness or problem loan where risk of loss may be apparent.

Special Mention — Loans assigned to this category are currently protected but are weak. Although concerns exist, the Company is currently protected and loss is unlikely. Such loans have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date.

Substandard – Loans classified as substandard include poor liquidity, high leverage, and erratic earnings or losses. The primary source of repayment is no longer realistic, and asset or collateral liquidation may be the only source of repayment. Substandard loans are marginal and require continuing and close supervision by credit management. Substandard loans have the distinct possibility that the Company will sustain some loss if deficiencies are not corrected.

Doubtful – Loans classified doubtful have all the weaknesses inherent in those classified substandard with the added provision that the weaknesses make collection or the liquidation, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the assets, their classifications as losses are deferred until their more exact status may be determined.

Loss — Loans classified as loss are considered uncollectible and of such little value that their continuance as active assets of the Company is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be achieved in the future.

The following tables summarize our internal risk grouping by loan class as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     Pass      Watch List      Special
Mention
     Substandard      Doubtful &
Loss
     Total  
     (Dollars in thousands)  

Commercial and industrial

   $ 297,226       $ 122,117      $ 55,351       $ 15,510      $ 449       $ 490,653   

Real estate:

                 

Commercial real estate

                 

Owner occupied

     436,914         149,155        74,017         56,287        —           716,373   

Non-owner occupied

     1,102,953         254,669        71,282         48,774        —           1,477,678   

Construction

                 

Speculative

     7,594         383        1,513         17,519        —           27,009   

Non-speculative

     5,676         1,052        —           9,169        —           15,897   

SFR mortgage

     153,204         20,905        2,911         12,879        —           189,899   

Dairy & livestock and agribusiness

     18,204         71,184        66,598         51,574        5,397         212,957   

Municipal lease finance receivables

     40,860         19,197        20,984         —           —           81,041   

Consumer and other loans

     42,557         7,523        3,285         1,450        —           54,815   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered gross loans

   $ 2,105,188       $ 646,185      $ 295,941       $ 213,162      $ 5,846       $ 3,266,322   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2013  
     Pass      Watch List      Special
Mention
     Substandard      Doubtful &
Loss
     Total  
     (Dollars in thousands)  

Commercial and industrial

   $ 312,927       $ 128,068      $ 53,417       $ 17,950      $ 430       $ 512,792   

Real estate:

                 

Commercial real estate

                 

Owner occupied

     449,853         147,165        74,999         57,934        —           729,951   

Non-owner occupied

     1,104,065         242,431        81,088         49,980        —           1,477,564   

Construction

                 

Speculative

     8,611         21        1,529         17,617        —           27,778   

Non-speculative

     6,940         3,190        —           9,201        —           19,331   

SFR mortgage

     152,500         20,485        3,302         12,946        —           189,233   

Dairy & livestock and agribusiness

     43,588         86,580        92,514         69,005        2,605         294,292   

Municipal lease finance receivables

     43,445         18,338        20,893         6,430        —           89,106   

Consumer and other loans

     43,225         6,938        3,449         1,491        —           55,103   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered gross loans

   $ 2,165,154       $ 653,216      $ 331,191       $ 242,554      $ 3,035       $ 3,395,150   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for Loan Losses

The Company’s Credit Management Division is responsible for regularly reviewing the allowance for loan losses (“ALLL”) methodology, including loss factors and economic risk factors. The Bank’s Director of Loan Committee provides Board oversight of the ALLL process and approves the ALLL methodology on a quarterly basis.

Our methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers the Bank’s overall loan portfolio. Refer to Note 3 – Summary of Significant Accounting Policies for a more detailed discussion concerning the allowance for loan losses.

Management believes that the ALLL was appropriate at March 31, 2014 and December 31, 2013. No assurance can be given that economic conditions which adversely affect the Company’s service areas or other circumstances will not be reflected in increased provisions for loan losses in the future.

The following tables present the balance and activity related to the allowance for loan losses for non-covered held-for-investment loans by portfolio segment as of March 31, 2014 and 2013:

 

     For the Three Months Ended March 31, 2014  
     Ending
Balance
December 31,
2013
     Charge-offs     Recoveries      Provision for
Loan Losses
    Ending
Balance
March 31,
2014
 
     (Dollars in thousands)  

Commercial and industrial

   $ 10,834       $ (454 )   $ 455       $ (1,999 )   $ 8,836   

Real estate:

            

Commercial real estate

     39,402         —          68         (70 )     39,400   

Construction

     1,305         —          778         (1,625 )     458   

SFR mortgage

     2,718         —          —           (436 )     2,282   

Dairy & livestock and agribusiness

     11,728         —          144         (2,605 )     9,267   

Municipal lease finance receivables

     2,335         —          —           (816 )     1,519   

Consumer and other loans

     960         (13 )     12         (9 )     950   

Unallocated

     5,953              60       6,013   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total allowance for loan losses

   $ 75,235       $ (467 )   $ 1,457       $ (7,500 )   $ 68,725   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents
     For the Three Months Ended March 31, 2013  
     Ending
Balance
December 31,
2012
     Charge-offs     Recoveries      Provision for
Loan Losses
    Ending
Balance
March 31,
2013
 
     (Dollars in thousands)  

Commercial and industrial

   $ 11,652       $ (357 )   $ 99       $ 919     $ 12,313   

Real estate:

            

Commercial real estate

     47,457         —          37         (769 )     46,725   

Construction

     2,291         —          126         (293 )     2,124   

SFR mortgage

     3,448         (142 )     34         266       3,606   

Dairy & livestock and agribusiness

     18,696         —          14         (2,139 )     16,571   

Municipal lease finance receivables

     1,588         —          —           1,044       2,632   

Consumer and other loans

     1,170         (47 )     13         (3 )     1,133   

Unallocated

     6,139              975       7,114   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total allowance for loan losses

   $ 92,441       $ (546 )   $ 323       $ —        $ 92,218   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

The following tables present the recorded investment in non-covered loans held-for-investment, and the related allowance for loan losses by portfolio segment, based on the Company’s methodology for determining the allowance for loan losses as March 31, 2014 and 2013:

 

     March 31, 2014  
     Recorded Investment in Loans      Allowance for Loan Losses  
     Individually
Evaluated for
Impairment
     Collectively
Evaluated for
Impairment
     Individually
Evaluated for
Impairment
     Collectively
Evaluated for
Impairment
 
     (Dollars in thousands)  

Commercial and industrial

   $ 5,940       $ 484,713      $ 882       $ 7,954   

Real estate:

           

Commercial real estate

     33,907         2,160,144        320         39,080   

Construction

     26,688         16,218        —           458   

SFR mortgage

     11,692         178,207        47         2,235   

Dairy & livestock and agribusiness

     27,972         184,985        2,656         6,611   

Municipal lease finance receivables

     —           81,041        —           1,519   

Consumer and other loans

     397         54,418        96         854   

Unallocated

              6,013   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 106,596       $ 3,159,726      $ 4,001       $ 64,724   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     March 31, 2013  
     Recorded Investment in Loans      Allowance for Loan Losses  
     Individually
Evaluated for
Impairment
     Collectively
Evaluated for
Impairment
     Individually
Evaluated for
Impairment
     Collectively
Evaluated for
Impairment
 
     (Dollars in thousands)  

Commercial and industrial

   $ 4,579       $ 528,362      $ 1,055       $ 11,258   

Real estate:

           

Commercial real estate

     41,505         1,954,693        1         46,724   

Construction

     27,491         28,212        —           2,124   

SFR mortgage

     13,593         148,429        428         3,178   

Dairy & livestock and agribusiness

     25,327         258,545        2,560         14,011   

Municipal lease finance receivables

     —           109,727        —           2,632   

Consumer and other loans

     226         56,312        27         1,106   

Unallocated

              7,114   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 112,721       $ 3,084,280      $ 4,071       $ 88,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Past Due and Nonperforming Loans

We seek to manage asset quality and control credit risk through diversification of the non-covered loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank’s Credit Management Division is in charge of monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. Reviews of nonperforming, past due non-covered loans and larger credits, designed to identify potential charges to the allowance for loan losses, and to determine the appropriateness of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers and any guarantors, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors. Refer to Note 3 – Summary of Significant Accounting Policies for additional discussion concerning the Bank’s policy for past due and nonperforming loans.

Loans are reported as a troubled debt restructuring when the Bank grants a concession(s) to a borrower experiencing financial difficulties that the Bank would not otherwise consider. Examples of such concessions include a reduction in the interest rate, deferral of principal or accrued interest, extending the payment due dates or loan maturity date(s), or providing a lower interest rate than would be normally available for new debt of similar risk. As a result of these concessions, restructured loans are classified as impaired. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan losses.

Generally, when loans are identified as impaired they are moved to our Special Assets Department. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, unless the loan is determined to be collateral dependent. In these cases, we use the current fair value of collateral, less selling costs. Generally, the determination of fair value is established through obtaining external appraisals of the collateral.

Speculative construction loans are generally for properties where there is no identified buyer or renter.

The following tables present the recorded investment in, and the aging of, non-covered past due and nonaccrual loans and loans past due by class of loans as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014  
     30-59
Days Past
Due
     60-89
Days Past
Due
     90+ Days
Past Due
and
Accruing
     Total Past
Due and
Accruing
     Nonaccrual
(1)
     Current      Total Loans
and
Financing
Receivables
 
     (Dollars in thousands)  

Commercial and industrial

   $ —         $ —         $ —         $ —         $ 4,821       $ 485,832      $ 490,653   

Real estate:

                    

Commercial real estate

                    

Owner occupied

     28         —           —           28        4,377         711,968        716,373   

Non-owner occupied

     492         —           —           492        7,475         1,469,711        1,477,678   

Construction

                    

Speculative

     —           —           —           —           9,867         17,142        27,009   

Non-speculative

     —           —           —           —           —           15,897        15,897   

SFR mortgage

     432         —           —           432        7,868         181,599        189,899   

Dairy & livestock and agribusiness

     —           —           —           —           5,397         207,560        212,957   

Municipal lease finance receivables

     —           —           —           —           —           81,041        81,041   

Consumer and other loans

     8         —           —           8        397         54,410        54,815   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered gross loans

   $ 960       $ —         $ —         $ 960      $ 40,202       $ 3,225,160      $ 3,266,322   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) As of March 31, 2014, $23.2 million of nonaccruing loans were current according to original or restructured terms, $1.6 million were 30-59 days past due, $387,000 were 60-89 days past due, and $15.0 million were 90+ days past due.

 

24


Table of Contents
     December 31, 2013  
     30-59
Days Past
Due
     60-89
Days Past
Due
     90+ Days
Past Due
and
Accruing
     Total Past
Due and
Accruing
     Nonaccrual
(1)
     Current      Total Loans
and
Financing
Receivables
 
     (Dollars in thousands)  

Commercial and industrial

   $ 900       $ 93      $ —         $ 993      $ 3,861       $ 507,938      $ 512,792   

Real estate:

                    

Commercial real estate

                    

Owner occupied

     220         —           —           220        4,105         725,626        729,951   

Non-owner occupied

     303         —           —           303        8,305         1,468,956        1,477,564   

Construction

                    

Speculative

     —           —           —           —           9,966         17,812        27,778   

Non-speculative

     —           —           —           —           —           19,331        19,331   

SFR mortgage

     773         935        —           1,708        7,577         179,948        189,233   

Dairy & livestock and agribusiness

     —           —           —           —           5,739         288,553        294,292   

Municipal lease finance receivables

     —           —           —           —           —           89,106        89,106   

Consumer and other loans

     75         —           —           75        401         54,627        55,103   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered gross loans

   $ 2,271       $ 1,028      $ —         $ 3,299      $ 39,954       $ 3,351,897      $ 3,395,150   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) As of December 31, 2013, $23.9 million of nonaccruing loans were current according to original or restructured terms, $473,000 were 30-59 days past due, $854,000 were 60-89 days past due, and $14.7 million were 90+ days past due.

Non-Covered Impaired Loans

At March 31, 2014, the Company had non-covered impaired loans of $106.6 million. Of this amount, there was $9.9 million in nonaccrual commercial construction loans, $7.9 million of nonaccrual SFR mortgage loans, $11.8 million of nonaccrual commercial real estate loans, $4.8 million of nonaccrual commercial and industrial loans, $5.4 million of nonaccrual dairy & livestock and agribusiness loans and $397,000 of consumer and other loans. These non-covered impaired loans included $90.4 million of loans whose terms were modified in a troubled debt restructuring, of which $24.0 million were classified as nonaccrual. The remaining balance of $66.4 million consisted of 44 loans performing according to the restructured terms. The impaired loans had a specific allowance of $4.0 million at March 31, 2014. At December 31, 2013, the Company had classified as impaired, non-covered loans with a balance of $106.9 million with a related allowance of $3.2 million.

 

25


Table of Contents

The following tables present information for held-for-investment loans, individually evaluated for impairment by class of loans, as of and for the periods indicated below:

 

     As of and For the Three Months Ended
March 31, 2014
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 
     (Dollars in thousands)  

With no related allowance recorded:

              

Commercial and industrial

   $ 4,173       $ 4,859      $ —         $ 4,230      $ 15   

Real estate:

              

Commercial real estate

              

Owner occupied

     10,108         10,768        —           10,221        117   

Non-owner occupied

     21,928         27,740        —           22,103        215   

Construction

              

Speculative

     17,519         18,407        —           17,550        77   

Non-speculative

     9,169         9,169        —           9,184        140   

SFR mortgage

     11,214         12,911        —           11,266        26   

Dairy & livestock and agribusiness

     16,582         17,430        —           16,902        189   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     290         295        —           291        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     90,983         101,579        —           91,747        779   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial and industrial

     1,767         2,109        882         1,771        —     

Real estate:

              

Commercial real estate

              

Owner occupied

     1,871         2,344        320         1,871        —     

Non-owner occupied

     —           —           —           —           —     

Construction

              

Speculative

     —           —           —           —           —     

Non-speculative

     —           —           —           —           —     

SFR mortgage

     478         486        47         479        —     

Dairy & livestock and agribusiness

     11,390         12,042        2,656         11,608        75   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     107         165        96         107        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     15,613         17,146        4,001         15,836        75   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered impaired loans

   $ 106,596       $ 118,725      $ 4,001       $ 107,583      $ 854   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

26


Table of Contents
     As of and For the Three Months Ended
March 31, 2013
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 
     (Dollars in thousands)  

With no related allowance recorded:

              

Commercial and industrial

   $ 2,873       $ 3,617      $ —         $ 2,899      $ 18   

Real estate:

              

Commercial real estate

              

Owner occupied

     13,616         14,827        —           13,630        122   

Non-owner occupied

     27,877         38,306        —           28,092        202   

Construction

              

Speculative

     18,272         18,607        —           18,272        77   

Non-speculative

     9,219         9,219        —           9,219        141   

SFR mortgage

     10,184         12,821        —           10,319        16   

Dairy & livestock and agribusiness

     20,843         21,874        —           19,170        98   

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     141         196        —           141        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     103,025         119,467        —           101,742        674   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

              

Commercial and industrial

     1,706         1,871        1,055         1,723        —     

Real estate:

              

Commercial real estate

              

Owner occupied

     12         14        1         16        —     

Non-owner occupied

     —           —           —           —           —     

Construction

              

Speculative

     —           —           —           —           —     

Non-speculative

     —           —           —           —           —     

SFR mortgage

     3,409         4,040        428         3,415        —     

Dairy & livestock and agribusiness

     4,484         4,944        2,560         4,603        —     

Municipal lease finance receivables

     —           —           —           —           —     

Consumer and other loans

     85         87        27         43        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     9,696         10,956        4,071         9,800        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered impaired loans

   $ 112,721       $ 130,423      $ 4,071       $ 111,542      $ 674   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

27


Table of Contents
     As of December 31, 2013  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 
     (Dollars in thousands)  

With no related allowance recorded:

        

Commercial and industrial

   $ 4,668       $ 5,927      $ —     

Real estate:

        

Commercial real estate

        

Owner occupied

     13,041         14,133        —     

Non-owner occupied

     20,399         26,155        —     

Construction

        

Speculative

     17,617         18,408        —     

Non-speculative

     9,201         9,201        —     

SFR mortgage

     10,919         12,516        —     

Dairy & livestock and agribusiness

     17,702         17,702        —     

Municipal lease finance receivables

     —           —           —     

Consumer and other loans

     385         445        —     
  

 

 

    

 

 

    

 

 

 

Total

     93,932         104,487        —     
  

 

 

    

 

 

    

 

 

 

With a related allowance recorded:

        

Commercial and industrial

     365         379        365  

Real estate:

        

Commercial real estate

        

Owner occupied

     —           —           —     

Non-owner occupied

     —           —           —     

Construction

        

Speculative

     —           —           —     

Non-speculative

     —           —           —     

SFR mortgage

     486         489        103  

Dairy & livestock and agribusiness

     12,110         12,783        2,702  

Municipal lease finance receivables

     —           —           —     

Consumer and other loans

     16         19        4  
  

 

 

    

 

 

    

 

 

 

Total

     12,977         13,670        3,174  
  

 

 

    

 

 

    

 

 

 

Total non-covered impaired loans

   $ 106,909       $ 118,157      $ 3,174  
  

 

 

    

 

 

    

 

 

 

The Company recognizes the charge-off of impairment allowance on impaired loans in the period in which a loss is identified for collateral dependent loans. Therefore, the majority of the nonaccrual loans as of March 31, 2014 and December 31, 2013 have already been written down to their estimated net realizable value. The impaired loans with a related allowance recorded are on nonaccrual loans where a charge-off is not yet processed, on nonaccrual SFR loans where there is a potential modification in process, or on smaller balance non-collateral dependent loans.

As of March 31, 2014 and December 31, 2013, impaired construction speculative loans included one nonaccruing loan that represents the Company’s only participating interest in a loan classified under the Shared National Credit program. The outstanding balance of this loan was $9.9 million as of March 31, 2014 and $10.0 million at December 31, 2013.

Reserve for Unfunded Loan Commitments

The allowance for off-balance sheet credit exposure relates to commitments to extend credit, letters of credit and undisbursed funds on lines of credit. The Company evaluates credit risk associated with the off-balance sheet commitments at the same time it evaluates credit risk associated with the loan and lease portfolio. The Company recorded zero provision for unfunded loan commitments for the three months ended March 31, 2014 and 2013. At March 31, 2014 and December 31, 2013, the balance of the reserve was $9.1 million and was included in other liabilities.

 

28


Table of Contents

Troubled Debt Restructurings (“TDR”)

Loans that are reported as TDRs are considered impaired and charge-off amounts are taken on an individual loan basis, as deemed appropriate. The majority of restructured loans are loans for which the terms of repayment have been renegotiated, resulting in a reduction in interest rate or deferral of principal. Refer to Note 3 – Summary of Significant Accounting Policies, Troubled Debt Restructurings, included herein.

As of March 31, 2014, there were $90.4 million of loans classified as TDR, of which $24.0 million were nonperforming and $66.4 million were performing. TDRs on accrual status are comprised of loans that were accruing interest at the time of restructuring or have demonstrated repayment performance in compliance with the restructured terms for a sustained period and for which the Company anticipates full repayment of both principal and interest. At March 31, 2014, performing TDRs were comprised of 13 commercial real estate loans of $22.1 million, two construction loans of $16.8 million, 11 dairy & livestock loans of $22.6 million, 11 SFR mortgage loans of $3.8 million, and seven commercial and industrial loans of $1.1 million. There were no loans removed from TDR classification during the three months ended March 31, 2014 and 2013.

The majority of TDRs have no specific allowance allocated as any impairment amount is normally charged off at the time a probable loss is determined. We have allocated $3.1 million and $2.7 million of specific allowance to TDRs as of March 31, 2014 and December 31, 2013, respectively.

The following tables provide a summary of the activity related to TDRs for the three months ended March 31, 2014 and 2013:

 

    For the Three Months Ended March 31,  
    2014     2013  
    (Dollars in thousands)  

Performing TDRs:

   

Beginning balance

  $ 66,955      $ 50,392   

New modifications

    41        10,245   

Payoffs and payments, net

    (602     (4,195

TDRs returned to accrual status

    —          1,149   

TDRs placed on nonaccrual status

    —          —     
 

 

 

   

 

 

 

Ending balance

  $ 66,394      $ 57,591   
 

 

 

   

 

 

 

 

    For the Three Months Ended March 31,  
    2014     2013  
    (Dollars in thousands)  

Nonperforming TDRs:

   

Beginning balance

  $ 25,119      $ 31,309   

New modifications

    —          100   

Payoffs and payments, net

    (1,151     (694

TDRs returned to accrual status

    —          (1,149

TDRs placed on nonaccrual status

    —          —     
 

 

 

   

 

 

 

Ending balance

  $ 23,968      $ 29,566   
 

 

 

   

 

 

 

 

29


Table of Contents

The following tables summarize loans modified as troubled debt restructurings during the three months ended March 31, 2014, and 2013:

Modifications (1)

 

    For the Three Months Ended March 31, 2014  
    Number
of Loans
    Pre-Modification
Outstanding
Recorded
Investment
    Post-Modification
Outstanding
Recorded
Investment
    Outstanding
Recorded
Investment at
March 31, 2013
    Financial Effect
Resulting From
Modifications (2)
 
    (Dollars in thousands)  

Commercial and industrial:

         

Interest rate reduction

    —        $ —        $ —        $ —        $ —     

Change in amortization period or maturity

    1        41       41        39       —     

Real estate:

         

Commercial real estate:

         

Owner occupied

         

Interest rate reduction

    —          —          —          —          —     

Change in amortization period or maturity

    —          —          —          —          —     

SFR mortgage:

         

Interest rate reduction

    —          —          —          —          —     

Change in amortization period or maturity

    —          —          —          —          —     

Other

    —          —          —          —          —     

Dairy & livestock and agribusiness:

         

Interest rate reduction

    —          —          —          —          —     

Change in amortization period or maturity

    —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-covered loans

    1        41       41        39       —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    For the Three Months Ended March 31, 2013  
    Number
of Loans
    Pre-Modification
Outstanding
Recorded
Investment
    Post-Modification
Outstanding
Recorded
Investment
    Outstanding
Recorded
Investment at
March 31, 2014
    Financial Effect
Resulting From
Modifications (2)
 
    (Dollars in thousands)  

Commercial and industrial:

         

Interest rate reduction

    —        $ —        $ —        $ —        $ —     

Change in amortization period or maturity

    2        204        204        193       95   

Real estate:

         

Commercial real estate:

         

Owner occupied

         

Interest rate reduction

    —          —          —          —          —     

Change in amortization period or maturity

    1        168        168        168       —     

SFR mortgage:

         

Interest rate reduction

    —          —          —          —          —     

Change in amortization period or maturity

    —          —          —          —          —     

Dairy & livestock and agribusiness:

         

Interest rate reduction

    —          —          —          —          —     

Change in amortization period or maturity

    8        9,973        9,973        9,855       —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-covered loans

    11      $ 10,345      $ 10,345      $ 10,216     $ 95   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The tables exclude modified loans that were paid off prior to the end of the period.
(2) Financial effects resulting from modifications represent charge-offs and specific allowance recorded at modification date.

As of March 31, 2014, there were no loans that were previously modified as a troubled debt restructuring within the previous 12 months that subsequently defaulted during the three months ended March 31, 2014.

 

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7. EARNINGS PER SHARE RECONCILIATION

Basic earnings per common share are computed by dividing income allocated to common stockholders by the weighted-average number of common shares outstanding during each period. The computation of diluted earnings per common share considers the number of tax-effected shares issuable upon the assumed exercise of outstanding common stock options. Potentially dilutive common shares are excluded from the computation of diluted earnings per share in periods in which the effect would be antidilutive. For the three months ended March 31, 2014 and 2013, shares deemed to be antidilutive, and thus excluded from the computation of earnings per common share were 130,000 and 1.0 million shares, respectively.

The table below summarizes earnings per common share and diluted earnings per common share, and reconciles the numerator and denominator of both earnings per common share calculations.

 

    For the Thee Months Ended March 31,  
    2014     2013  
    (In thousands, except per share amounts)  

Earnings per common share:

   

Net earnings

  $ 28,661      $ 21,615   

Less: Net earnings allocated to restricted stock

    127        69   
 

 

 

   

 

 

 

Net earnings allocated to common shareholders

  $ 28,534      $ 21,546   
 

 

 

   

 

 

 

Weighted average shares outstanding

    105,192        104,564   

Earnings per common share

  $ 0.27      $ 0.21   
 

 

 

   

 

 

 

Diluted earnings per common share:

   

Net income allocated to common shareholders

  $ 28,534      $ 21,546   
 

 

 

   

 

 

 

Weighted average shares outstanding

    105,192        104,564   

Incremental shares from assumed exercise of outstanding options

    599        246   
 

 

 

   

 

 

 

Diluted weighted average shares outstanding

    105,791        104,810   

Diluted earnings per common share

  $ 0.27      $ 0.21   
 

 

 

   

 

 

 

 

8. FAIR VALUE INFORMATION

Fair Value Hierarchy

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

The following disclosure provides the fair value information for financial assets and liabilities as of March 31, 2014. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels (Level 1, Level 2, and Level 3).

 

    Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.

 

    Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

    Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flows and similar techniques.

There were no transfers in and out of Level 1 and Level 2 measurement during the three months ended March 31, 2014 and 2013.

Determination of Fair Value

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for financial instruments not recorded at fair value.

 

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Cash and Cash Equivalents— The carrying amount of cash and cash equivalents is considered to approximate fair value due to the liquidity of these instruments.

Interest-Bearing Balances Due from Depository Institutions — The carrying value of due from depository institutions is considered to approximate fair value due to the short-term nature of these deposits.

FHLB Stock — The carrying amount of FHLB stock approximates fair value, as the stock may be sold back to the FHLB at carrying value.

Investment Securities Held–to- Maturity — Investment securities held-to-maturity are valued based upon quotes obtained from an independent third-party pricing service. The Company categorized its held-to-maturity investment as a level 3 valuation.

Investment Securities Available-for-Sale — Investment securities available-for-sale are generally valued based upon quotes obtained from an independent third-party pricing service. This service uses evaluated pricing applications and model processes. Observable market inputs, such as, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data are considered as part of the evaluation. The inputs are related directly to the security being evaluated, or indirectly to a similarly situated security. Market assumptions and market data are utilized in the valuation models. The Company reviews the market prices provided by the third-party pricing service for reasonableness based on the Company’s understanding of the market place and credit issues related to the securities. The Company has not made any adjustments to the market quotes provided by them and accordingly, the Company categorized its investment portfolio within Level 2 of the fair value hierarchy.

Loans Held-for-Sale — Loans held-for-sale are carried at the lower of cost or fair value. The fair value is derived from third party sale analysis, existing sale agreements, or appraisal reports on the loans’ underlying collateral.

Non-Covered Loans — The carrying amount of loans and lease finance receivables is their contractual amounts outstanding, reduced by deferred net loan origination fees and the allocable portion of the allowance for loan losses.

The fair value of loans, other than loans on nonaccrual status, was estimated by discounting the remaining contractual cash flows using the estimated current rate at which similar loans would be made to borrowers with similar credit risk characteristics and for the same remaining maturities, reduced by deferred net loan origination fees and the allocable portion of the allowance for loan losses. Accordingly, in determining the estimated current rate for discounting purposes, no adjustment has been made for any change in borrowers’ credit risks since the origination of such loans. Rather, the allocable portion of the allowance for loan losses is considered to provide for such changes in estimating fair value. As a result, this fair value is not necessarily the value which would be derived using an exit price. These loans are included within Level 3 of the fair value hierarchy.

Non-covered impaired loans and OREO are generally measured using the fair value of the underlying collateral, which is determined based on the most recent appraisal information received, less costs to sell (approximately 8%). Appraised values may be adjusted based on factors such as the changes in market conditions from the time of valuation or discounted cash flows of the property. As such, these loans and OREO fall within Level 3 of the fair value hierarchy.

The majority of our commitments to extend credit carry current market interest rates if converted to loans. Because these commitments are generally unassignable by either the borrower or us, they only have value to the borrower and us. The estimated fair value approximates the recorded deferred fee amounts and is excluded from the following table because it is not material.

Covered Loans — Covered loans were measured at fair value on the date of acquisition. Thereafter, covered loans are not measured at fair value on a recurring basis. The above valuation discussion for non-covered loans is applicable to covered loans following their acquisition date.

Swaps — The fair value of the interest rate swap contracts are provided by our counterparty using a system that constructs a yield curve based on cash LIBOR rates, Eurodollar futures contracts, and 3-year through 30-year swap rates. The yield curve determines the valuations of the interest rate swaps. Accordingly, the swap is categorized as a Level 2 valuation.

Deposits & Borrowings — The amounts payable to depositors for demand, savings, and money market accounts, and short-term borrowings are considered to approximate fair value. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value of long-term borrowings and junior subordinated debentures is estimated using the rates currently offered for borrowings of similar remaining maturities. Interest-bearing deposits and borrowings are included within Level 2 of the fair value hierarchy.

Accrued Interest Receivable/Payable — The amounts of accrued interest receivable on loans and lease finance receivables and investments and accrued interest payable on deposits and borrowings are considered to approximate fair value and are included within Level 2 of the fair value hierarchy.

 

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Assets and Liabilities Measured at Fair Value on a Recurring Basis

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013:

 

    Carrying Value at
March 31, 2014
    Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
 
    (Dollars in thousands)  

Description of assets

       

Investment securities - AFS:

       

Government agency

  $ 316,829      $ —        $ 316,829      $ —     

Residential mortgage-backed securities

    1,512,176        —          1,512,176        —     

CMO’s / REMIC’s - residential

    351,373        —          351,373        —     

Municipal bonds

    564,685        —          564,685        —     

Other securities

    5,000        —          5,000        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total investment
securities - AFS

    2,750,063        —          2,750,063        —     

Interest rate swaps

    10,674        —          10,674        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 2,760,737      $ —        $ 2,760,737      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Description of liability

       

Interest rate swaps

  $ 10,674      $ —        $ 10,674      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $ 10,674      $ —        $ 10,674      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

    Carrying Value at
December 31, 2013
    Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
 
    (Dollars in thousands)  

Description of assets

       

Investment securities - AFS:

       

Government agency

  $ 326,525      $ —        $ 326,525      $ —     

Residential mortgage-backed securities

    1,379,943        —          1,379,943        —     

CMO’s / REMIC’s - residential

    366,175        —          366,175        —     

Municipal bonds

    586,091        —          586,091        —     

Other securities

    4,908        —          4,908        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities - AFS

    2,663,642        —          2,663,642        —     

Interest rate swaps

    10,846        —          10,846        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 2,674,488      $ —        $ 2,674,488      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Description of liability

       

Interest rate swaps

  $ 10,846      $ —        $ 10,846      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $ 10,846      $ —        $ 10,846      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis

We may be required to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a non-recurring basis that were still held on the balance sheet at March 31, 2014 and December 31, 2013, respectively, the following tables provide the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets for investments that had losses during the period.

 

    Carrying Value at
March 31, 2014
    Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
    Total Losses
For the Three
Months Ended
March 31, 2014
 
    (Dollars in thousands)        

Description of assets

         

Impaired loans-non-covered:

         

Commercial and industrial

  $ 3,068      $ —        $ —        $ 3,068     $ 981   

Real estate:

         

Commercial real estate

    1,871        —          —          1,871       320   

Dairy & livestock and agribusiness

    2,100        —          —          2,100       420   

Consumer and other loans

    94        —          —          94       94   

Other real estate owned:

         

Covered

    —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 7,133      $ —        $ —        $ 7,133     $ 1,815   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Carrying Value at
December 31, 2013
    Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs

(Level 3)
    Total Losses
For the Year Ended
December 31, 2013
 
    (Dollars in thousands)  

Description of assets

         

Impaired loans-non-covered:

         

Commercial and industrial

  $ 529      $ —        $ —        $ 529     $ 627   

Real estate:

         

Commercial real estate

         

Dairy & livestock and agribusiness

    11,899        —          —          11,899       2,096   

Consumer and other loans

    2        —          —          2       2   

Other real estate owned:

         

Covered

    504        —          —          504       434   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 12,934      $ —        $ —        $ 12,934     $ 3,159   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Fair Value of Financial Instruments

The following disclosure presents estimated fair value of financial instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company may realize in a current market exchange as of March 31, 2014 and December 31, 2013, respectively. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

 

    March 31, 2014  
          Estimated Fair Value  
    Carrying
Amount
    Level 1     Level 2     Level 3     Total  
    (Dollars in thousands)  

Assets

         

Total cash and cash equivalents

  $ 421,386      $ 421,386      $ —        $ —        $ 421,386   

Interest-earning balances due from depository institutions

    70,000        —          70,000        —          70,000   

FHLB stock

    25,560        —          25,560        —          25,560   

Investment securities available-for-sale

    2,750,063        —          2,750,063        —          2,750,063   

Investment securities held-to-maturity

    1,730        —          —          2,291       2,291   

Non-covered loans held-for-sale

    —          —          —          —          —     

Total loans, net of allowance for loan losses

    3,334,147        —          —          3,387,259       3,387,259   

Accrued interest receivable

    21,775        —          21,775        —          21,775   

Swaps

    10,674        —          10,674        —          10,674   

Liabilities

         

Deposits:

         

Noninterest-bearing

  $ 2,688,585      $ 2,688,585      $ —        $ —        $ 2,688,585   

Interest-bearing

    2,422,201        —          2,423,139        —          2,423,139   

Borrowings

    826,076        —          844,486        —          844,486   

Junior subordinated debentures

    25,774        —          25,762        —          25,762   

Accrued interest payable

    1,083        —          1,083        —          1,083   

Swaps

    10,674        —          10,674        —          10,674   

 

    December 31, 2013  
          Estimated Fair Value  
    Carrying
Amount
    Level 1     Level 2     Level 3     Total  
    (Dollars in thousands)  

Assets

         

Total cash and cash equivalents

  $ 94,693      $ 94,693      $ —        $ —        $ 94,693   

Interest-earning balances due from depository institutions

    70,000        —          70,000        —          70,000   

FHLB stock

    32,331        —          32,331        —          32,331   

Investment securities available-for-sale

    2,663,642        —          2,663,642        —          2,663,642   

Investment securities held-to-maturity

    1,777        —          —          2,296       2,296   

Non-covered loans held-for-sale

    3,667        —          —          8,897        8,897   

Total loans, net of allowance for loan losses

    3,470,996        —          —          3,527,725       3,527,725   

Accrued interest receivable

    22,051        —          22,051        —          22,051   

Swaps

    10,846        —          10,846        —          10,846   

Liabilities

         

Deposits:

         

Noninterest-bearing

  $ 2,562,980      $ 2,562,980      $ —        $ —        $ 2,562,980   

Interest-bearing

    2,327,651        —          2,328,488        —          2,328,488   

Borrowings

    911,457        —          932,408        —          932,408   

Junior subordinated debentures

    25,774        —          25,819        —          25,819   

Accrued interest payable

    1,111        —          1,111        —          1,111   

Swaps

    10,846        —          10,846        —          10,846   

The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2014 and December 31, 2013. Although management is 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 above.

 

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Table of Contents
9. BUSINESS SEGMENTS

The Company has identified two principal reportable segments: Business Financial and Commercial Banking Centers (“Centers”) and the Treasury Department. The Company’s subsidiary bank has 37 Business Financial Centers and six Commercial Banking Centers organized in geographic regions, which are the focal points for customer sales and services. The Company utilizes an internal reporting system to measure the performance of various operating segments within the Bank which is the basis for determining the Bank’s reportable segments. The chief operating decision maker (currently our CEO) regularly reviews the financial information of these segments in deciding how to allocate resources and to assess performance. Business Financial and Commercial Banking Centers are considered one operating segment as their products and services are similar and are sold to similar types of customers, have similar production and distribution processes, have similar economic characteristics, and have similar reporting and organizational structures. The Treasury Department’s primary focus is managing the Bank’s investments, liquidity, and interest rate risk. Information related to the Company’s remaining operating segments, which include construction lending, dairy & livestock lending, leasing, CitizensTrust, and centralized functions have been aggregated and included in “Other.” In addition, the Company allocates internal funds transfer pricing to the segments using a methodology that charges users of funds interest expense and credits providers of funds interest income with the net effect of this allocation being recorded in administration.

The following table represents the selected financial information for these two business segments. GAAP does not have an authoritative body of knowledge regarding the management accounting used in presenting segment financial information. The accounting policies for each of the business units is the same as those policies identified for the consolidated Company and disclosed in Note 3 — Summary of Significant Accounting Policies. The income numbers represent the actual income and expenses of each business unit. In addition, each segment has allocated income and expenses based on management’s internal reporting system, which allows management to determine the performance of each of its business units. Loan fees included in the Centers category are the actual loan fees paid to the Company by its customers. These fees are eliminated and deferred in the “Other” category, resulting in deferred loan fees for the consolidated financial statements. All income and expense items not directly associated with the two business segments are grouped in the “Other” category. Future changes in the Company’s management structure or reporting methodologies may result in changes in the measurement of operating segment results.

The following tables present the operating results and other key financial measures for the individual operating segments for the periods indicated:

 

     For the Three Months Ended March 31, 2014  
     Centers      Treasury      Other     Eliminations     Total  
     (Dollars in thousands)  

Interest income, including loan fees

   $ 33,091       $ 16,432      $ 11,539      $ —        $ 61,062   

Credit for funds provided (1)

     7,074         —           11,463        (18,537 )     —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest income

     40,165         16,432        23,002        (18,537 )     61,062   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Interest expense

     1,637         2,373        110        —          4,120   

Charge for funds used (1)

     1,090         12,797        4,650        (18,537 )     —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest expense

     2,727         15,170        4,760        (18,537 )     4,120   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income

     37,438         1,262        18,242        —          56,942   

Provision for loan losses

     —           —           (7,500     —          (7,500
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     37,438         1,262        25,742        —          64,442   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Noninterest income

     4,782         —           6,716        —          11,498   

Noninterest expense

     11,828         196        19,133        —          31,157   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 30,392       $ 1,066      $ 13,325      $ —        $ 44,783   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Segment assets as of March 31, 2014

   $ 5,525,494       $ 3,264,736      $ 843,026      $ (2,730,738 )   $ 6,902,518   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

(1) Credit for funds provided and charges for funds used is eliminated in the consolidated presentation.

 

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Table of Contents
     For the Three Months Ended March 31, 2013  
     Centers      Treasury     Other     Eliminations     Total  
     (Dollars in thousands)  

Interest income, including loan fees

   $ 35,435       $ 12,788     $ 10,590      $ —        $ 58,813   

Credit for funds provided (1)

     6,312         —          2,559        (8,871 )     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     41,747         12,788       13,149        (8,871 )     58,813   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     1,499         2,417       308        —          4,224   

Charge for funds used (1)

     1,073         10,514       (2,716     (8,871 )     —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     2,572         12,931       (2,408     (8,871 )     4,224   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     39,175         (143 )     15,557        —          54,589   

Provision for loan losses

     —           —          —          —          —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     39,175         (143 )     15,557        —          54,589   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

     5,106         2,094       (455     —          6,745   

Noninterest expense

     11,577         184       19,037        —          30,798   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Segment pre-tax profit (loss)

   $ 32,704       $ 1,767     $ (3,935   $ —        $ 30,536   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Segment assets as of March 31, 2013

   $ 4,985,725       $ 2,622,402     $ 788,016      $ (2,130,376 )   $ 6,265,767   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Credit for funds provided and charges for funds used is eliminated in the consolidated presentation.

 

10. DERIVATIVE FINANCIAL INSTRUMENTS

The Bank is exposed to certain risks relating to its ongoing business operations and utilizes interest rate swap agreements (“swaps”) as part of its asset/liability management strategy to help manage its interest rate risk position. As of March 31, 2014, the Bank has entered into 82 interest-rate swap agreements with customers and 82 with a counterparty bank. The swap agreements are not designated as hedging instruments. The purpose of entering into offsetting derivatives not designated as a hedging instrument is to provide the Bank a variable-rate loan receivable and provide the customer the financial effects of a fixed-rate loan without creating significant volatility in the Bank’s earnings.

The structure of the swaps is as follows. The Bank enters into a swap with its customers to allow them to convert variable rate loans to fixed rate loans, and at the same time, the Bank enters into a swap with the counterparty bank to allow the Bank to pass on the interest-rate risk associated with fixed rate loans. The net effect of the transaction allows the Bank to receive interest on the loan from the customer at a variable rate based on LIBOR plus a spread. The changes in the fair value of the swaps primarily offset each other and therefore should not have a significant impact on the Company’s results of operations. Our interest rate swap derivatives are subject to a master netting arrangement with one counterparty bank. None of our derivative assets and liabilities are offset in the balance sheet.

We believe our risk of loss associated with our counterparty borrowers related to interest rate swaps is mitigated as the loans with swaps are underwritten to take into account potential additional exposure, although there can be no assurances in this regard since the performance of our swaps is subject to market and counterparty risk.

 

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Balance Sheet Classification of Derivative Financial Instruments

As of March 31, 2014 and December 31, 2013, the total notional amount of the Company’s swaps was $214.6 million, and $221.5 million, respectively. The location of the asset and liability, and their respective fair values are summarized in the table below:

 

    March 31, 2014  
    Asset Derivatives     Liability Derivatives  
    Balance Sheet
Location
    Fair
Value
    Balance Sheet
Location
  Fair
Value
 
    (Dollars in thousands)  

Derivatives not designated as hedging instruments:

       

Interest rate swaps

    Other assets      $ 10,674     Other liabilities   $  10,674   
   

 

 

     

 

 

 

Total derivatives

    $ 10,674        $  10,674   
   

 

 

     

 

 

 
    December 31, 2013  
    Asset Derivatives     Liability Derivatives  
    Balance Sheet
Location
    Fair
Value
    Balance Sheet
Location
  Fair
Value
 
    (Dollars in thousands)  

Derivatives not designated as hedging instruments:

       

Interest rate swaps

    Other assets      $ 10,846     Other liabilities   $ 10,846   
   

 

 

     

 

 

 

Total derivatives

    $ 10,846       $ 10,846   
   

 

 

     

 

 

 

The Effect of Derivative Financial Instruments on the Condensed Consolidated Statements of Earnings

There was no gain recognized in the condensed consolidated statements of earnings for the three months ended March 31, 2014 and 2013:

 

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11. OTHER COMPREHENSIVE INCOME (LOSS)

The tables below provide a summary of the components of other comprehensive income (“OCI”) for the three months ended March 31, 2014 and 2013:

 

     For the Three Months Ended March 31, 2014  
     Before-Tax      Tax Effect      After-Tax  
     (Dollars in thousands)  

Investment securities available-for-sale:

        

Net change in fair value recorded in accumulated OCI

   $ 24,781       $ 10,407      $ 14,374   
  

 

 

    

 

 

    

 

 

 

Net change

   $ 24,781       $ 10,407      $ 14,374   
  

 

 

    

 

 

    

 

 

 

 

     For the Three Months Ended March 31, 2013  
     Before-Tax     Tax Effect     After-Tax  
     (Dollars in thousands)  

Investment securities available-for-sale:

      

Net change in fair value recorded in accumulated OCI

   $ (11,696   $ (4,913 )   $ (6,783

Net realized gains reclassified into earnings (1)

     (2,094     (879 )     (1,215
  

 

 

   

 

 

   

 

 

 

Net change

   $ (13,790   $ (5,792 )   $ (7,998
  

 

 

   

 

 

   

 

 

 

 

(1) Net realized gains are included in noninterest income in the unaudited condensed consolidated statements of earnings and comprehensive income for the three months ended March 31, 2013.

The following table provides a summary of the change in accumulated other comprehensive income for the three months ended March 31, 2014 and 2013:

 

     Investment Securities
Available-for-Sale
 
     (Dollars in thousands)  

Balance, January 1, 2014

   $ (9,330

Net change in fair value recorded in accumulated OCI

     14,374   
  

 

 

 

Balance, March 31, 2014

   $ 5,044   
  

 

 

 
     Investment Securities
Available-for-Sale
 
     (Dollars in thousands)  

Balance, January 1, 2013

   $ 43,251   

Net change in fair value recorded in accumulated OCI

     (6,783

Net realized gains reclassified into earnings

     (1,215
  

 

 

 

Balance, March 31, 2013

   $ 35,253   
  

 

 

 

 

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12. BALANCE SHEET OFFSETTING

Assets and liabilities relating to certain financial instruments, including, derivatives and securities sold under repurchase agreements (“repurchase agreements”), may be eligible for offset in the condensed consolidated balance sheets as permitted under accounting guidance. Our interest rate swap derivatives are subject to a master netting arrangement with one counterparty bank. Our interest rate swap derivatives require the Company to pledge investment securities as collateral based on certain risk thresholds. Investment securities that have been pledged by the Company to the counterparty bank continue to be reported in the Company’s condensed consolidated balance sheets unless the Company defaults.

In November 2006, we began a repurchase agreement product with our customers, which includes master netting agreements that allow for the netting of collateral positions. This product, known as Citizens Sweep Manager, sells our securities overnight to our customers under an agreement to repurchase them the next day. The repurchase agreements are not offset in the condensed consolidated balances.

 

    Gross Amounts
Recognized in the
Condensed
Consolidated
Balance Sheets
    Gross Amounts
offset in the
Condensed
Consolidated
Balance Sheets
    Net Amounts of
Assets Presented in
the Condensed
Consolidated Balance
Sheets
    Gross Amounts Not Offset in the
Condensed Consolidated
Balance Sheets
    Net Amount  
          Financial
Instruments
    Collateral
Pledged
   
    (Dollars in thousands)  

March 31, 2014

           

Financial assets:

           

Derivatives not designated as hedging instruments

  $ 10,674     $ —        $ —        $ 10,674      $ —        $ 10,674   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 10,674     $ —        $ —        $ 10,674      $ —        $ 10,674   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial liabilities:

           

Derivatives not designated as hedging instruments

  $ 11,921     $ (1,247   $ 10,674     $ 1,247      $ (16,544 )   $ (4,623

Repurchase agreements

    626,802       —          626,802       —          (734,614 )     (107,812
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 638,723     $ (1,247   $ 637,476     $ 1,247      $ (751,158 )   $ (112,435
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2013

           

Financial assets:

           

Derivatives not designated as hedging instruments

  $ 10,846     $ —        $ —        $ 10,846      $ —        $ 10,846   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 10,846     $ —        $ —        $ 10,846      $ —        $ 10,846   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial liabilities:

           

Derivatives not designated as hedging instruments

  $ 12,908     $ (2,062   $ 10,846     $ 2,062      $ (16,179 )   $ (3,271

Repurchase agreements

    643,251       —          643,251       —          (649,385 )     (6,134
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 656,159     $ (2,062   $ 654,097     $ 2,062      $ (665,564 )   $ (9,405
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

13. SUBSEQUENT EVENTS

On February 18, 2014, CVB and America Bancshares, Inc. announced that they have entered into a definitive Stock Purchase Agreement, pursuant to which American Security Bank (“ASB”), the principal subsidiary of America Bancshares, Inc., will be sold to and merged with Citizens Business Bank, the principal subsidiary of CVB. The transaction is valued at $57.0 million, subject to certain potential adjustments, for all of the outstanding shares of common stock of ASB and will be paid for by CBB using 100% cash. ASB has total assets of approximately $412 million at December 31, 2013 and five branches located in Newport Beach, Laguna Niguel, Corona, Lancaster, and Apple Valley. ASB also has two electronic branch locations in the High Desert area and a loan production office in Ontario, California. ASB is a community/business bank with a primary focus on small to medium-sized businesses and their owners. The transaction received regulatory approvals and waivers in April 2014 and is currently scheduled to close on May 15, 2014.

 

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

The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of CVB Financial Corp. and its wholly owned subsidiaries. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of our operations. This discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013, and the unaudited condensed consolidated financial statements and accompanying notes presented elsewhere in this report.

CRITICAL ACCOUNTING POLICIES

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

The following is a summary of the more judgmental and complex accounting estimates and principles. In each area, we have identified the variables most important in the estimation process. We have used the best information available to make the necessary estimates to value the related assets and liabilities. Actual performance that differs from our estimates and future changes in the key variables could change future valuations and impact the results of operations.

 

    Allowance for Loan Losses (“ALLL”)

 

    Troubled Debt Restructurings

 

    Investment Securities

 

    Goodwill Impairment

 

    Acquired Loans

 

    Covered Loans

 

    Covered Other Real Estate Owned

 

    FDIC Loss Sharing Asset

 

    Non-Covered Other Real Estate Owned

 

    Fair Value of Financial Instruments

 

    Income Taxes

 

    Share-Based Compensation

Our significant accounting policies are described in greater detail in our 2013 Annual Report on Form 10-K in the “Critical Accounting Policies” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 3 to the Unaudited Condensed Consolidated Financial Statements, “Significant Accounting Policies,” contained herein, which are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

For the first quarter of 2014, we reported net income of $28.7 million, compared with $21.6 million for the first quarter of 2013. This represents a year-over-year increase of $7.0 million, or 32.60%. Diluted earnings per share were $0.27 per share for the first quarter of 2014, compared to $0.21 for the same period in 2013. Net income for the first quarter of 2014 included a $7.5 million loan loss provision recapture, a $5.3 million pre-tax gain on the sale of one loan held-for-sale at December 31, 2013, and a $2.3 million increase in interest income resulting from the full payoff of one non-performing commercial real estate loan. By comparison, the first quarter of 2013 included a net pre-tax gain of $2.1 million on the sale of investment securities.

At March 31, 2014, total assets of $6.90 billion increased $237.6 million, or 3.56%, from total assets of $6.66 billion at December 31, 2013. Earning assets totaled $6.55 billion at March 31, 2014, an increase of $223.9 million, or 3.54%, when compared

 

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with total earning assets of $6.32 billion at December 31, 2013. The increase in earning assets during the first three months of 2014 was primarily due to a $291.4 million increase in interest-earning deposits with other institutions and an $86.4 million increase in investment securities, partially offset by a $147.0 million decrease in total loans and a $6.8 million decrease in FHLB stock.

Investment securities totaled $2.75 billion at March 31, 2014, up from $2.67 billion at December 31, 2013. As of March 31, 2014, we had a pre-tax unrealized net gain of $8.7 million on our overall investment securities portfolio, compared to a pre-tax unrealized net loss of $16.1 million at December 31, 2013. During the first quarter of 2014, we purchased $168.4 million of MBS with an average yield of 2.18%. Our new purchases of MBS have an average duration of approximately four years. We also purchased $3.1 million in municipal securities with an average tax-equivalent yield of 3.65%.

Total loans and leases, net of deferred fees and discount, of $3.40 billion at March 31, 2014, decreased by $147.0 million, or 4.14%, from $3.55 billion at December 31, 2013. Quarter-over-quarter, total non-covered loans decreased by $132.0 million, and covered loans decreased by $15.0 million. The $132.0 million decrease in non-covered loans was principally due to decreases of $81.3 million in dairy & livestock and agribusiness loans, $22.1 million in commercial and industrial loans, $13.5 million in commercial real estate loans and $8.1 million in municipal lease finance receivables. The majority of the decline in dairy & livestock and agribusiness loans was primarily attributed to improved profitability due to higher milk prices and normal seasonal paydowns. This decrease in loans was partially offset by an increase of $6.1 million in our SFR mortgage-direct loans (excluding pools), for the first quarter of 2014. The market for new loans continued to remain very competitive. Our loan pipeline showed signs of improvements, but we remain cautious in terms of credit quality.

Noninterest-bearing deposits were $2.69 billion at March 31, 2014, an increase of $125.6 million, or 4.90%, compared to $2.56 billion at December 31, 2013. At March 31, 2014, noninterest-bearing deposits were 56.21% of total deposits, compared to 52.41% at December 31, 2013 and 50.50% at March 31, 2013. Our average cost of total deposits for the quarter ended March 31, 2014 was 10 basis points, compared to 11 basis points for the same period of 2013.

At March 31, 2014, we had $25.8 million of junior subordinated debentures, unchanged from December 31, 2013. At March 31, 2013, junior subordinated debentures totaled $46.4 million. On April 7, 2013, we redeemed the remaining outstanding capital and common securities issued by CVB Statutory Trust II, totaling $20.6 million. We took these actions to reduce our funding costs.

The $7.5 million recapture of loan loss provision during the first quarter of 2014 was primarily the result of a decrease in total loans and leases and improved credit quality. This compares with a $6.8 million recapture for the fourth quarter of 2013, $3.8 million for the third quarter of 2013, $6.2 million for the second quarter of 2013, and zero provision for loan losses for the previous eight consecutive quarters. The allowance for loan losses was $68.7 million, or 2.11% of total non-covered loans at March 31, 2014, compared to $75.2 million, or 2.22%, at December 31, 2013.

Our capital ratios remain well-above regulatory standards. As of March 31, 2014, our Tier 1 leverage capital ratio totaled 11.48%, our Tier 1 risk-based capital ratio totaled 18.98% and our total risk-based capital ratio totaled 20.24%.

 

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ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Performance

 

     For the Three Months Ended
March 31,
    Variance  
     2014     2013     $     %  
     (Dollars in thousands, except per share amounts)  

Net interest income

   $ 56,942      $ 54,589      $ 2,353        4.31

Recapture of (provision for) loan losses

     7,500        —          7,500        —     

Noninterest income

     11,498        6,745        4,753        70.47

Noninterest expense

     (31,157     (30,798     (359     -1.17

Income taxes

     (16,122     (8,921     (7,201     -80.72
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

   $ 28,661      $ 21,615      $ 7,046        32.60
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per common share:

        

Basic

   $ 0.27      $ 0.21      $ 0.06        28.57

Diluted

   $ 0.27      $ 0.21      $ 0.06        28.57

Return on average assets

     1.72     1.38     0.34  

Return on average shareholders’ equity

     14.74     11.32     3.42  

Efficiency ratio

     45.52     50.21     -4.69  

Income and Expense Related to Covered Assets

The following table summarizes the components of income and expense related to covered assets excluding normal accretion of interest income on covered loans for the periods indicated:

 

     For the Three Months Ended March 31,  
     2014     2013  
     (Dollars in thousands)  

Interest income

    

Interest income-accretion

   $ 1,707      $ 4,393   

Noninterest income

    

Decrease in FDIC loss share asset

     (1,707     (4,023

Net gain on sale of OREO

     —          376   

Noninterest expense

    

Legal and professional

     8        (131

OREO write-down

     —          —     

OREO expenses

     (5     (58

Other expenses (appraisals, and etc.)

     (43     (275
  

 

 

   

 

 

 

Net (loss) income before income tax benefit (expense) related to covered assets

   $ (40   $ 282   
  

 

 

   

 

 

 

Income and expense related to covered loans include accretion of the difference between the carrying amount of the covered loans and their expected cash flows, net decrease in the FDIC loss sharing asset as well as the other noninterest income and noninterest expenses related to covered loans.

The discount accretion of $1.7 million for the first quarter 2014, recognized as part of interest income from covered loans, decreased $2.7 million, compared to $4.4 million for the first quarter of 2013. This decrease was reduced by the changes in the FDIC loss sharing asset, a net decrease of $1.7 million for the first quarter of 2014, compared to a net decrease of $4.0 million for the first quarter of 2013.

At March 31, 2014, the remaining discount associated with the SJB loans approximated $11.2 million. Based on the current forecast of expected cash flows of these loans, approximately $7.9 million of the discount is expected to accrete into interest income over the remaining lives of the respective pools and individual loans, which approximates 4.3 years and 2.0 years, respectively. The FDIC loss sharing asset totaled $1.4 million at March 31, 2014. The loss sharing asset will continue to be reduced by loss claims submitted to the FDIC with the remaining balance amortized on the same basis as the discount on the related loans, not to exceed its remaining contract life, which expires in October 2014.

Net gain on sales of OREO was zero and $376,000 for the three months ended March 31, 2014 and 2013, respectively.

 

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Noninterest expense, including OREO expenses, legal and professional expenses and other covered asset related expenses, totaled $40,000 and $464,000 for the three months ended March 31, 2014 and 2013, respectively. Covered loans decreased $43.1 million to $156.5 million at March 31, 2014 from $199.6 million at March 31, 2013.

Net Interest Income

The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans and investments (earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is the taxable-equivalent of net interest income as a percentage of average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average earning assets minus the cost of average interest-bearing liabilities. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the international, national and state economies, in general, and more specifically the local economies in which we conduct business. Our ability to manage net interest income during changing interest rate environments will have a significant impact on our overall performance. As of March 31, 2014, our balance sheet is slightly liability-sensitive over a two year horizon assuming no balance sheet growth; this means interest-bearing liabilities will generally reprice faster than interest-earning assets. Therefore, our net interest margin is likely to modestly decrease in sustained periods of rising interest rates and modestly increase in sustained periods of declining interest rates. We manage net interest income through affecting changes in the mix of earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to earning assets, and in the growth of earning assets. See Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operation –Asset/Liability and Market Risk Management – Interest Rate Sensitivity Management included herein.

 

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The table below presents the interest rate spread, net interest margin and the composition of average interest-earning assets and average interest-bearing liabilities by category for the periods indicated, including the changes in average balance, composition, and average yield/rate between these respective periods:

 

     For the Three Months Ended March 31,  
     2014     2013  
     Average            Yield/     Average            Yield/  
     Balance     Interest      Rate     Balance     Interest      Rate  
     (Dollars in thousands)  

INTEREST-EARNING ASSETS

              

Investment securities (1)

              

Taxable

   $ 2,069,265      $ 10,279         2.01   $ 1,792,429      $ 6,747         1.52

Tax-advantaged

     571,207        5,278         5.05     625,850        5,541         4.85

Investment in FHLB stock

     31,729        604         7.72     56,336        343         2.47

Federal funds sold and interest-earning deposits with other institutions

     269,256        245         0.36     92,205        135         0.59

Loans held-for-sale

     367        —           0.00     75        1         5.41

Loans (2)

     3,483,408        42,949         5.00     3,401,825        41,653         4.97

Yield adjustment to interest income from discount accretion

     (12,698     1,707           (24,075     4,393      
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

     6,412,534        61,062         3.98     5,944,645        58,813         4.15

Total noninterest-earning assets

     360,116             391,964        
  

 

 

        

 

 

      

Total assets

   $ 6,772,650           $ 6,336,609        
  

 

 

        

 

 

      

INTEREST-BEARING LIABILITIES

              

Savings deposits (3)

   $ 1,720,715        879         0.21   $ 1,633,789        882         0.22

Time deposits

     671,775        307         0.19     711,942        359         0.20
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing deposits

     2,392,490        1,186         0.20     2,345,731        1,241         0.21

FHLB advances and other borrowings

     955,817        2,934         1.24     806,613        2,983         1.50
  

 

 

   

 

 

      

 

 

   

 

 

    

Interest-bearing liabilities

     3,348,307        4,120         0.50     3,152,344        4,224         0.54
  

 

 

   

 

 

      

 

 

   

 

 

    

Noninterest-bearing deposits

     2,562,549             2,322,640        

Other liabilities

     73,029             87,143        

Stockholders’ equity

     788,765             774,482        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 6,772,650           $ 6,336,609        
  

 

 

        

 

 

      

Net interest income

     $ 56,942           $ 54,589      
    

 

 

        

 

 

    

Net interest income excluding discount

     $ 55,235           $ 50,196      
    

 

 

        

 

 

    

Net interest spread - tax equivalent

          3.48          3.61

Net interest spread - tax equivalent excluding discount

          3.37          3.29

Net interest margin

          3.60          3.83

Net interest margin - tax equivalent

          3.72          3.86

Net interest margin - tax equivalent excluding discount

          3.60          3.54

Net interest margin excluding loan fees

          3.54          3.77

Net interest margin excluding loan fees - tax equivalent

          3.66          3.80

 

(1) Non tax-equivalent (TE) rate was 2.38%, and 2.30% for the three months ended March 31, 2014 and 2013, respectively.
(2) Includes loan fees of: $791, and $741 for the three months ended March 31, 2014, and 2013, respectively. Prepayment penalty fees of $585, and $954 are included in interest income for the three months ended March 31, 2014 and 2013, respectively.
(3) Includes interest-bearing demand and money market accounts.

 

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Table of Contents

Net Interest Income and Net Interest Margin Reconciliations (Non-GAAP)

We use certain non-GAAP financial measures to provide supplemental information regarding our performance. Net interest income for the three months ended March 31, 2014 and 2013 include a yield adjustment of $1.7 million, and $4.4 million, respectively. These yield adjustments relate to discount accretion on covered loans, and are reflected in the Company’s net interest margin. We believe that presenting net interest income and the net interest margin excluding these yield adjustments provides additional clarity to the users of financial statements regarding core net interest income and net interest margin.

 

     For the Three Months Ended March 31,  
     2014     2013  
     Average
Balance
     Interest     Yield     Average
Balance
     Interest     Yield  
     (Dollars in thousands)  

Total interest-earning assets (TE)

   $ 6,412,534       $ 62,992        3.98   $ 5,944,645       $ 60,845        4.15

Discount on acquired loans

     12,698         (1,707       24,075         (4,393  
  

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-earning assets, excluding SJB loan discount and yield

   $ 6,425,232       $ 61,285        3.87   $ 5,968,720       $ 56,452        3.83
  

 

 

    

 

 

     

 

 

    

 

 

   

Net interest income and net interest margin (TE)

      $ 58,872        3.72      $ 56,621        3.86

Yield adjustment to interest income from discount accretion

        (1,707          (4,393  
     

 

 

        

 

 

   

Net interest income and net interest margin (TE), excluding yield adjustment

      $ 57,165        3.60      $ 52,228        3.54
     

 

 

        

 

 

   

The following tables present a comparison of interest income and interest expense resulting from changes in the volumes and rates on average earning assets and average interest-bearing liabilities for the periods indicated. Changes in interest income or expense attributable to volume changes are calculated by multiplying the change in volume by the initial average interest rate. The change in interest income or expense attributable to changes in interest rates is calculated by multiplying the change in interest rate by the initial volume. The changes attributable to interest rate and volume changes are calculated by multiplying the change in rate times the change in volume.

 

     Comparision of Three Months Ended March 31,
2014 Compared to 2013
Increase (Decrease) Due to
 
     Volume     Rate     Rate/
Volume
    Total  
     (Dollars in thousands)  

Interest income:

        

Taxable investment securities

   $ 1,036      $ 2,162      $ 334      $ 3,532   

Tax-advantaged securities

     (460     216        (19     (263

Investment in FHLB stock

     (150     730        (319     261   

Fed funds sold & interest-earning deposits with other institutions

     263        (52     (101     110   

Loans HFS

     4        (1     (4     (1

Loans

     1,047        243        6        1,296   

Yield adjustment from discount accretion

     (2,076     (1,157     547        (2,686
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     (336     2,141        444        2,249